By Elizabeth Kopple
There are two types of targets for an activist investor. The first type of target requires a simple and obvious solution. The second type of target requires a more complicated and detailed solution. Both types of targets can offer the investor rich returns, and we will look at both types here.
Targets with a simple and obvious solution
These types of targets require that the activist win control of a board and implement changes with a narrow scope. In these cases, the activist selects the target, researches the target, figures out who the right people are to serve on the board, runs an election campaign to get the right people elected and then the activist steps back while the new board implements the needed simple changes.
Overall, the new board will be implementing simple, tactical solutions that are narrow in scope. Such solutions include returning excess cash to shareholders in a dividend, share buy-back or debt refinance or restructuring. The new board can also prevent management from wasting cash on foolish acquisitions.
In these targets with a simple and obvious solution, the activist usually has an opportunity to end excessive corporate spending and to streamline corporate functions.
Few things anger investors as much as lavish corporate spending. I assessed a target that had costly executive office space in New York City even though the firm and its management team were headquartered hundreds of miles away. The offices were rarely used. Another company I analyzed bought a private jet and used it to fly the CEO and his family on vacations. The corporate jet was rarely used for a legitimate business purpose. A third firm hosted a corporate retreat for over a hundred executives and their spouses. The corporate retreat took place at a super luxury hotel in Europe. No business was conducted during the retreat.
Inappropriate spending can take many forms. One management team I targeted built a swimming pool at corporate headquarters and insisted that only their family members could use the pool. Another CEO expensed his children’s private school tuition. When an activist can identify such abusive patterns in advance, the activist can usually win the election by simply highlighting the abuses in the activist presentation and showing the presentation to ISS and to the shareholders.
Nepotism can also be a problem. One microcap I studied in detail had nepotism at all levels. The board meetings looked more like family reunions. There were also transactions with outside suppliers owned by the family members of the top executives. Another company rented real estate at inflated prices from related parties. At all of these companies the path for activism was simple and clear cut. Show the shareholders proof of the inappropriate behavior, win the election, and then step back as the new Board of Directors fixes the problems.
Targets that require a more complicated and difficult solution
To illustrate an activist target that required a complicated and difficult solution, we will highlight the example of Metropolitan Health Networks, Inc. (formerly, NYSE: MDF). This activist target required much more work to turn around, but fortunately the activists were able to recruit a superstar team to get the job done. An activist investor group installed a new Board at MDF in the spring of 2010. The stock was trading at $3.04 at the time with an enterprise value of $121MM.
Activist shareholders had increasingly become disenchanted with a long history of poor decision-making, self-dealing and a lack of strategic direction at the Board level. The incumbent Board, in particularly, became at odds with the CEO, Michael Earley, and forced his resignation. Activist shareholders, along with a team of activist Board members, sided with Earley to take back control of MDF and institute a strategy for growth. Earley was rehired. Mark Stolper was one of six directors appointed to the new MDF Board. He was a key member of the activist team. Stolper is the CFO of RadNet (NASDAQ: RDNT), the country’s largest owner and operator of medical diagnostic imaging services. His healthcare expertise along with his knowledge of financing and M&A added a great deal to the MDF Board.
Once the new Board was established, the fortunes of MDF began to change. Earley’s management team and the New Board constructively evaluated the strategic opportunities and alternatives of MDF. Earley and his team were encouraged with the support and involvement of the New Board to reach out to industry players, evaluate business proposals and look at financing strategies. Board committees were established to investigate merger and acquisition opportunities, financing strategies and strategic expansion plans.
In June 2011 MDF acquired Continucare. Continucare gave MDF an expanded contract with Humana and new relationships with United Healthcare, Coventry, and Wellcare. It nearly doubled revenue. By 2012, the combined entity was at a run rate of $700-$800 million in sales. Stolper worked in conjunction with Early and other Board members and advisors to structure the acquisition and related financing of Continucare. This acquisition was instrumental in ultimately attracting Humana as an acquirer, as the combination created the clear leader in Florida (the nation’s largest Medicare Advantage marketplace) in providing medical services to the senior population.
MDF’s CEO Michael Earley and his activist-appointed Board worked together to improve key areas:
- Re-engineered management compensation and option grants
- Focused compensation on long-term operational success
- Expanded customer base beyond Humana
- Created the opportunity to acquire Continucare, one of MDF’s large competitors in the Florida marketplace
- Negotiated a fully underwritten $355MM financing from GE Capital related to the Continucare acquisition
- Supported an increased share buyback
- Gained equity research coverage
- Increased trading volume and improved liquidity
The successes of the team resulted in MDF being acquired by Humana in December of 2012 for $11.25 per share -- a deal valued at $850MM. Annual revenue had grown from $350MM to over $700MM. Net Income, EBITDA and free cash flow increased significantly during this period. The value creation was made possible by the complex and involved work of the CEO and turnaround board. It was a huge success for investors.
In any activist campaign, whether simple or complex, there are likely to be plenty of unknown elements. Learning to like surprises is a key driver of success.
Editor's Note: Elizabeth Kopple is a Director with IDWR Multi-Family Office, an organization that invests its own capital in micro cap proxy contests. Ms. Kopple is Co-Director of The Activists Association: www.activistsassociation.com. She can be reached at firstname.lastname@example.org.
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