Struggling companies sometimes need a push in the right direction, these two value-priced companies could use a push from activist investors.
Activist investors buy stocks of undervalued companies that need outside pressure to help turn them around. The most successful activists emphasize changes in company leadership, as that is the most effective route for making improvements. The CEO, overseen by the board of directors, determines how the company uses its resources, including its people, factories, intangible assets like technology and brands, and other assets. If the strategic and tactical application of these resources is headed in the wrong direction, the company will struggle. Once resource usage becomes more productive, corporate prosperity usually returns.
Sometimes activists describe their push for leadership change politely as a “governance” issue, or in blunt terms, like activist Kimmeridge Energy Management recently wrote, “Ovintiv is one of the more egregious examples of misalignment in the sector, whether it’s the excessive compensation relative to performance, the low insider ownership, or the lack of any meaningful board refreshment.”
The other component of a successful campaign is starting with an undervalued stock. Low investor expectations provide a margin of safety, as the shares already likely discount a dour future. And, any improvements will likely restore at least some faith in the company’s prospects, helping drive the stock higher.
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Two well-known companies fit the activist investor target checklist but have yet to see any meaningful activist involvement: IBM (IBM) and Walgreens Boots Alliance (WBA).
IBM (IBM) – IBM was once the dominant technology company, providing the critical hardware as the world shifted from manual calculating to computers. In the early 1990s, after losing much of its relevance, new outsider CEO Lou Gerstner engineered a major turnaround by shifting IBM’s focus to the software and services that surrounded its hardware. This turnaround was legendary: Gerstner had little technology experience, yet under his guidance IBM restored its prominence, leading to a 6x gain in its share price over the next decade.
Today, IBM again struggles with relevance. Its revenues have continued to fall for the better part of a decade despite numerous acquisitions, including last year’s $34 billion acquisition of RedHat. While divestitures played a role in earlier revenue declines, these deals represented failures rather than successes. The 2014 divestiture of its PC business to Lenovo at least generated cash proceeds (IBM had to pay Global Foundries $1.5 billion to take its chip-making operations). Lenovo went on to successfully rejuvenate this once-struggling business.
IBM’s new CEO, Arvind Krishna, is aggressively working to turn around IBM’s fortunes. His focus on the cloud, partly by removing via spin-off IBM’s Managed Infrastructure Services segment, may lead to new growth. But IBM clearly has major challenges, as competitors Amazon (AMZN), Microsoft (MSFT), and others have huge advantages. The stock is a chronic laggard. It is cheap, trading at 8.9x this year’s estimated earnings. The high 5.2% dividend yield appears durable. No activists currently have a meaningful stake in IBM, but given its strategic crossroads, the opportunity seems ripe for a major activist investor stake.
Walgreens Boots Alliance (WBA) – Trading at 10.9x earnings, Walgreens is clearly a cheap stock. It is also among the worst-performing large cap stocks over the past decade, offering some contrarian appeal. Its 4.9% dividend yield appears sustainable, paying investors to wait. However, the company is strategically adrift, and earnings estimates continue to slip. Amazon’s recent announcement that it will be entering the mail-order pharmacy business adds a new and potentially debilitating competitor to the industry.
In an encouraging sign, Walgreens’ CEO recently announced his retirement, providing an opening for activist investors. The company clearly needs the fresh perspective that an outside CEO can provide, and an activist investor (perhaps Trian Partners, a consumer-oriented activist whose pressure led to a turnaround at Proctor & Gamble. See their presentation here ) could be instrumental in guiding the board of directors in their selection process.
Walgreens’ yet-to-be-named CEO must produce a clear and sound plan that is crisply executed at both the strategic and store levels. The new leadership will need to determine the fate of its nearly 19,000 retail stores, the ongoing merits of its 27% stake in pharmacy wholesaler Amerisource Bergen, the plan for its mail order joint venture, and whether to pursue a health care insurance strategy like competitor CVS or some other approach.
Turnaround investors should put both of these companies on their watch list.
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