Gary Claar, founder of Claar Advisors, and former portfolio manager at JANA Partners talks activism at NYU. Here are the highlights from the interview. Don’t forget – sign up for our free daily newsletter to stay in the activist investing know.
Mr. Claar, thanks for taking the time to speak with us. You started your career as a corporate attorney. How important was that early experience in the legal world, and how did this path ultimately lead to investment management?
Thanks for this opportunity to introduce myself as I prepare to teach Value Investing: Special Situations and Activism at NYU Stern next semester. Ultimately, I am very glad I got a background in corporate law for several reasons. It was great training in problem solving and in being precise and wholly accountable for everything you say. Surprisingly, this differentiated me in business as someone people could rely on and heap responsibility on. It also gave me a broader perspective as an investor, which was particularly valuable in the multi-disciplinary arena known as event-driven investing. Having a good feel for boardroom dynamics or the bankruptcy process or the mechanics of securities offerings are some examples. My path to investment management from law was not so smooth. I was an outsider who had to bang on the door for a while to get in. I was constantly learning on the fly. During this time, I discovered I had an entrepreneurial streak. I somewhat relished the opportunity to re-invent myself professionally and broaden my network in spite of all the risks and uncertainties.
In the mid-1990’s, you became in-house counsel with the hedge fund Perry Partners and eventually a principal at another hedge fund before launching your own. What were some of the fundamental lessons you learned in the early years of your investing career?
As I bounced around and tried to become a money manager, I learnt a lot. I saw Wall Street’s best and brightest move away from risk arbitrage, which had become too competitive. They began to embrace special situation equity strategies, which married both event analysis and fundamental analysis. Around this time, Joel Greenblatt wrote his first book, “You Can Be a Stock Market Genius”, which told where to look for the most inefficient markets. Joel has claimed the book only helped a few rising hedge fund managers, and I was fortunate to be among them. This stage in my career involved learning as much as possible while trying to earn enough to justify throwing away a perfectly good legal career. There were a lot of ups and downs. Other valuable lessons I learned were more entrepreneurial, such as how to communicate ideas, how to set realistic business goals and how to perform honest self-assessments.
In 1998, you founded your first firm, Marathon Advisors LLC. Tell us how you navigated the dot-com boom and bust. Did this experience impact the way you valued tech and Internet stocks in later years?
Yes, I was fortunate that the markets were so crazy in the first year of my launch – it kept my new business solvent at its critical early stage. The dot-com boom required those who were raised on value investing principles to think outside the box. A value investing discipline is not supposed to confine you to only low multiple, low growth stocks – its merits are in keeping you away from large losses. I was able to apply a value-investing framework to all kinds of businesses with undervalued optionality to the Internet. It helped me navigate the boom without getting caught in the bust. A memorable investment of the boom time was Nielsen Media. It was a small cap spinoff of Cognizant Corp. Shareholders dumped it because of its size. But it was basically a natural monopoly in audience measurement with a highly incentivized management team. Plus it had a “new economy” angle to potentially measure the Internet. It quickly tripled and got bought out. There was a silver lining to the bust and the bear market of 2000-2002 as well. Value stocks, especially small caps, had been absolutely left for dead in the mania. Not only were new economy stocks overvalued but also many blue chip stocks had risen to over 25x earnings. So in the wake of the mania, it was rather easy to outperform the market indices with off-the-run value stocks and special situations. The hedge fund industry blossomed at this time, especially long/short and event-driven strategies.
In 2001, you became a founder and comanager of JANA Partners with Barry Rosenstein. At the time, you were willing to fold your fund Marathon Advisors into JANA to amass roughly $50M AUM. Could you talk to us about the decision to link with JANA?
Marathon was a one-man shop. Though performance was fine, it was reaching its natural limits. In 2001, I was looking for the right partner or strategic alliance. Barry was also looking for a complementary partner for the public market activist-oriented vehicle he was planning. We met and found we had a lot in common. We recognized the activist opportunity in small caps but agreed it was best to make that part of a broader long/short, event-oriented strategy. We could see we had complementary skills and the division of function between us would be quite natural. Basically I’d work in front of screens while Barry would be out meeting investors and companies. There was synergy despite the fact that he lived in San Francisco and I was in New York. From our fairly modest beginnings, we built a strong firm and reputation. The activism set us apart from the many other funds popping up at that time. The earliest JANA crusade was Herbalife, many years before the current pyramid scheme imbroglio. Its founder and largest shareholder had died leaving behind chaos. It traded near net cash and had a high ROIC business. JANA and Steel Partners demanded that the board right the ship or sell the company. They soon sold to private equity at a big premium.
You were with JANA Partners for over a decade. In 2011, the firm forced the split of then 123-year-old McGraw-Hill into separate Global Markets and Textbook Publishing companies. Could you discuss your strategy before taking the position, and how you identified McGraw-Hill as a quagmire of locked-up value?
Certainly. McGraw-Hill is a terrific example of the great care an activist must take in selecting targets. For years and years there was talk about the clear merits of separating Standard & Poor’s and the higher-growth Financial group from the Education group. But conditions were never quite right for an activist. We needed to see sufficient stock underperformance and evidence of an elevated cost structure relative to peers. We needed to hear sufficient displeasure with management among the shareholder base. By 2011, the role of shareholder activists was more widely accepted and even century-old companies with founding family members in charge (like McGraw-Hill) were fair game. The bottom line is that an activist should know that if push comes to shove, he or she will have the votes. Very few activist campaigns go all the way to a proxy vote. This is because once management fears losing such a vote, they are willing to listen