Jeff Smith interview highlights and video via Wall Street Week
Jeff Smith, one of Wall Street’s most successful and respected activist investors, discusses the winding road that led him into activist investing, recent investments in Yahoo! (YHOO), Darden Restaurants (DRI), and Brink’s (BCO), and controversial stance on Olive Garden’s unlimited breadsticks. Smith completes a murderer’s row of Wall Street’s most revered activist investments, with Barry Rosenstein and Carl Icahn, that have appeared on Wall Street Week over the past month.
Financial markets endured a sluggish start to the week largely due to anxiety in Europe, but a “goldilocks” US jobs report on Friday, as well as a surprisingly decisive victory for the pro-business Conservative Party in the UK elections, spurred an impressive comeback Friday. The S&P rallied 1.4% on the day to erase prior losses and finish with the week up 0.4%.
At the end of October, the value investor and fund manager, Mohnish Pabrai, gave a virtual presentation and participated in a Q&A session with Boston College and Harvard Business School students. Pabrai on intrinsic value Among the subjects discussed, Pabrai was asked about his approach to calculating a company's intrinsic value and the data points Read More
Fixed income markets also rebounded as the 10-year US Treasury yield fell back to 2.12% Friday after hitting 2.28% the day prior, while the yield on 10-year German bund retreated to 0.55% after hitting 0.75% following Bill Gross’ assertion that bunds are the “short-of-a-lifetime.” Market weakness midweek was also attributed to bearish comments from Federal Reserve Chair Janet Yellen, who remarked that US equity market valuations were still “quite high.”
The US economy created 223,000 non-farm jobs in April according to Friday’s payrolls report, which was basically in-line with consensus expectations. The unemployment rate fell to 5.4%, the lowest reading since May 2008, although the labor participation rate and wage growth remain concerns. Continuing jobless claims also decreased by 28,000 to 2.2 million for the week ended April 25th, which is the lowest reading since November 2000.
A “goldilocks” economic number is one that is good enough to indicate healthy growth of the US economy but not too good that it could lead the Federal Reserve to tighten monetary policy. While most economists entered the year expecting the Fed to start raising interest rates sometime in 2015, the odds now stand around 50-50 for a rate hike in that time-frame. Lukewarm economic data and ongoing dovish monetary policy from world central banks, which triggered a rapid, sharp rise in the dollar, are factors that have diminished the Fed’s haste to tighten.
Uncertainty surrounding the latest round of Greek bailout negotiations weighed on the markets through mid-week. Monday marks the latest deadline for the Greek government to iron out a reforms-for-cash deal that will allow the debt-ridden nation to continue to meet its financing obligations as a part of the EU/IMF bailout package, making this week’s Wall Street Week guest, former Greek Prime Minister George Papandreou, very timely.
Papandreou believes that the framework for Greek deal will be ironed out by Monday’sdeadline, but he stated that there is no contingency in place in the event that negotiations take a wrong turn—which is likely the reason for persistent in financial market weakness whenever such deadlines approach.
In the UK, where pre-election polls predicted a close race between Prime Minster David Cameron’s Conservative Party and more left-leaning Labour and Liberal Democrat parties, Thursday’s election results turned into a one-sided affair. The Conservative party, which is seen as more pro-business, enjoyed a massive win that gives it a firm majority and strong governing mandate. However, the party has also been vocal about wanting to stage a referendum on the UK’s membership in the European Union by 2017, a prospect whose implications will be hotly debated over the next 18 months.
At the SkyBridge Alernatives (SALT) Conference this week, the prevailing opinion seemed to be that the Fed likely will not raise rates this year and equity markets could continue to rise, but that if there is a bubble in financial markets today, it is in fixed income. Macro hedge funds that have tried to time currency and fixed income markets this year based on Fed policy expectations have underperformed, while activist and event driven have enjoyed success thanks to low interest rates, bullishness and healthy M&A appetite. While indexing strategies have performed well since the bottom of the financial crisis in 2009, we could be entering an environment where active stock pickers start to re-assert their alpha status.
Would Greece ever really leave the Eurozone?
While there is inevitable posturing during bailout negotiations, most pundits have maintained that the continent’s most debt-ridden country would reach a deal with its creditors to remain part of the 15-year-old Euro pact. However, with improving economic conditions in the rest of the Eurozone and political pressures starting to mount on both sides of the table, the possibility of a “Grexit” has never felt more real—and sentiment is growing that it might not be Greece’s decision at all.
When the far-left Greek SYRIZA party swept into power in the January 2015 general elections on an anti-austerity platform, fears increased that the government would be willing to default. New leaders demanded, much to the delight of the crowd, that the EU and IMF relax stringent reform demands that have eaten away at the Greek people’s already-deteriorating quality of life.
Young Greek Prime Minister Alexis Tsipras’ popularity was built on those promises to abandon the bailout, end cooperation with international creditors and curtail austerity measures. However, he was forced to dramatically tone down that rhetoric in February during negotiations to extend the rescue package. In late February, a deal was reached to extend it by four months, bringing us to tomorrow’s latest deadline.
Greek Finance Minister Yanis Varoufakis, an even more volatile and celebrity-obsessed figure, has repeatedly exasperated EU negotiators with brazen threats, erratic behavior and lines in the sand, but more recently he has been pushed to the side in negotiations to help smooth over the process. The Greek coalition seems to have become a more willing and good-faith partner, but at the same time patience from the other side of the table seems to be waning.
As former Greek Prime Minister George Papandreou stated on this week’s episode of Wall Street Week, most expect Greece to kick the can further down the road this week and reach another short-term deal with creditors. However, the conversation in Europe is now starting to move in a different direction—that the Eurozone, especially its most influential member Germany, would be better off without Greece.
With bond yields having plummeted in Europe, some even into negative territory, and economic data improving, the risk of a domino effect has diminished significantly from the depths of the Eurozone debt crisis. Greece, after all, only has economic output equivalent to the state of the Connecticut.
Papandreou believes that while contagion risks have indeed receded, the most destabilizing aspect of a “Grexit” would be the precedent it set. Countries like Spain, Italy and Portugal remain heavily indebted, and while lower borrowing costs have pushed them away from the brink of calamity, a time could come in the future where anti-austerity political movements create an environment similar to the current one in Greece. If larger members eventually followed Greece’s lead by exiting the Eurozone, the regional alliance’s days would surely be numbered, and with it the benefits of a single-currency union.
For her part German Chancellor Angela Merkel has remained a staunch advocate of Greece remaining in the Eurozone. However, an article in Bloomberg this morningsuggests that she is facing mounting pressure from within her political party to give up on Greece for the sake of the Euro:
“Members of Merkel’s Christian Democratic bloc are openly challenging her stance of keeping Europe’s most-indebted country in the 19-nation currency region. Even some officials in the Finance Ministry are leaning toward the conclusion that the euro area would be better off without Greece, two people familiar with the matter said.”
Even German lawmakers who have previously voted for Greek bailout extensions are increasingly changing their tune. If Greece were allowed to leave the monetary union, some influential figures think that the Euro could conceivably be strengthened and rules applied more strictly to other countries. While, as Papandreou pointed out on our show and Merkel has repeatedly stated, Greece holds strategically important geo-political value due to its proximity to Ukraine, Turkey and the Baltic nations, the reality is that economically it sits on the fringes of Europe.
Greece’s societal entitlement and economic framework needed to be reset – there is little debate about that. But Papandreou and others have acknowledged that it was a mistake to make such extreme austerity cuts in the middle of a deep recession. The Greek youth unemployment rate stands alarmingly today at around 50%. Something needs to be done to break the current cycle, and policy makers increasingly believe that the only way to do that would be for Greece to exit the Eurozone.
Financial markets have generally endured weakness whenever the possibility, however remote, of a “Grexit” re-emerges, but that softness has always been transitory up to this point. While risks have certainly subsided, the selling we saw in pockets last week is a reminder of deep-seated anxiety and uncertainty.
After all, the Eurozone is nothing more than a grand experiment, so there is no precedent to help predict the implications of certain outcomes. Investors have become somewhat complacenct due to strength in equity markets over the last six years, but lest we forget that a mountain of debt, not explosive growth, has financed this fragile and narrow economic recovery.
At this stage a “Grexit” would not, based on fundamentals, drop a grenade pin, but it could scream “fire” in a crowded, anxious theater.
On three of the first four Wall Street Week episodes, we have had guests who are among the most successful and respected activist investors in the industry—JANA Partners’ Barry Rosenstein, Icahn Enterprises’ Carl Icahn and, this week, Starboard Value’s Jeff Smith.
While those in the financial industry are likely familiar with the concept of activist investing, we wanted to give all of our readers a more basic understanding of the practice.
An activist investor purchases a large stake in a publicly traded company that it perceives as being undervalued and then attempts to gain seats on the company’s board of directors in order to affect change on the company to unlock shareholder value. If the company’s board resists an activist’s overtures, the activist may force a proxy contest in which all shareholders are called to vote on the board of directors. Proxy contests are rare, but represent the nuclear option for activists.
An activist identifies a potential target largely through fundamental analysis of a company’s balance sheet. At its core, true activism is a value investing strategy that involves an investor looking for companies that are trading at a discount to their true long-term intrinsic value.
When an activist buys a large number of shares in a company, they begin rolling out a turnaround strategy. There are many reasons why an investor might perceive a company to be undervalued, including mismanagement by the company’s executives, operational inefficiencies relative to competitors, excessive costs and/or insufficient size of capital return programs (dividends and share buy-backs). An activist may also see the potential for greater shareholder value if a company pursues strategic mergers, acquisitions or spin-offs.
Once the activist fund has gained seats on the board, it then works to rectify targeted issues in order to bring the company’s earnings multiple and valuation in line with the broader market and industry peers. The investor could look to sell its shares once the company reaches a suitable valuation, or, as many activist investors do, become a long-term shareholder. That decision usually comes down to whether the investor believes it can realize the greater returns by retaining ownership in the company or allocating to another targeted company.
Because an activist’s turnaround strategy often includes cutting excess costs at a company, which could include jobs, historically there has been some criticism of activist strategies. However, Rosenstein, Icahn and Smith have all noted how much more positive the attitude toward activism has become over the last 15 years as understanding of its inherent nature and benefits has grown. Activists are now (increasingly over the last decade) called upon by mutual or pension fund managers who would like to see corporate cronyism, complacency and ineptitude corrected. Activists are summoned to do the “dirty work” to unlock shareholder value in companies those buy-side investors own.
However, not all supposed activist investors are created equal. There are some less credible investors that label themselves as activists who resort to manipulation and threats to trigger short-term price appreciation in a stock. When the price rises they quickly sell. In Episode 3, Carl Icahn called these actors “pump and dumps,” or those who aim to realize short-term gains without addressing the underlying long-term issues plaguing the company and shareholders.
When a highly-respected activist investor with an established track record discloses a new position in a stock, it can often trigger a large immediate gain in the price of the stock due to the expectation that the investor will be able to unlock value. Some investors choose to monitor and piggyback on the ideas of activists in an effort to achieve above-market investment returns. When an investor purchases a stake of 5% or more in a company, it must file an SEC form 13D. When a 13D filing is made it often signals to the market that the company has become an activist target.
Activist strategies can be attractive because they largely do not depend on macroeconomic and market forces. Activist investors operate from a “bottom-up” perspective, meaning they analyze individual companies, rather than a “top-down” perspective, which prioritizes analysis of broader macro market forces in investing. Because of this, when asset prices generally become richly valued and there is anxiety about market index prices, money could flow into activist strategies as investors search for ways to achieve returns independent of potentially fragile broader market conditions.
The 7th annual SkyBridge Alternatives (SALT) Conference took place this past week at the Bellagio Resort & Casino in Las Vegas, and once again delivered the diverse thought leadership that has made it a can’t-miss event. This year’s speaker line-up included high-profile economists, investors, entrepreneurs, policy makers, athletes and artists. In defiance of the old adage, what happened in Las Vegas didn’t stay there – it spawned headlines across the news media.
The Wall Street Week team was a keen observer of conference festivities and this week we bring you selections from among the 300+ articles and videos written or broadcast across major media outlets related to SALT:
SALT Conference Draws Hedge Fund Stars to Las Vegas (New York Times Dealbook, Alexandra Stevenson)
What to Expect from SALT 2015 (Fox Business TV)
The Bull Market in Bonds Is Over, Says Fortress’s Novogratz, An Interview from the SALT Conference (Bloomberg, Madeline McMahon and Kelly Bit)
El-Erian Sees Market ‘Delusion’ Amid ‘New World’ (Wall Street Journal Moneybeat, Rob Copeland)
Peter Schiff: We’re not headed for a Fed rate hike – we’re headed for QE4 instead! (Business Insider, Jonathan Marino)
Dan Loeb bashes Warren Buffett at hedge fund conference (Fortune, Stephen Gandel)
Chanos: Loeb vs Buffett About Personalities, Not Ideas (Bloomberg TV)
Anthony Scaramucci on Dan Loeb vs. Warren Buffet (ValueWalk, Staff)
Volatile Bull Market Runs 6-12 More Months: Troy Gayeski (Bloomberg TV)
Marathon CEO Says Puerto Rico Debt Among Firm’s ‘Best Ideas’ (Bloomberg, Laura Keller)
Top 5 predictions from the SALT hedge fund conference (USA Today, Kaja Whitehouse)
SALT Conference Activist Roundup (ValueWalk, Activist Stocks)
SALT 2015: Top Investment Ideas from Bass, Burbank, Chanos & Cooperman (Benzinga, Charles Enser)
T. Boone Pickens predicts higher gas, oil prices for next winter (New York Post, Michelle Celarier)
Branson argues for end to the war on drugs (Las Vegas Review-Journal, Richard Velotta)