Tuesday, June 18, 2013
|| Starboard Value founder Jeffrey Smith|
You could argue that Jeffrey Smith, the founder, chief executive officer and chief investment officer of New York–based activist hedge fund firm Starboard Value, is the Carl Icahn of small-cap shareholder activist campaigns. But unlike Icahn, who has experienced a few high-profile failures in recent years, Smith is on a hot streak.
Smith — who created Starboard in March 2011 through a spin-off from Ramius, the investment management subsidiary of the Cowen Group — has scored big successes in his activist campaigns, adding or replacing some 100 corporate directors at 35 companies since 2004. Lately, Smith has notched victories against three targets: DSP Group, a maker of wireless chipsets; Quantum Corp., a small data management company; and Tessera Technologies, which makes imaging systems for smartphones. But Smith faces an even bigger battle with Office Depot, the struggling office products retailer that has agreed to merge with rival OfficeMax.
A look at Starboard’s recent wins shows how effective Smith can be at agitating for change. At the June 10 annual meeting of DSP, shareholders elected four new board members, and two of those directors were nominated by Starboard. The hedge fund is DSP’s second-largest shareholder. In May, Tessera agreed to appoint six of Starboard’s nominees to its board of directors and expanded its board from eight to 12 members.
Also in May, Starboard settled with Quantum, which named Smith to its board of directors and expanded the size of its board from eight to nine members. Quantum also agreed to nominate two additional Starboard-recommended directors for election at the 2013 annual meeting in place of two incumbent directors.
But when it comes to Office Depot, Smith will have his work cut out for him. The struggling retailer’s revenues are falling; its 2012 revenues of $10.7 billion are down 26 percent from 2008. It also posted a loss of $0.39 per share for all of 2012.
And things are not improving. In the first quarter, Office Depot’s sales dropped 5.4 percent from the same period a year earlier, while ongoing earnings came in flat, below consensus forecasts of $0.05 per share.
That’s in large part because North American same-store sales dropped by 5 percent. S&P Capital IQ forecasts a further 5 percent decline in sales for this year, while Barclays recently lowered its 2013 earnings forecast from a $0.07 per share profit to a $0.03 per share loss based on a 3.4 percent sales decline estimate. Starboard owns 14.8 percent of the stock.
Analysts argue that Office Depot will be better off if the merger with OfficeMax goes through, because the two struggling companies will be stronger combined. (The deal is being reviewed by antitrust experts at the Justice Department, and Office Depot said it expects the deal to be completed by the end of the year.)
But Smith likes the stock regardless of whether the merger happens. “We believe Office Depot is cheap, whether it is as a stand-alone company or combined,” Smith said at the April 22 Active-Passive Investor Summit in New York, in a rare on-the-record comment.
Smith thinks the company needs a new chief executive officer and new board members. He is also trying to unseat three directors at Office Depot and nominate four of his own directors. Starboard called on the company to hold an annual meeting to discuss these proposals prior to the closing of the merger; Smith accused the company of delaying the meeting and urged the Delaware court to force Office Depot’s hand. The company finally announced on Monday that it will hold the meeting on August 21.
Office Depot and OfficeMax each announced they will hold special shareholder meetings on July 10 to vote on their proposed merger. And last week Office Depot said it agreed to sell its half of its Latin American joint venture with Mexican retailer Grupo Gigante back to that company for about $690 million in cash. This transaction was a big priority for Starboard.
Shortly before that deal was announced, Starboard told shareholders in a letter that it is important to get its nominees on the board before the merger is completed. “There is always a chance that the OfficeMax merger may not be consummated, and Office Depot should not wait to plan and build a strategy for a far improved company,” it stated. “Despite the Board’s continued indications that it wishes to work with us to address our concerns, there has been little to no progress in our discussions to date.”
Sell-side analysts who are eager to see the deal completed as soon as possible do not seem happy with Smith’s intrusion. Bradley Thomas, who follows Office Depot for KeyBanc Capital Markets and has a buy recommendation on the stock, declines to comment on Smith or discuss his strategy. However, he makes it clear that uncertainty surrounding the fate of the merger deal and the potential for a change in the directors has caused the stock to trade at a lower price than he thinks it should. “There is a lot of confusion and uncertainty for investors,” he says. “They are not sure what they are getting from an event standpoint. The stocks will be higher when the deal goes through.”
Ian Gordon, an analyst with S&P Capital IQ, is more directly critical of Smith. “He is probably causing more of a distraction than the management team needs at this time,” Gordon says. “The distraction outweighs other things the activist may bring to the company.”
For his part, Smith says Office Depot must address secular changes — such as that people are printing less, resulting in lower consumption of paper and ink — and boost its online business, regardless of what happens with the merger.
“We want to strengthen the board now,” Smith told the audience at the investment conference in April. “If it remains a stand-alone company, we don’t want to find a problem later.”
Monday, February 25, 2013
As any China watcher knows by now, China's global energy acquisition forays have tended to be big, hairy deals that capture the merger arbitrageurs' imagination. A few hedge fund firms led by Paulson & Co. played the uncertainties over the $15.1 billion acquisition of Canadian oil company Nexen by the China National Offshore Oil Corp., better known as CNOOC, and came out winners.
Nexen, which owns oil sands and shale gas assets in Canada's Alberta province, the North Sea and the Gulf of Mexico, was in the merger arbs' crosshairs for months, as regulatory approvals, particularly from the U.S. Treasury Department's Committee on Foreign Investment in the United States, an interagency body that reviews key foreign investment, hung in the balance. CFIUS finally gave the deal its stamp of approval on February 12, and it is expected to close on Monday, February 25. CFIUS' approval paves the way for China's biggest offshore drilling company to gain access to Nexen oil and gas platforms and for the first time engage in deepwater drilling within the U.S.'s littoral waters in the Gulf.
The acquisition calls for CNOOC to acquire shares of Calgary, Alberta–based Nexen, traded on both the New York Stock Exchange and Toronto Stock Exchange, for $27.50 a share in cash, a 61 percent premium over the July 20 closing price, according to the terms of the deal announced July 24. Canadian regulators agreed to the acquisition in December, but there were enough uncertainties over the course of the approvals period for arbs to trade on.
North of the border, the Nexen takeover bid by CNOOC raised a bevy of concerns, primarily relating to Canadian jobs and broader environmental concerns. In the U.S., among the ostensible worries was that the proposed takeover would allow the state-run Chinese company to drill near U.S. military assets.
From a macroeconomic perspective, the Nexen acquisition — which ranks sixth of the 18 largest global mergers and acquisitions tracked by Bloomberg — validates hefty bets placed by U.S. hedge fund managers anticipating that Canada's energy sector will remain a lucrative investment arena, particularly from China. China's demand for oil is expected to grow by 5 percent or nearly 500,000 million barrels a day in 2013, according to a February 6 report by Barclays Capital in Singapore.
Enter Paulson & Co. John Paulson's firm and other hedge funds came in as the stock slipped in the fourth quarter of 2012. It dipped to $23.51 on November 8, the lowest price during the period, when shares topped $26.
Among U.S. hedge fund investors, Paulson & Co. took the largest bet on Nexen, filings with the Securities and Exchange Commission show. Paulson's firm purchased 6 million shares in Nexen in the third quarter of 2012, the period prior to Canadian regulators' approval of the merger. At that point, certain provincial lawmakers in Calgary had opposed the measure, citing concerns that jobs would be lost, and it looked to be a big gamble. Indeed Cnooc's acquisition bid would later prove a central campaign issue in Canadian by-elections held on November 26.
Another buying opportunity came in early December, when the stock hit $23.52 on December 7, before rising back to $25.90 on December 10, the day Ottawa approved the merger. Paulson & Co. scooped up a big chunk amounting to 19.5 million shares in the fourth quarter, regulatory filings show.
Paulson & Co.'s total holding had grown to 25.5 million shares, representing roughly 4.8 percent of Nexen outstanding shares. As merger arb investments go, this was a relatively significant portfolio interest, valued at roughly $699.5 million at the February 12 close price of $27.43.
Based on the $23.51 per share low in November, the increase in value of Paulson & Co.'s total stake was roughly $100 million, or about 14 percent, over the November 8 period, when the stock was trading at lower $23.51.
It's also worth noting that gains in Nexen, as a merger arbitrage play, might have been magnified with the use of options positions. Kenneth Griffin's Citadel took a smaller bet but the firm used a combination of stocks, puts and calls. Citadel owned 100,000 in Nexen common stock at the start of 2013 but also held 188,000 shares in additional options, according to filings.
Other hedge funds with stakes in Nexen include Moore Capital Management and fixed-income player Halcyon Asset Management.
Thomas Steyer's Farallon Capital Management was also a sizable investor. San Francisco–based Farallon owns 7.8 million shares in Nexen, a stake worth roughly $214 million at the February 22 closing price.
Like Paulson & Co., Farallon invested in the stock after the deal announcement but before regulatory approvals from Ottawa and Washington. Its initial holding, 8.7 million shares in Nexen, was purchased in the third quarter.
However, perhaps the Farallon arb team may have been less optimistic about the deal getting final approval. Farallon sold about 900,000 shares in the fourth quarter, prior to U.S. regulators' green-lighting. Steyer, a clean energy advocate who retired at the end of 2012, may have sensed that the U.S. would veto the buyout, given the political climate and furor over another energy project, the TransCanada Keystone XL pipeline. Keystone by then had become a flashpoint that spurred protest actions on the eve of the U.S. presidential elections, and thereafter.
Even if Farallon blinked, Nexen's stock price changed little. The stock was trading in a tight range at the close of 2012 anyway. Its biggest daily price move was on December 10, when it rose by 14.3 percent to $26.89, approaching the $27.50 per share acquisition price.
Although there were regulatory uncertainties, the risks of the deal collapsing were debatable. Nexen's financials were solid, although it has underperformed the broader sector. In fiscal year 2011, Nexen revenue rose 5 percent to $2.4 billion. Net income was a healthy $697 million, and the company had paid off $800 million in long-term debt.
For Nexen, CNOOC's acquisition bid was timely. A 25-year drilling contract in Yemen had expired, and the business needed capital to expand operations. North Sea drilling accounted for the biggest oil production, but the Gulf offered tremendous growth potential. in 2011, it booiked an additional "probable reserve" of 65 billion barrels of oil per day near and around its Appomattox deepwater site in the region, according to filings. The company described it as one of its "most exciting prospects."
Even though Nexen executives appeared to downplay its importance in the face of U.S. regulatory hurdles, Nexen was banking on the proximity of U.S. ports infrastructure in the Gulf to help cut the prohibitive costs of deepwater drilling operations. In 2011, Nexen resumed drilling in the Gulf of Mexico, following an expiration of a U.S.-imposed moratorium on drilling. And in 2012, Nexen was able to secure additional permits from the U.S. government in the Angel Fire basin, due south of New Orleans.
Paulson and other hedge fund investors rightly saw Nexen as a macro bet on Canadian natural resources and China's seemingly insatiable hunger for energy sources, even in the face of an overall slowdown in global growth. Paulson just happens to have reaped the biggest windfall by following the mantra, whatever you do, do it big.
Wednesday, February 20, 2013
The best distressed investors are not merely opportunists, they also know how to engineer their own luck, often years in advance. Consider David Tepper’s Appaloosa Management. His Short Hills, New Jersey–based firm is poised for a lofty profit from a dual-airline bet that took flight when US Airways and the bankrupt American Airlines announced an $11 billion merger on February 14.
The all-stock deal, expected to close in the third quarter, will create the U.S.’s largest air carrier with 6,700 daily flights to 56 countries. That’s the big M&A headline. Behind the scenes, Tepper’s investment team had long been weighing the likelihood of further consolidation in the airline industry and managed to correctly time its investments in both US Airways’ stock and American Airlines’ debt.
Regulatory filings show that at the time the merger was announced, Appaloosa was among the largest stakeholders in US Airways, the smaller of the two companies. US Airways shares had been on the ascent since last summer amid improved financial results and widespread speculation that the nation’s fifth-largest carrier was a prime acquisition target. The stock began 2012 trading at $5.60, but ended the year at $13.50 per share.
The merger announcement itself had little immediate impact on US Airways’ stock, but between the start of the second quarter of 2012, when the company hired an M&A adviser, and February 15, the stock gained 46.3 percent.
Tepper’s hedge fund firm began buying a small position in US Airways in the first quarter of 2010, when shares were trading at about $7.20 apiece. By then the stock had recovered from a low of about $2.00 in 2009. Appaloosa held 2.6 million shares as its initial investment, based on filings. Since early 2012, it has owned in excess of 7 percent of US Airways stock, or about 12 million shares, worth roughly $174 million, based on the February 15 closing price of $14.50. Other large investors in the New York Stock Exchange–listed stock include Soros Fund Management and funds managed by Stanley Drukenmiller’s family office, according to regulatory filings.
A big portion of the 12 million shares that Appaloosa owns — about 7.4 million — was added to the portfolio during the first quarter of 2012, when the stock was trading at about $7.50. The value of Appaloosa’s 12 million share stake weighed in at $174 million at the February 15 closing price of $14.50. This represents a nearly 50 percent gain on the shares, from the start of the second quarter in 2012, when the stock was trading at $7.47.
US Airways was only one part of Appaloosa’s focus on the airline industry at the time when the portfolio looked a bit like a crowded airport terminal. It had holdings in both United Air Lines and Continental Airlines, which later merged to form United Continental Holdings in October 2010. It also owned a piece of both Delta Air Lines and American Airlines.
But it was American Airlines’s filing for Chapter 11 bankruptcy protection in November 2011 that provided the impetus for Appaloosa and other creditors to champion a merger. With that in mind, it’s easy to understand the subsequent amassing of US Airways stock in 2012.
Although American Airlines' reported an annual loss of $471 million in 2010, it had cash aplenty, enough to keep running comfortably until the middle of 2012. Still, creditors such as Appaloosa were eager for AMR, American Airlines's parent, to strike a buyout deal rather than undergo a protracted solo recovery. Likely suitors, according to Wall Street analysts, included Delta and US Airways.
For American Airlines, US Airways turned out to be the only viable merger partner. The combined carrier, which will keep the “American Airlines” name, is expected to boast annual revenues of $38.7 billion.
Under the terms, the merger calls for a 72 percent ownership by AMR stakeholders and 28 percent from US Airways shareholders.
Appaloosa shrewdly sat on both sides of the M&A table, with its equity and debt holdings.
According to an October filing with the U.S. Bankruptcy Court Southern District of New York, Appaloosa, as a creditor, had at least $27.2 million in claims against AMR. Of this, less than $7 million had been allocated for recovery. At that time Appaloosa joined New York–based Marathon Asset Management in writing a letter to AMR, claiming that the company was not providing enough transparency about bankruptcy proceedings to unsecured creditors like hedge funds, according to a Bloomberg report on October 20. Marathon was part of a wider group that included York Capital Management, King Street Capital Management and other firms that held up to $1 billion of AMR’s unsecured debt load of $2.4 billion. Some of the debt held by Appaloosa is tied to equipment and aircraft assets and leases.
Court documents also indicate debt holdings were acquired by Appaloosa from Citigroup in August 2012. Why buy it in the first place? The dollar amount represented by the debt may be less significant than the fact that it ensured Appaloosa a voice in the reorganization plan, which seemed predestined to include a coveted merger deal at some point. The move was in line with the underlying strategy of unsecured debt holders such as Marathon to get their own ad hoc subcommittee with the ability to offer input on any AMR reorganization plan directly, rather than indirectly through banks acting as trustees on their behalf.
Perhaps more importantly, it opened the door for unsecured hedge fund creditors to see otherwise confidential AMR data and financial information and contractual materials (such as labor negotiations) that would be relevant to any M&A negotiation.
AMR’s court-imposed deadline to file its own reorganization plan lapsed in September at about the time US Airways made its initial pitch, which required negotiations with its own labor force.
For all intents and purposes, the debt holders are the big winners in the merger, which allows all unsecured and corporate bondholders, such as Appaloosa, to be “made whole” and receive interest on credit facilities extended from the start of Chapter 11 filing. Though specific numbers have yet to be disclosed on the debt side, filings indicate the convertible debt might be turned into preferred shares of the newly formed carrier, with a minimum value set at the floor of $10.87. Creditors have pledged to support the merger plan, pending regulatory approval, filings say.
Even if its debt holdings yield a modest return to Appaloosa, there is no doubt Tepper is making a providential landing on his firm’s two-sided bets. The only problem for the rest of Tepper’s portfolio now is that the U.S. is simply running out of large and midsize carriers available to merge. The hedge fund firm still holds 10.4 million shares in Delta and 9.1 million shares in United Continental Holdings, based on recent regulatory filings.
Time to look overseas?
Wednesday, February 06, 2013
By Pete Gallo
Leave it to a Tiger Cub to know when to pounce on a growth stock that Wall Street left undervalued and unloved. John Griffin’s Blue Ridge Capital is showing handsome gains from a rebound in the shares of Sirius XM Radio, the largest satellite radio company in the U.S.
The New York–based hedge fund firm owns 78.8 million shares of Nasdaq-traded Sirius XM, making it one of the company’s biggest shareholders, regulatory filings show. Since the hedge fund first bought shares in 2011, its holding has grown to roughly $247.4 million in value, representing a 52 percent increase, or about $129.2 million in unrealized gains.
Sirius XMshares rose to a new, five-year high at $3.20 on February 5, as trading volumes surged on news that the company boosted revenue and matched earnings estimates for 2012. It had $3.4 billion in revenue last year, up 13 percent from 2011. The company ended 2012 with 23.9 million subscribers, 2 million more than when the year began, marking its biggest annual subscriber gain since 2007. Adjusted ebitda jumped 26 percent to $920 million, from $731 million in 2011.
Still, while shares of the New York–based satellite radio enterprise appear to be coming out of a prolonged slump post-financial crisis, it was far from a sure bet for the hedge fund manager founded by the former protégé of Tiger Management Corp.’s Julian Robertson Jr. After all, Sirius XM Radio had lost much of its luster since its heyday as a $60 stock a decade or so ago.
|| Blue Ridge Capital's John Griffin|
Named after the brightest star in the constellation Canis Major, the dog star, Sirius XM spent the better part of the past three years living up to its name. The stock had fallen from $3 in 2008 to a trough of about $0.25 in 2009. It’s been an uphill climb since. Shares hit $2 in 2011 but didn’t fully recover until last month.
The stock’s lift stemmed in part from stronger U.S. auto sales, a trend that became apparent in 2011. For Sirius XM — which broadcasts about 135 channels, including news, sports, music and entertainment, through two satellite radio systems — this translated into a larger potential-customer base. According to some industry estimates, the company holds about a 70 percent share of pre-installed satellite radio in new cars sold in the U.S.
Sirius XM’s slow-moving retrench worked out just fine for Blue Ridge. The hedge fund first invested in Sirius XM in 2011, then built up its stake to 55.4 million shares by year’s end. In 2012, it accumulated another 23.4 million shares, bringing the tally to 78.8 million, or about 1.51 percent of outstanding shares, as of September 30, according to Securities and Exchange Commission filings.
Blue Ridge wasn’t the only hedge fund firm tuned in to Sirius XM. Regulatory filings show that Steven Cohen’s SAC Capital Advisors is an investor in the satellite radio company, as is famed value investor Leon Cooperman’s Omega Advisors.
What helped boost the stock was the fact that existing shareholder Liberty Media Corp, fresh from its recent spinoff of Starz, in mid-January took majority ownership in the troubled company. Liberty’s interest has been fueling momentum.
Given the runup in Sirius XM’s share price, is it time for Blue Ridge and other hedge funds to cash out?
Griffin, who had been president of Tiger before launching Blue Ridge in 1996, built a reputation for picking early Internet and technology stocks and trading on growth stocks. What his investment team at Blue Ridge plans to do depends on whether it views Sirius XM as a value, growth or momentum play. Evidently it’s a bit of each.
Sirius XM, itself a successor of two national satellite radio providers, was initially seen as a kind of competitor for local terrestrial radio via AM-FM tuners. But that was a pre-2008 scenario. Alternatives — both free and pay-for services — have proliferated and expanded their reach, including Pandora’s popular streaming service and Apple’s iTunes.
Sirius XM has already rebounded from a market capitalization perspective. Whether it can post gains against these digital upstarts, not to mention retrenching radio stations, is another matter.
There are compelling reasons for Blue Ridge to stick around. First off, Sirius XM customers are “paid” subscribers, and that’s the magic word when it comes to a media-content company delivering steady profits. Subscribers plunk down a steady $14.19 per month, and Sirius XM already has an installed base of about 24 million.
What’s more, in January the company rolled out a new streaming service that will allow customers to listen to customized “on-demand” content for another $3.50 per month. This represents a new revenue source that gives the radio provider ammunition against Pandora and others, which are still struggling with ways to monetize services to their sizable customer base.
This new Sirius XM service — regrettably given the unpronounceable name “MySXM” — allows specialty shows to be delivered in a kind of podcast format to subscribers. (Sounds like a good idea; I’d even be willing to throw in an extra $1 just to get a vowel in the name.)
New services to monetize existing radio content supports an argument for a growth thesis, though this is yet unproven. On the value-investing side, the results are already apparent. Griffin’s Blue Ridge must have been pleased to see that in the last quarter of 2012 revenues grew on a year-over-year basis by some 14 percent, hitting $900 million. Sirius XM’s management seems to have learned the hard lessons of consumer penny pinching post-2008. It finally tightened its own fiscal belt by lowering expenses. Operating margins were a healthy 26 percent last quarter.
Blue Ridge must also be curious to see if Sirius XM’s latest, and quirky, marketing blitz will deliver. The company is furiously trying to woo back lapsed subscribers — but without spending a cent. In February the satellite radio company is reactivating dormant accounts so that preinstalled hardware in cars will once again stream music and talk for a limited 60 days, tempting drivers to re-subscribe.
With the stock recently hitting a four-year high, one can’t blame Sirius XM management, led by interim CEO James Meyer, for its enthusiasm in describing 2012 as a “great” year. The company is also repackaging past content to maximize star appeal via a new channel, named Town Hall, that will feature interviews with celebrities, musicians, sports stars and comedians.
Sirius XM is now back where it was in 2008, albeit in an arguably more competitive consumer environment where cash is tight and competition is fiercer than ever. Cost cutting measures have yielded much improved results, improving the stock’s value proposition, and Liberty Media provided a nice technical driver.
Blue Ridge is already in a good spot. It should only get better, if consumers prove equally enthusiastic as the satellite radio company’s management hopes.