I haven’t ever written about Insider Monkey before, but I’ve used their website and admired their editorial content for a while — they started as a site that tracks big insiders, particularly hedge funds and other high profile investors, using their public filings and news sources, and they’ve evolved to offer an investment strategy (and accompanying paid newsletter) that tries to piggyback on the most successful activists and hedge fund managers (and the most lucrative segments of the market).
They offer other premium-priced research as well, including analysis of individual funds and their portfolios as reported in their 13-F filings, and commentary on ways to emulate the trading and strategies of admired hedge funds in your own portfolio (meaning, without paying hedge fund fees), but the product they seem most proud of is their Small Cap Hedge Fund Strategy, which they sell as part of their $350 Hedge Fund Alpha newsletter — essentially, that’s a strategy designed to follow the small companies that are targeted by multiple hedge funds, and over a couple of years they’ve found it beats the market.
But last week I also got a teaser pitch from them that caught my eye, and a few readers have also forwarded the same ad, so I thought we’d solve it for you and get you started on checking it out if you’re curious. They call this the “#1 Top-Ranked Activist Stock in the World”, and here’s the hintification:
“Our stock picking strategy identifies the best stock picks of the best hedge fund managers like David Tepper, Warren Buffett, George Soros, David Einhorn, and Steve Cohen.
“We will now share one of the strategies we use to identify the “best stock picks”
“About seven years ago, a study was done by renowned professors from Columbia, Duke, and other academic institutions and it was published in The Journal of Finance, one of the most prestigious academic publications in the world.
“The study showed that, on average, activist funds outperformed the market by an average of 20.6 percentage points per year.
“In fact, the top 25% of activist hedge funds beat the market by 28.3 percentage points annually.”
In many ways, though hedge fund activists are often derided by long-term investors and company management (and even by Warren Buffett, who was quite an “activist” himself in his early days), we’re really in a “golden age” of activism — folks like Bill Ackman and Carl Icahn have made activism, and its financial rewards, into headline news (perhaps partly because of their billionaire boy spats), and beyond the hugely successful billionaire activist investors there are hundreds of little baby hedge funds who are trying to reap the same rewards by investing in companies, pushing them to do something (spin off a division, raise the dividend or buyback, change the CEO, cut spending that they see as wasteful, etc.), and then reaping the rewards as the stock price rises.
And yes, some activists are pretty clearly better at it than others — whether because they have a reputation that companies respect, or because they have huge amounts of capital to deploy, or have genuinely good ideas in partnering with management, or whatever other reason. All of them also make mistakes, and fail sometimes, but there’s a reason why so many of the well-known investors we see on CNBC or in the Wall Street Journal are activists: they generally move stock prices. Sometimes that movement comes simply from the fact that an activist is involved, which gives the potential for something big or different to happen in a situation that investors might have perceived as boring before, and in those cases it can be tough for investors to profit alongside the hedge funds because they buy at lower prices before announcing their intent, and the stock goes up pretty quickly once that intent is publicly known. But sometimes the stock price gains come over a longer period of time as news about what the activist is trying to do continues to trickle out, or bidding wars begin if a company might be put up for sale… and sometimes the gains are simply hard-won or come over time as actual improvements at the company are made.
Which is where Insider Monkey comes in, they say:
“… if you didn’t know anything about investing and all you did was mimic the campaigns alongside the funds, you still would have beat the market by a very large margin.
“Better yet, if you identified the best activist hedge funds and their most promising ideas by analyzing historical patterns, you could have beaten the market by anywhere from 28.3 to 153.2 percentage points annually!
“That’s what Insider Monkey’s new activist investor newsletter is all about.”
None of this activism has much of a quantifiable track record, frankly (I think the Journal of Finance article they’re talking about is this one from August 2008, and their data set is only seven years and seemed to me to indicate a decline in the “kick” from activism over that time), and every case is individual — so while I’d agree that following the best activist shareholders is probably going to work out, it almost certainly won’t work out with every pick, you’d have to trade a lot of them to give the strategy’s “edge”, whatever it might be, enough opportunity to work, and you’d probably have to be nimble and attentive enough to get in close to when the activists do, or at similar prices, for the best results.
So from my perspective, it’s an admirable goal and a worthwhile thing to study and it may be worth following these activist “whales” in your trading to some extent… but the data about past results isn’t that compelling because activists are all quite different, there’s no one strategy that works above others for activists, and no one seems to have really tracked the results of activist campaigns with a data set of compelling size or scope (understandably so — I assume it was a huge challenge just to gather the data for their study of 2001-2006 in that Journal of Finance paper)
But I’m always interested to read about stocks that are current or possible activist targets, so let’s see what the Insider Monkey folks are teasing in their ad campaign:
“At Insider Monkey, our proprietary software recently flagged a transaction by one of the best activist hedge fund managers.
“This hedge fund is well-known in the tight circles on Wall Street, but it’s still considered under the radar.
“The manager started this fund and what sets it apart is that those running it are known as ‘the nice guys on Wall St.'”
Oooh, OK — “under the radar” sounds good. Who is this investor?
“The fund manager has decades of experience serving in the M&A department at Morgan Stanley before making his career at one of the big private equity firms that were famous for their big leveraged buyouts (LBO’s) in the late 80’s. His firm was making so much money, it was profiled in the book ‘The Predator’s Ball.’Are you getting our free Daily Update
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“The new fund he started likes to operate a little under the radar. It doesn’t quite have the name recognition that Carl Icahn’s Icahn Capital or Nelson Peltz’s Trian Partners has, but this only serves as an advantage to you.
“What sets it apart from other funds is that it only invests in companies that will work with it, where it respects the management, who will listen to its suggestions and figure out what is best for shareholders.
“Basically, management at the targeted companies like him and don’t try to fight him!”
Ah, OK — this is perhaps less of a “name-recognition” guy than Ackman or Cohen or Loeb or Icahn, at least when it comes to retail investors, but he’s certainly a big and well-known activist investor. This is Clifton Robbins, who runs the Blue Harbour Group funds, and he’s certainly gotten his share of press — he was profiled as a “lover not a fighter” in the Wall Street Journal a couple years ago, he pitches his public positions on CNBC just like everyone else, and he is a member of the (large) camp of activists who generally prefer to avoid being “confrontational.”
Obviously, it’s easier to get management to change things than to force management out or replace the board — sometimes boards and management listen, sometimes they don’t and the adversarial stuff comes in, but Robbins says that his firm goes through a long process of engaging management before they buy stock in a company, he thinks there’s a place for aggressive activism but doesn’t want to do it himself. I think I’ve only written about Clifton Robbins once, back when he gave a presentation on Chico’s to the Value Investing Congress a couple years ago (the stock has been flat in the 20 months or so since then, for whatever that’s worth — he thought it was worth $22-28 and it’s never gotten close to that, Blue Harbour still owns more than 7% of Chico’s).
So which Blue Harbour stock is Insider Monkey talking about? Clues:
“We analyzed historical patterns and identified that one of the most successful activist campaign patterns is one where several activists target a company that has several lines of business.
“Considering our recommendation today, the targeted company is involved in five businesses, though they are famous for their nuclear operations and manufacturing.
“Most of these businesses are extremely profitable and resilient to recessions. They have long-term relationships with the Department of Energy, the U.S. Navy, and so on that go back decades.
“They are very profitable and have stable cash flows, something every investor loves. These are the types of businesses that you’d like to own forever.
“The problem is, however, that one of the business segments has been consistently losing money over the years.
“This business specializes in small nuclear reactors….
“… now the company that is targeted by our friendly activist already agreed to be split up into two separate companies within the next few months.
“Investors will be able to properly assess each business on its own merits.
“The activist fund is betting the market will rerate the stock with an immediate 40% increase to shareholder value within the next 6-8 months.”
So who is it? Thinkolator sez we’re looking at Babcock and Wilcox (BWC).
Babcock and Wilcox is a nuclear and energy firm with a pretty broad footprint in power plant technology and operations, but their two big businesses are nuclear power (they offer technical services to nuclear power plants and do waste handling, but their largest division makes the reactors that run aircraft carriers, submarines and the like) and power generation (emissions control, coal and gas-fired plant operations, renewable power, industrial equipment, all non-nuclear).
And, yes, they do also have a money-losing R&D project, called mPower, that helped to depress the stock last year — they are cutting their investment in that division down to a more manageable $15 million/year and looking for new partners, but it’s been a disappointment so far. That probably shouldn’t come as a huge surprise, the idea of small and modular nuclear power generation is appealing but every change in the nuclear business moves slowly… and really, it’s not a huge part of the business, but it’s where a lot of the future hopes for Babcock and Wilcox apparently rested. So cutting back on mPower spending is helping already, and their announcement back in November that they’ll be splitting the company roughly in half has also helped.
And Blue Harbour is the largest shareholder, with about 10% of the company — there are some other value/activist funds invested as well, including Starboard Value. Blue Harbour first announced a large stake in the company about a year ago, filing their 13D, and they added to their position over the Winter — the stock is close to where Blue Harbour probably acquired their 6% position, in the low-$30s, though presumably they lowered their cost basis when they added to the position in what was probably the high $20s late last year. But really, the price is pretty close to where it was when it caught the eye of the activists.
The big move by the company, arguably, was the slashing of their investment in the mPower project, which had been expected to suck up somewhere in the neighborhood of $60-100 million a year in R&D spending but is now targeted at about $15 million, but that decision from the company came a year ago or so as well. Activists have talked about cost overruns and bloated budgets, I don’t have any insight into that, and I haven’t seen Blue Harbour’s initial presentation that they made to a closed activist conference last year so I don’t know if the split in the company was part of the original “unlock value” plan, but it is the sort of thing that activists do generally like.
The spinoff will happen sometime fairly early this Summer, it appears, so it’s not far off now — BWC will remain as the nuclear business, which is mostly selling their small reactors to the US navy, and the new company will be called BWX Technologies and will own the power generation business. The argument is that BWX will be freer to expand more overseas to pursue power plant work, along with the typical spin-off arguments that the separate companies will benefit from more focused management and will be more attractive to investors as “pure plays” on their different business segments. That often works out well, though I can’t say that I know a lot about the prospects for power plant emissions control (or the competition in that segment) or for North American nuclear services and/or new nuclear naval vessels. Their earnings are quite volatile with new contract wins and the like, though the adjusted earnings that analysts generally go by look fine — the combined company earned about $2 a share by that measure last year, and is growing earnings at about 10% a year, so paying $33 for the stock seems perfectly reasonable (that’s a trailing PE of about 16.5, or a 2016 estimated PE of about 13).
I’d have to read a lot more to get comfortable with their spinoff plans and with a decision about which half of the company I’d want to hold on to (not that you couldn’t hold both, of course) — both seem like good businesses with large order backlogs, though their big cyclical drivers are quite different, and I haven’t seen a lot of detailed breakdown about what the margins or growth prospects are like for the different divisions. You can see the their most recent company presentation here which describes how the split will work, and they say they’ll continue working on margins, but that’s presumably also baked in to the analyst estimates and general investor expectations.
So what do you think? Interested in this activist target? It seems as though Blue Harbour isn’t done with their investment in this one yet, so they presumably see more opportunity for improvement — whether they really think it’s going to jump by 40-60% specifically, I don’t know. Frankly, at this point I’d probably wait to see whether the spinoff results in a wholesale selloff of one of the new companies and creates a compelling value opportunity, as often happens with spun-off divisions, but right now it seems, well, perfectly reasonable if not outlandishly exciting… and my sense is that although the power generation business is probably a steadier grower, it might be possible to get the nuclear business on the cheap. Fingers crossed. If you’ve got an opinion on Babcock and Wilcox, feel free to shout it out with a comment below.