James A Mitarotonda, who is CEO of Barington Capital Group, makes no secret of the fact that he is a true believer in the American dream.
A hard worker, even since childhood, he has done and seen it all – paper routes, running a delicatessen, reviving a men’s fashion department in Bloomingdale’s, a stint at Citibank, financing small companies and then, finding his true calling – value investing with an activist twist.
Interview with Mitarotonda
The July 2014 issue of Value Investor Insight carries an insightful interview with Mitarotonda and his colleagues George Hebard, Alexander kohl and Jared Landaw.
A classic investment
He is especially proud of the 2009 investment in Gerber Scientific, a company involved in a host of businesses such as apparel equipment, prescription eyewear, specialty graphics and sign making. The company was then trading around $3 and suffering from poor return on capital as well as bloated overhead costs. The stock had underperformed the benchmark small cap index by 95%.
Mitarotonda immediately identified that the company’s problems stemmed from its haphazard mix of businesses that lacked scale, distribution and capital. He was able to get management to restructure by divesting two business units, thereby reducing debt, cutting overheads and consolidating its manufacturing operations.
“Management did a great job on execution, which led to the board being approached in mid-2011 with an acquisition offer that it ended up accepting at $11 per share,” says Mitarotonda.
Because of his past experience at managing businesses for himself or for large corporate employers, he is able to quickly grasp the company’s fundamental issues, formulate appropriate strategy and take the company’s board and employees along with him as he implements all those actions that lead to the creation of a successful business.
“A great deal of inertia can creep into boards and into the management ranks,” says Mitarotonda, referring to Gerber Scientific, whose board had remained basically unchanged for over a decade. “I’ve never been overly influenced by the status quo,” he says, a quality that allows him to bring a fresh perspective to the business, as well as to push the desired changes through.
His first love however, is undisputedly value investing. “We are looking for ideas that are out of favour, where valuations have declined for industry or company specific reasons,” he explains. “Only after we determine that value is there to we attempt to do the detailed work necessary to craft an action plan to unlock it.”
Value investing opportunities are unearthed by screening for “chronic or outsized” underperformers, and companies that are available at valuations which are out of sync considering their book values or free cash flow. Out of favour sectors and multi-segment, multi-business companies are also scrutinised for hidden opportunity.
Ideas are generated through Barington’s network in industry and company boards as well as CEOs.
Mitarotonda also finds value when a company stock falls disproportionately following an adverse event, a case in point being Darden Restaurants, Inc.(NYSE:DRI). The stock of the restaurant chain crashed precipitously by 17% in December 2012 following a bad quarter and lowered guidance by the management.
Are opportunities hard to come by in a roaring bull market such as recently?
Not really, clarifies colleague George Hebard – that’s because there are always plenty of opportunities available, regardless of the level of the broad market, where “the management team doesn’t appear to be rising to the occasion.”
However, there is one qualification: Barington never buys the top on an individual-stock basis, preferring to analyse the historical stock performance in the context of the market as well as peers.
Clearly, Mitarotonda likes to stick to the knitting. Barington has sound domain knowledge of consumer businesses such as restaurants, apparel, footwear and retail, as well as basic industrial businesses.
“We have confidence in our ability to value these kinds of businesses and to accurately assess the opportunities to improve their financial performance,” he says. “I wouldn’t have nearly the same confidence with, say, a high-tech or biotech company.”
He also prefers not to spread himself thin, and may hold a maximum of about a dozen activist positions. Of these, the top five could constitute as much as 60 to 65% of the total portfolio.
Investments are expected to generate an approximate 30% IRR, as the group is much disciplined on what it pays on investments.
Mitarotonda takes care to clarify that his brand of shareholder activism is not combative. “While we want to be actively involved in helping turn around the business, that doesn’t mean we start out yelling and screaming and threatening to run a proxy fight,” he emphasises.
The preferred route for him is to collaborate with the companies privately and “engage with them behind-the-scenes,” in acknowledgement of the fact that a plan for value creation is more likely to succeed in a collaborative atmosphere.
However, Mitarotonda is not afraid to wield the stick when so required, and in case where the management is recalcitrant, he is perfectly ready to take his case directly to the shareholders. “We’ve only had to do that four times in our history,” he clarifies.
Conversely, he is also not shy calling a spade a spade and to exit an investment which is unlikely to generate long-term value given management attitude. He cites the example of Borders Group, Inc.(OTCMKTS:BGPIQ), the retail operator of book, music and movie superstores and mall-based bookstores, in which Barington invested at a buy price of approximately $19.
“After a meeting with the CEO I put an order in to sell our entire position and we ended up getting out at around $16,” recalls Mitarotonda. “It became clear that we were not on the same page,” he says of the new CEO who had joined Borders Group, Inc.(OTCMKTS:BGPIQ) from Saks.
On the ‘rise and rise’ of shareholder activism, Mitarotonda makes the interesting observation that hedge funds are now sizeable investors compared to mutual funds, and are more aggressive in their hunt for better returns derived from undervalued or poorly managed companies. “When mutual funds were the primary stockholders, they by their nature were more passive,” he says.
Hedge funds and other activist investors therefore act more like owners and this will perpetuate the long-term success of shareholder activism.
Case study: Darden Restaurants, Inc.(NYSE:DRI)
Mitarotonda was impressed by Darden Restaurants, Inc. (NYSE:DRI)’s bouquet of a valuable brands, excellent free cash flow and “incredibly valuable real estate worth approximately $ 4 billion.” He also saw scope for significant reduction in overhead costs.
In addition, the tell-tale signs of underperforming management were all present via declining return on capital and equity, ill-fated acquisitions and overly expensive market promotion strategies that were doing nothing for same-store sales at the two leading brands, Red Lobster and Olive Garden.
“We determined fairly early on that the company was being terribly mismanaged and had the potential to deliver significantly better returns for shareholders under a stronger management team,” says Mitarotonda.
He recommended a reduction in the complexity of the business and its eight restaurant brands by splitting it up into two separate arms, one for the mature businesses, and the other for the brands currently under development. The structure would benefit brands because of enhanced management focus and better operating execution. He also felt that the company needed to aggressively shed costs.
“The company has announced $60 million in annual SG&A cuts since we first shared our recommendations with them,” reveals Mitarotonda. “We think the appropriate number is more like $200 million.”
He also suggested that the company should unlock the substantial value of its real estate by transferring it to a publicly traded REIT.
Current outlook on Darden Restaurants, Inc. (DRI)
Activist investor Starboard Value has also taken a stake in the restaurant chain, and is supported by Barington in the activist effort against the company.
The investors are particularly miffed by the company’s sale of its Red Lobster business, allegedly at a “fire-sale” price. The company ignored shareholders’ demands for a vote on the transaction. “In over 14 years of investing, we’ve never seen such a blatant disregard for shareholder interests,” fumes Mitarotonda.
In fact, Starboard Value has filed a complaint in the Ninth Judicial Circuit Court of Florida requiring the company to provide books and records that would help gain insight into the company’s agreement in May to sell Red Lobster to Golden Gate Capital, as well as to evaluate whether to bring an action to enjoin the sale or for breach of fiduciary duty against the company’s current board of directors and management.
Separately, immediately after the closure of the Red Lobster sale, Darden Restaurants, Inc.(NYSE:DRI) announced that long-time Chairman and Chief Executive Clarence Otis would step down. The company also proposed to nominate only nine members to the next annual meeting, leaving the door open for the activist investors to take over the balance three seats in the 12-member board.
Mitarotonda is a bit cynical of the company’s motives, even though the changes in the chairman and CEO are welcome. “The gestures appear to us to be more an 11th hour attempt by incumbent directors to retain their board seats than an indication that they are finally seeing the light,” he claims.
Mitarotonda estimates that Darden shares would be fairly valued in the mid-$60s versus the prevailing price of $ 46.66.