This column was originally published on RealMoney on Jan. 19 at 1:00 p.m. EST. It's being republished as a bonus for TheStreet.com readers.
Not many strategies worked last year. Many tried and true hedge fund tricks failed miserably. Convertible arbitrage was down more than 5% on most of the hedge fund indices, and merger arbitrage was flat. What worked was picking stocks that were down and out but had potential, and rocking the boat until an entrenched management turned around.
Naysayers can point to individual cases like
and say, "That stock has gone nowhere, so activism doesn't work," but it's best to look at the funds that are doing this type of investing and see how they've performed as a group. (Fortunately, there is no index following this group, so it hasn't been inundated with dollars to the point at which it becomes a useless strategy.)
Jolly Roger, which had activist plays over the past year in
Cutter & Buck
( CBUK) and
, rose 20% in 2005, with a 5.9% gain in November and a flat December. It logged a 30% return in 2004, and 41% in 2003.
Barington Capital, run by Jim Mitaronda, is coming off of a successful multiyear battle with privately held Register.com, and recently started to tangle with
. Barington gained 14.9% in 2005. Interestingly, in the bear market years (2000-02), Barington posted gains of 10%, 50% and 13%, respectively. Activism appears to be uncorrelated with the broader large-cap indices.
Jana Partners, an activist fund whose dealings with
( SWW) I recently wrote about in my
newsletter, was up 11.4% in 2005. From 2001 to 2004, it respectively logged yearly returns of 27%, 10%, 45% and 26%. Not so bad. None of these guys are making big macro bets on the markets. That's never been the way to make a lot of money (compare with John Henry, who does make such bets, and who is coming off of a 60% drawdown this year). What these guys do is find hard-luck stocks that haven't performed to their potential, and then they try to unlock it.
Three Battles Activists Should Win in 2006
I think activists will win out this year over
, Time Warner and the
New Germany Fund
William Ackman is urging McDonald's to spin off its 8,000 company-owned franchises. He contends this would provide better transparency and governance of an underperforming, mismanaged branch of the company. McDonald's has demurred, saying the market wouldn't necessarily reward the stock. The good news for investors is that regardless of what McDonald's chooses to do, most parties agree the shares are deeply undervalued and deserve to be shaken up.
Everybody's favorite activist, Carl Icahn, is currently waging a war with Time Warner. He's calling for the company to split into four separate units: cable, Internet, publishing and movies/TV. This is no simple task, so Icahn hired iconoclastic banker Bruce Wasserstein of Lazard to help him. Together they are waging a proxy fight to win board seats to push through their strategic alternatives.
In regard to the recent
-AOL deal, Icahn writes: "I am not opposed to Time Warner entering into an AOL transaction that creates long-term value. However, I am deeply concerned that the Time Warner board may be on the verge of making a disastrous decision concerning an agreement with Google if this agreement would make it more difficult in any way or effectively preclude a merger or other type of transaction with companies such as IAC/InterActive, eBay, Yahoo! or Microsoft, etc., etc."
I agree with Icahn that there is tremendous value in Time Warner, and I think 2006 will be a big year in this face-off. I don't always agree with his suggestions, but hey, that's why he's Icahn and I'm me. Within the next week, we should see more details on his plans for Time Warner.
Philip Goldstein has been waging a brutal battle with the New Germany Fund for over a year, and it's leading to litigation. In a nonbinding vote, shareholders have approved the conversion of the fund to an open-ended structure, which would eliminate the huge discount at which the fund is trading. I think Goldstein will be successful in pushing this fund open, and I think this will be a good year for the German economy, especially with the World Cup coming. I'm also hoping Goldstein wins in his court battle against the
hedge fund-registration program. I'm going through this process now, and it's a drag.
Three Battles That Could Begin
I believe activists will begin to make some noise regarding
Like McDonald's, Denny's looks like a classic real estate play. With more than 230 properties nationwide, though it's concentrated primarily in California and Texas, there may be substantial value that could be uncovered. Denny's is also operating on an outdated business model that is hiding its true value.
I'm also keeping an eye on
( OPMR) and
( MAPS), because funds known for their activism have taken passive positions of over 5% in them. At any point, these companies could find themselves fair game for a battle.
Third Point, run by Dan Loeb, has taken a 7.6% stake in Optimal Group, which processes credit card payments for Web sites. It has a $460 million market capitalization, $177 million in net cash (cash minus debt) and $55 million in cash flow from operations in the past 12 months, not to mention 200% earnings growth. It's hard to tell from the filings, but it looks like Third Point may have accumulated the bulk of its shares around $19. Currently, the stock is just under $22.
I own shares in MapInfo, which makes location intelligence software for uses ranging from homeland security and crime analysis to marketing and customer service. Activist fund Cannell Capital owns 9% of the company, and Kopp Advisors is in for 7%. The company has a good balance sheet, with $50 million in net cash, strong cash flow ($15 million coming from operations in the past 12 months) and a market capitalization of $280 million. Throw in 100% year-over-year earnings growth and I'm happy owning it at these levels. From the SEC filings, it looks like Cannell bought in at around $13 a share; the stock is currently at $14 and change.
I think 2006 will be a banner year for activists. Many people believe activists are scrooges out to make a quick buck, and I'd agree that many are just that, but they also facilitate the flow of capital, which is absolutely necessary in a capitalist system.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider Optimal Group and MapInfo to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
At the time of publication, Altucher and/or his fund was long McDonald's Denny's, Time Warner, MapInfo and Optimal Group, although positions may change at any time.
James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of
Trade Like a Hedge Fund
Trade Like Warren Buffett
. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback;
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