By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics”
Sotheby’s activist campaign
Sothebys (NYSE:BID) announced recently that reached a deal with activist investor Daniel Loeb and his firm, Third Point LLC which owns a 9.64% stake in the company. Company agreed to increase the size of the board of directors to fifteen members from twelve, and add three Third Point nominees: Daniel Loeb, Harry Wilson, and Olivier Reza. Since start of the activist campaign, some progress has been made: during March 2014, Sothebys (NYSE:BID) paid to its shareholders a special dividend of $300 million dollars or $4.34 per share. Company also authorized a $150 million share repurchase program which it plans to use mainly to offset the effect of employee stock options issuance. Most problematic issues that were raised by activist investors were related to areas of corporate governance, management inefficiency, and general business underperformance. It is not a surprise that such high-profile “intermediary” business as Sothebys (NYSE:BID) is plagued by management’s conflicts of interests with shareholders and is an easy prey for many people involved in the business. It is understandable that management and board were unreceptive and hostile when activist investor demanded more transparency and accountability from such an exotic business.
Type of activist campaign
When analyzing and following activist investors, it is important to pay attention to the type of campaign. Campaigns which are more corporate-governance oriented may be an indication that the company is not managed well and that management is corrupt and non-cooperative. In these types of cases, it might take a long time to fight management, gain board seats, and eventually to enact the necessary reforms. On the other hand, campaigns that call on companies to sell some non-core assets, distribute extra cash, or spin-off part of the business and focus on the performance of the main division, do not necessarily imply that management is corrupt. It is more likely that management will cooperate, and the campaign will unlock value for shareholders.
IHI Corporation (TYO:7013) is a mid-capitalization ($6.3 billion USD) Japanese industrial company. IHI Corp produces ships, aero-engines, turbochargers for automobiles, industrial machines, power station boilers and other facilities, suspension bridges and other transport-related machinery. IHI Corp is listed on Tokyo Stock Exchange and is a member of NIKKEI 225 Index, which consists of 225 leading Japanese companies.
Third Point’s valuation thesis
In its recently published quarterly letter to investors, hedge fund manager Daniel Loeb disclosed a position in IHI Corporation (TYO:7013). In the letter to investors investment thesis was described. According to Third Point, IHI Corps owns valuable non-core real estate: a large land bank in Toyosu, a central district of Tokyo, located in the vicinity of 2020 Tokyo Olympic Village and other real estate that includes office buildings and retail properties. Based on company’s 2013 Annual Report (March 2013), this real estate had fair market value of 252 billion yen. According to Third Point, the firm hired independent appraisers and received a much higher valuation of about 350 billion yen for the same assets. Such valuation implies that this non-core real estate represents 55% of company’s current market capitalization. According to Third Point, a spin-off of these real estate holdings into a separate company can help unlock significant value for shareholders. In addition to real estate, IHI Corporation (TYO:7013) has a number of other businesses that offer attractive prospects, such as aerospace segment and automotive segment. Third Point put a 1,000 yen target price on company’s shares, which would provide a 150% return.
Based on a recent share price, IHI Corporation (TYO:7013) had market capitalization of 640 bilyen. Company had net debt of 327 bil yen while enterprise value equaled 967 bil yen. IHI Corp is trading at an EV/EBITDA multiple of x10.5, and a P/E multiple of x19.2, based on results in the fiscal year that ended in March 2013. Adjusting enterprise value by the value of non-core real estate holdings (using Third Point’s estimate), IHI Corp is valued at an EV/EBITDA multiple of x6.7. Should the company decide to pursue a spin-off or other strategic transaction related to its real estate, the influence on the share price can be significant as property value (as estimated by Third Point) accounts for 55% of company’s market capitalization.