This column was originally published on RealMoney on Aug. 22 at 10:37 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.
Dan Loeb from Third Point is not known for his polite requests to management. I have featured Loeb here before in
, and repeatedly cited my favorite quote of his, which came from a letter to Star Gas CEO Irik Sevin: "I was amused to learn, in the course of our investigation, that at Cornell University there is an 'Irik Sevin Scholarship.' One can only pity the poor student who suffers the indignity of attaching your name to his academic record."
But polite is what Dan Loeb, an activist money manager who often gets his way when tangling with corporate managements, was in his recent 13D filing for
Western Gas Resources
( WGR), a $3.2 billion market-cap company that operates in the natural gas market. The stock has certainly benefited from the recent run in natural gas prices, leaving its trading range between $25 and $35, which it had staked out all year, to jump to a new 52-week high of $45.80. It closed Friday at 43.44.
Although the stock has run, and Loeb has accumulated 6.45 million shares to become the largest shareholder in the company, with 8.6% of the company he still thinks there's room for the stock to go significantly higher.
In the 13D filing submitted last week he wrote: "Our own estimates of the Company's intrinsic value are well in excess of both the current trading levels of approximately $42.50 and "Street" valuations such as that of UBS at $54.00 per share." In an interview with Reuters, Loeb stated that he felt shares should be valued at more than $60 a share.
First off, the letter was unlike his usual "gloves off" strategy in that he commended the management team: "We are impressed with the progress that Western Gas Resources, Inc. (the "Company") has made in obtaining permits in the Powder River Basin and elsewhere which will enable it to reach and exceed its production-growth objectives."
But it wasn't all happy talk, as he subsequently outlined several methods he felt the company should use for unlocking this value.
"We recommend that the Company immediately utilize its significant borrowing capacity to initiate a share repurchase program of $300-$500 million, representing 10%-15% of the outstanding shares. In addition, we urge the Company to use a portion of future operating cash flow to purchase shares."
CEO Peter Dea has said that he would rather use cash to step up its natural gas production and use any additional cash flows to pay dividends, rather than borrow more. Loeb's point is that one should borrow now while the market is incorrectly valuing the company
vis a vis
natural gas prices:
"We vehemently disagree with the Board's view that the Company should wait until the "cash is in the bank" before pursuing such a course of action, as we believe there is a window of opportunity to buy back shares "on the cheap" before the market comes to appreciate the impact of the current natural gas strip on future cash flow."
Loeb also took the step of consulting a bank on whether Western Gas could borrow the amounts needed for a share repurchase program: "We have already discussed the Company's borrowing capacity with a global investment bank which has confirmed that such a sum would be easy to finance."
He further recommends splitting up the company to make it easier for the market to value its components, but feels the share repurchase program should come first:
"We still believe that shareholders would be well served by separating the Company's midstream gathering assets from its resource intense E&P business, but now recommend that such a transaction be preceded by a significant share repurchase."
Finally, Loeb makes a direct request to join the board and, I have to say, his request bordered on funny:
"I also have excellent news, which I would like to share with you and the Board: After significant reflection regarding the time commitments and constraints that such a responsibility would entail, I have decided to volunteer to serve on the Company's Board of Directors..."
The reason it borders on funny is because of the sequence of events this effort will likely trigger. The company will consider and perhaps even announce a buyback, but it will fall short of Loeb's request.
Dea does not sound like the type to put on additional debt in order to repurchase shares, regardless of how cheap these shares become. This is similar to the battle with
and Carl Icahn, as well as Icahn's battle with
, where he ultimately forced the company into a $4 billion stock repurchase plan.
The CEO of a company really has three constituents -- his customers, his debtholders and his shareholders. He has to satisfy his customers every day and try to satisfy the other two groups as well, but that's often impossible. In Time Warner's case, Dick Parsons has paid down debt from $30 billion to $13 billion, but there are benefits to equity holders in remaining leveraged (return on equity stays high), and the CEO can use excess cash flows to buy back stock, making equity holders larger owners of those cash flows.
I also don't think Dea is going to be splitting up the company anytime soon. He told Reuters after the filing that the board took "a hard look" at the plan and decided not to do it. Meanwhile, according to Reuters, analysts at Wachovia, Jefferies and Merrill have all written reports agreeing with Dea not to split the company.
Given that they are rejecting the first two ideas that Loeb has, I also think it doubtful that they will put Loeb on the board.
In other words, the next letter might not be so nice. My guess is there's some initial excitement baked into the stock now that Loeb is involved. But after carving out a new trading range, in the long term, some part of Loeb's requests will be honored (through the cliched "hell or high water") and the stock goes higher. But between here and there, the 13D filings will probably get interesting.
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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. At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. 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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