Editor's Note: The following is an excerpt available exclusively at TheStreet.com from an interview originally published by Value Investor Insight.
The epiphany came to Jeffrey Ubben while managing the then $5 billion Fidelity Value Fund in the mid-1990s: "I just didn't know what I owned. With so much new money coming in, I was constantly adding to 150 positions, which to me was a recipe for mediocrity."
Since leaving Fidelity to join merchant bank Blum Capital and then starting ValueAct Capital in 2000, Ubben's results have been anything but mediocre. By making large bets and working with management and boards to increase shareholder value, ValueAct has returned an annual 18.1% net of fees over the past five years, vs. 6.3% for the Russell 2000.
Value Investor Insight: How does your brand of shareholder activism differ from what you see out there today?
: Much of what you see today is "buy shares today and tomorrow throw a hissy fit." The focus is on shortening time horizons by being your own catalyst.
That's a problem for me, because that style is transparent and could discredit all activists. Boards can say activists are just worried about making their quarterly or monthly performance numbers, and there's something to that, frankly. Writing a nasty letter is going to lose the pop it has now - the activism is going to have to have more integrity than that.
Our idea of activism is to get really involved and help new or current management lead the business and extend the run of a successful investment. The more of our portfolio we can have in great assets with great management where we're helping control the capital decisions - that's nirvana.
How did your investment in Acxiomundefined evolve -- or devolve -- into your making a $25 per share offer for the entire company?
We went to them in 2003 with a plan to realize equity value by getting out of the high-growth game and focusing on growing with their customers at 7%-10% per year while emphasizing free cash flow and returns on assets. They responded initially and the stock went up quickly from $16 to $25. We took money off the table at the end of 2004, because we generally like to sell 85-cent dollars to recycle money back into 50-cent dollars.
In 2005, performance relative to the plan they'd laid out went off the tracks when they returned to their old cap-spending ways. We still believed the company was a great asset, so bought back in at $20 and tried to work with them to get back on track. But this time the more we talked with management, the more disingenuous they were, saying one thing and doing another.
I approached the board in the spring of 2005 with our concerns about management's ability to run the company and made a case for why it made sense to have a shareholder in the board room. They came back and said they didn't think it was right ever to have a large shareholder on the board. I knew then we were in trouble. It told me this was an entrenched, founder's board that was not going to make the transition necessary to avoid being a structural underperformer. I had no recourse at that point but to offer a premium for control that would allow us to bring in a new management team and realize the potential of the business.
What's the next step?
We have our board and management slate lined up for a proxy fight. We're not going to back down because there's value here. Companies can get run into the ground when investors just say "to hell with this" and walk away. At the very least, the pressure we're putting on them might result in their performing better than they otherwise would.
Tell us about Reynolds & Reynolds (REY) , a holding you've recently "called up" to the big leagues.
Reynolds provides dealer-management software and services to auto retailers. There's an incredible industry dynamic: Reynolds and
split 80% of the market and sell their services on a monthly basis, so most of the revenues are recurring in nature. Auto dealers generally aren't technologists, so you don't tend to have competitive battles over the fastest, newest thing.
We met the new CEO, Fin O'Neill, and came away thinking he was a leader who will make the hard decisions. We bought some stock but didn't fully commit until he wrote off $90 million of capitalized software related to the technology the old CEO had bet the company's future on. That's a hard decision - they already had 70 customers on the new system.
What's the new game plan?
The company makes 15% operating margins with 75% of its revenue on autopilot, but its earnings and stock price have done very little over the last five years. The first critical thing is to rebuild the sales organization, giving incentives back and organizing to be more responsive to customer needs.
Auto dealers need help in talking to their customers directly, so the company is providing add-on customer-relationship-management solutions that you're starting to see show up in top-line growth. If they can get revenues growing even 5-7% per year, there's tremendous profitability leverage, especially as they pursue broad-based cost-cutting that wasn't going to happen under the old CEO.
The overall formula is pretty simple: Get the margins to 20% by turning around an underperforming recurring revenue stream and cutting costs. Buy back stock with the significant amount of cash they have on their balance sheet. Watch earnings per share grow rapidly and then get back to a historical multiple on a much higher EPS. It's not rocket science.
With the stock currently around $28, what do you see as the upside?
We've been thrown a curve ball on this. The company has had to stop buying back stock because their auditors are making them go back and look at some of their accounting for long-term software contracts. That's not affecting the stock price because the market has figured out there's no fundamental new information in any of this. But it's disappointing that some of the buybacks have been delayed.
This doesn't change anything in how we look at the business or stock. We think the earnings power of the company is $2.50 per share, almost double the $1.30 they make now. So even with no multiple expansion, we think the stock can double within two to three years.
At the time of publication, Ubben's firm was long Acxiom and Reynolds & Reynolds, although holdings can change at any time.
This excerpt is from an interview published in the Jan. 31 issue of
Value Investor Insight
newsletter. For more information on
Value Investor Insight
, please visit
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Whitney Tilson is the co-founder and Chairman of Value Investor Media, Inc., and co-Editor-in-Chief of Value Investor Insight. He also for the past six years has successfully managed a number of value-oriented hedge funds, and recently launched two mutual funds.
John Heins is the co-founder and president of Value Investor Media, Inc., and co-editor-in-chief of Value Investor Insight. Prior to starting VIM, Mr. Heins was senior vice president and general manager of America Online's Personal Finance business.