Activist investors are one of the biggest catalysts in reviving out-of-favor companies. But activist-led turnarounds are not one size fits all.
A great way to find turnaround candidates is to look for companies whose stocks have underperformed the broad market. These companies probably have something wrong with them, otherwise the market would be more supportive of their shares. Struggling companies can languish for years, and their shares should be avoided unless something changes. One effective change is the arrival of an activist investor.
As many investors know, activist investors target poorly-performing companies. Activists typically buy between 2% and 9% of a company’s shares, then propose significant changes that could boost the company’s value, benefitting all shareholders. For turnaround investors, these can be outstanding investment opportunities.
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Our approach at the Cabot Turnaround Letter includes activist-led turnarounds. We search for and evaluate the prospects of a vast majority of activist campaigns. Each campaign and target company is unique, so we concentrate only on the ones that most closely fit our criteria.
We look for credible plans, which usually include leadership changes and improvements in operating efficiency that can produce higher profit margins. We also want a stock with low expectations (a low valuation) to provide more upside potential along with better downside protection in case the turnaround doesn’t work. We emphasize companies whose products and services we understand.
A recently-completed turnaround investment* was Trinity Industries (TRN). At our Buy recommendation, the shares were washed out, yet activist Value Act Capital owned a sizeable stake and held at least one board seat. We could readily understand its business – manufacturing and leasing railroad cars. Improvements in Trinity’s strategy and operations, as well as its leadership, led to a 92% return during our holding period.
A Tale of Two Activist Investor Turnarounds
The following two current activist campaigns provide a good contrast:
New Relic (NEWR) – Software company New Relic grew rapidly from its 2007 launch. Following its initial public offering in 2014, the shares surged nearly 4x, to over $112 by mid-2018. However, mounting competition led to disappointing results, sending the shares plunging nearly 40%. New Relic’s products haven’t been able to regain their former market leadership position, and now change is arriving. Pressure from activist investors including HMI Capital, a major shareholder with an 8.1% position, and Engaged Capital, has led to favorable turnover at the board of directors and the appointment of a new and highly credible CEO.
We’re impressed with these changes. They will likely lead the company to overhaul its products and operations, perhaps restoring New Relic to its former glory days. However, this type of turnaround is at the edges of our focus. New Relic’s valuation isn’t low, at 6.3x revenues and 300x EBITDA. Nor are its shares meaningfully out of favor, as they have outperformed the surging S&P 500 over the past four years despite the recent struggles. And we are not technology experts, so we can’t fully assess the reasons behind New Relic’s lost product leadership nor its progress or odds of regaining that leadership. The upside to the prior peak price is only about 45% – not enough to compensate us for our lack of expertise. For investors who understand New Relic’s products and markets, there could be upside sharply higher than 112. But, for us, the story exemplifies why “software turnaround” is an oxymoron.
Huntsman Corporation (HUN) – Until Starboard Value highlighted the stock, shares of this mid-cap specialty chemicals company had gone nowhere since their 2005 initial public offering at 23/share. While the cumulative dividends helped lift the total return to +80%, the gain paled in comparison to the S&P Chemicals industry (+411%) and the broad market (+417%). The major problem: Huntsman’s disappointing revenue growth and profit margins. Investors wonder if the company’s acquisitions and divestitures in recent years have been a value-destructive distraction. HUN’s weak shares and low 5.9x EBITDA multiple clearly fit our criteria. We see Starboard potentially pressing for new leadership, as the company’s chairman, president and CEO has been an employee for decades, with too much power consolidated in a single person who also happens to be the son of the legendary and highly successful founder. Starboard may seek the divestiture of several low-margin operations and a return of capital to shareholders from the under-leveraged balance sheet. Starboard holds a 5.6% stake, larger than the Huntsman Family’s 4.5% stake. This turnaround has many of the traits we look for.
* Initially recommended by the Cabot Turnaround Letter as a Buy in September 2019, then moved to a Sell in February 2021.
As specialists in turnaround investing, we focus on companies that have “the right stuff,” but whose shares are currently out of favor for what we believe are temporary or fixable reasons. We often look for a catalyst that will reverse the company’s direction back toward prosperity.
Our track record, independently compiled and reported by Mark Hulbert and Hulbert Ratings, has provided our subscribers with returns that are among the best in the industry: +110% return over the past 12 months, and +12.8% annualized returns over the past 20 years (compared to the 9.5% annualized 20-year total return for the S&P 500).
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Bruce has more than 25 years of value investing experience, managing institutional portfolios, mutual funds, and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company. Now he is helping his Cabot Undervalued Stocks Advisor readers find those undervalued stocks that let you buy low and sell high!Learn More >>