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INVESTING: The best investor activism focuses on the long term

October 8, 2007

It is certainly not welcome news for corporate executives to be informed that an "activist investor" has established a position in their company's stock.

Activist investors practice a confrontational style of investing, and the target of their criticism is usually the operational performance of the company's management. An activist's agenda usually is detailed in a list of brash demands communicated via press releases, Securities and Exchange Commission filings and on public conference calls, often sprinkled with colorful language to express their displeasure.

Shareholder activism can be beneficial to a company and its stakeholders. When a significant shareholder rattles the cage, it may prod a complacent management to consider various ways to improve returns. Common changes activists push for include stock repurchases, increased dividends, spinning off non-strategic subsidiaries, closing money-losing divisions and the outright sale of the company. In addition to pushing changes in business strategy, activists may wage a proxy contest for board seats and even attempt to force out bad management.

In the end, the bottom line as to whether the activism is successful is if it leads to long-term operational improvement in the business. This is probably best achieved with ongoing dialogue between significant long-term shareholders and management that confront their differences, while maintaining respect for each other.

Unfortunately, some hedge funds today practice a type of activism that may in fact be disruptive to the long-term operations of a business. Activism fails when the objective is to extract a quick return on investment. Some of the current "activists" are the same investors who were branded as corporate raiders in the 1980s. Hedge funds run by Carl Icahn and Nelson Pelz are back, along with some new faces, such as the aptly named Pirate Capital.

Back in the day, Icahn was accomplished in the art of "greenmail", a term given to the process by which an investor (corporate raider) would take a stake in a company, then threaten to acquire it and break it up into pieces. The raider would gladly "go away" if management bought out his stake at a higher price, earning him a profit.

Pirate Capital, formed in 2002, came out with guns blazing and attracted an industry following for a few years with decent performance results. Alas, Pirate has fallen on hard times over the past year, losing more than $1 billion in assets to poor investments and investor withdrawals.

Yet it is interesting to note that former SEC Chairman Richard Breeden, whose job once was to protect investors, now runs an activism hedge fund and is currently pushing for change at H&R Block. And locally, investors are stirring the pot at Steak n Shake and Emmis Communications Corp.

Shareholder activism comes in many forms, and for investors who want to invest alongside an activist investor, it is imperative to understand their motives.

Activism is a legitimate investment strategy if the changes serve to unlock long-term shareholder value. To be sure, activists often show up after a company has suffered a downturn in its business. It is then up to the shareholders at these companies to decide whether the activists' proposals offer better long-term solutions for the business, or whether management is steering the firm on the best course.



Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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