Do Activist Investors Let the Game Come to Them?

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Dear Fellow Investors,

As a recovering amateur athlete—the pinnacle of my athletic career was four years of Division III college golf—one concept became obvious at almost every level of athletic endeavor: let the game come to you. Rather than trying to impose your will on the opposing team or opposing player very quickly, you instead seek to discover your opponent’s weaknesses and use the duration of the contest to establish your superiority. We take a similar approach with our stock picking. When discussing security analysis, we’ve heard Warren Buffett and Charlie Munger say “Our job is to decide whether and the stock market’s job is to decide when.” Many times it takes three years or longer for an under-valued stock to get recognized in the stock market.

A great example of this concept comes from an NCAA Division I March Madness game a few years ago between the Princeton Tigers and the UCLA Bruins. Princeton played the game very slowly, milking the shot clock and attempting to negate their size and quickness disadvantage. Rather than be patient and let the game come to them, the Bruin players pushed and pushed the tempo to no avail and were subject to a huge upset defeat.

At Smead Capital Management we have witnessed a small deluge of interest in our companies from major activist investors. Amgen (AMGN), eBay (EBAY), Gannett (GCI) and Walgreens (WAG) have had large positions disclosed by activist investors. An activist investor buys a substantial position in a company’s common stock and then seeks to wield influence over the direction and capital allocation of the business to its executives and board. They do this to expedite the unlocking of what is called “shareholder value.”

Three questions arise from this current circumstance.  What does it mean to let the game come to you in investing? Why are activists interested in these companies? What is the difference between our long-duration approach to investing and the activists who own shares in our companies?

Since it’s received the most recent attention, let’s explore Amgen. Activist investor Daniel Loeb announced at a charity event in New York recently that he had upped his stake in Amgen and was making proposals about business strategy and capital allocation, which included breaking Amgen into two companies. We bought our original shares in May of 2008 at around $43 per share and it was still only trading at $52 in the summer of 2011. At that point, Amgen announced it first cash dividend at a higher annual percentage rate than the ten-year Treasury bond and a major stock buyback. They were doing all of this while spending 20% of their revenue on research and development, their most important long-term investment. On October 23rd 2014, the stock traded around $147.50 intraday. We have been well rewarded for letting the game come to us.

EBay has garnered ownership from Daniel Loeb’s firm and from Carl Icahn’s firm as well. EBay’s board succumbed to the pressure and announced that they will split the business into two companies. We started buying eBay in January of 2008 at $32 per share and proceeded to add to our position all the way through the downdraft. Our lowest purchase was at $10.80. EBay currently trades around $51 per share and has underperformed the stock market in 2013 and 2014. We believe the stock market will once again take care of the “when.”

Icahn also has a stake in Gannett and they beat him to the punch by announcing a split into two companies next year.

As for Walgreen Company, activist Jana Partners is very frustrated by the company’s unwillingness to make their purchase of European drug store company, Alliance Boots, a “tax-inversion” transaction.

These activists are paying us a back-handed compliment by buying into so many of our top holdings. Their analysis shows that these common stocks are undervalued, just as ours does. The difference is the time frame they operate in and in what duration their goals are made. If you decide “whether” as Buffett described and you can shorten the duration of your success, you can temporarily produce more spectacular results. However, they are not letting the game (in this case the verdict of the stock market) come to them. Instead, they are pushing the tempo like the UCLA Bruins.

In effect, activists are pushing forward future returns and possibly are forcing us to consider selling some of our favorite long-term holdings. Since there are a limited number of businesses which meet our eight criteria for stock selection, it means trying to find scarce investments and suffering the expense of making those changes. This is not a tempo we prefer in the stock market.

The stock market has historically bottomed when stocks have moved from weak hands to strong hands. Strong hands are usually viewed as investors who see value and seek to stay put for a long time. Our main concern with these activist investors is two-fold. First, will they push the tempo like UCLA and, regardless of their success, exit the stock in frustration? In this way, all they do is temporarily push up the stock and disrupt normal trading. In eBay’s case, this is exactly the affect Icahn’s stake has had.

Second, will they put one or more of our holdings into play as they push for quick action in the marketplace? It is great in the short run to get a company bought out from under you and have short-term performance get jacked up.  In the long run, we are much better off to own a wonderful business for longer than ten years and reap many times what we paid for it, while receiving numerous dividend increases on the ones which succeed.

The 23rd Psalm says, “The Lord is my Shepherd, I shall not want.” The psalmist inferred a confidence in where we are now and where we are going. We are very content to let the game come to us in the stock market and are not envious of the way activist investors seek to speed up the pace of their returns. Our hope is their affection for our companies won’t interrupt the long-duration wealth creating benefit of these companies which meet our eight criteria. A wise investor once observed, “The fewer decisions I make, the smarter I am.”

We once heard a wise investor say, “It is not in the buying and selling that money is made in the stock market, it is in the waiting.” By letting the game come to us and not pushing the companies for short-term reward, we seek to keep our trading costs low and enjoy more benefit from our best performing long-duration stocks.

Warmest Regards,

William Smead

The information contained in this missive represents SCM's opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

© Smead Capital Management

© Smead Capital Management

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