Thursday, November 12th, 2009
How to Find Hot Stocks Via Activist Investors
Activist hedge funds and investors aim to unlock value in their investments by petitioning the board and management to make changes to the company. Often times, these changes include implementing more efficient capital structures, initiating share buybacks, participating in mergers/acquisitions, and issuing special dividends among other things.
Do Activists Really Unlock Value?
Whether or not these strategies actually unlock value is a matter of much debate, especially considering the wide range of strategies employed and unscrupulous tactics used by a minority of activists, but Ramius Capital set out to dispel these myths and demonstrate value in its “Case for Shareholder Activism” research report that it issued in December of 2008.
The research report cites a number of studies that confirm the effectiveness of shareholder activism, including one conducted by four university professors analyzing nearly 800 activist events from 2001 to 2006. The authors found that some success was obtained in nearly two-thirds of the cases, with the target firm outperforming by 7-8% over a four-week period before and after the activist announcement was made by the hedge fund or investor.
Types of Shareholder Activism
Shareholder activism can be divided into four categories, including operational, corporate governance, financial and strategic. Understanding these categorizations is important in order to understand how quickly you can expect to see returns from the actions.
Operational Activism includes operational restructuring, productivity improvements, and cost reductions that can be made to enhance margins and improve the bottom-line. Typically, these changes can improve results over subsequent quarters.
Corporate Governance Activism includes improvements in the quality and effectiveness of the board and management team, while also re-evaluating incentives offered to both. Typically, these changes can result in multiple expansion over the long-term.
Financial Activism includes optimizing balance sheets, recapitalizing, buying back shares, and offering special dividends. Typically, these changes can result in value being unlocked in the near-term, if successful.
Strategic Activism includes refocusing corporate strategy, pursuing mergers and acquisitions, or divesting underperforming or unrelated businesses. Typically, these changes can result in value being unlocked in the near-term, if successful.
How to Find Activist Opportunities
High-profile activism is often spread across the financial newspapers, but finding niche opportunities can require a bit of digging. The first step is visiting the source of all information – the SEC’s EDGAR system at http://edgar.sec.gov.
However, we will go one step further and utilize their real-time filing search for our purposes at: http://searchwww.sec.gov/EDGARFSClient/jsp/EDGAR_MainAccess.jsp.
From this screen, we will search for two types of filings that are indicative of activism – the SC 13D and SC 13D/A filings. These can be selected by clicking on the “Advanced Search Page” link to the right, and then selecting the respective filings from the “In Form Type” dropdown menu. Clicking on the “Search” button will then produce all of the most recent filings.
To narrow this down to promising candidates, we will further narrow the search by typing “letter” into the search box. This will show us activist filings that include letters sent to the board of directors demanding changes. As a result, we can get a more complete picture of the story and understand exactly what is being done to unlock value.
Analyzing Activist Opportunities
Understanding the objectives of activists is paramount to profiting from their actions. Some activists may be looking for a quick buck by pushing a company to sell itself, while others may be looking to make long-term changes that won’t be seen for years. It is important to understand their timeframes and compare that to your objectives.
Finally, it is important to consider the activists “skin in the game” to determine how serious they are about the changes they are recommending. A hedge fund with a 5% stake in a micro-cap company may trying to hit a homerun, while one with a 50% stake may have a lot more luck in convincing the company to implement changes.
In the end, investing alongside activists can be profitable if done correctly. The key is taking the time to learn their objectives, look at their timeframe, and determine how well positioned they are to be demanding changes.
Written by Simon Monger
