Can ValueAct Capital Turn Rolls-Royce Into Gold?

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Rolls-Royce shares have been struggling for quite some time as the automaker continues to warn investors about lagging profits, sending many running for the day. However, ValueAct Capital Partners apparently sees great potential in the company, and, like chief Jeff Ubben has a reputation for doing, has taken a significant stake in the luxury automaker and aerospace company even though most investors are highly bearish on it.

 ValueAct sees treasure where others see trash

ValueAct is known for betting against the broader market and, in many cases, winning. The September issue of Activist Insight Premium looks at ValueAct’s stake in the luxury automaker and notes that the Rolls-Royce investment certainly fits in with the rest of the firm’s investments.

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For example, the activist firm upped its position in Twenty-First Century Fox two months ago, which Activist Insight calls a “distinctly awkward fit for an activist investor.” Also ValueAct managed to turn a profit from its stake in Martha Stewart Living even though Stewart went to jail.

Rolls-Royce stock dips

The last couple of months have not been good for Rolls-Royce. Today shares are down another 0.41% at 720 pence per share, and just a few days before Ubben’s firm disclosed its 5.4% stake in the luxury automaker, shares were down by nearly 16% for the year. ValueAct sunk £750 million into the company to buy up that stake.

There’s no denying that Rolls-Royce is in deep with problems, as it issued its third profit warning in a year and a half and faces two bribery investigations in Brazil and Indonesia. Despite all this, ValueAct is taking a solid foothold in the London-listed firm.

One of the reasons for ValueAct’s interest in Rolls-Royce is that the automaker recently appointed a new CEO. Warren East has a reputation for “engineering excellence,” according to Activist Insight. Also Liberum analysts estimate a recent order book disclosed by the company’s aerospace division to be worth about £76 billion. Also Rolls-Royce has been looking to build long-term revenue streams by offering maintenance contracts for its jet engines.

Why do other investors own Rolls-Royce?

Activist Insight notes that Investec analyst Rami Myerson argues that most investors who buy Rolls-Royce do so because of its aerospace division rather than for management’s diversification efforts or its land and sea business. The analyst believes Rolls-Royce should separate its aerospace division from the rest of its business or sell all of its non-aerospace businesses.

It seems likely that ValueAct will seek at least one seat on Rolls-Royce’s board, as it often does with its major investments. The firm is known for its relatively quiet, behind-the-scenes approach to activism, which has served it well for years.

What does ValueAct want?

Activist Insight also points out that ValueAct often seeks changes for management’s compensation or in pricing strategies. It seems unlikely that the firm will focus on compensation this time because management at Rolls-Royce earns bonuses based on profits and cash flow, so they did not get those bonuses last year because the requirements were not met.

It typically takes a long time for any changes to be made at the firms ValueAct invests in, and the same can be expected in this case. However, Activist Insight appears to speculate that ValueAct may not win this time if the company can suddenly boost its order book.

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