Circle of Competence Issue #26

Quote of the week: "Someone is sitting in the shade today because someone planted a tree a long time ago." - Warren Buffett

FOOD FOR THOUGHT

This week, after reading a Harvard Business Review piece on why activist hedge funds aren't good for companies, and a New Yorker profile on Paul Singer (the doomsday investor), I decided to dive a little deeper into the empirical economics of activist investments.

There are industry practitioners who praise activist investors, and those who despise them. On the academic side, there are several who support the effects of activists with empirical data that seem to point to increased financial performance of targeted firms (Lucian Bebchuk, Wei Jiang). There are also other financial experts and economists that are not so sure that hedge fund activists create long term value (Dr. Yvan Allaire, MIT).

I also found two interesting pieces from the corporate law firm Wachtell, Lipton, Rosen, & Katz on defending and dealing with activist investors (including the typical activist's playbook) and the new paradigm of corporate governance that is meant to help preemptively deter activists and encourage long term value creation by corporations.

Finally, there's good ole' Warren Buffett, who has a small handful of early activist investments in his career, but predominantly believes that most activist campaigns (but not all) are short-term focused and out for publicity and a quick buck.

So, where did I end up after reading through all of this? Well, as best as I can tell here are a few general arguments that are raised on both sides of the aisle:

In favor of activism:

1. These activists are pushing for better allocation of capital.

2. They are pressuring weak or unethical corporate governance practices.

3. They bring a fresh take on the company's strategy if it needs to change direction due to external pressures (competition, industry dynamics changing, technological disruption, etc.)

Not in favor of activism:

1. Activists care only about shareholder returns and do not take customers, employees, or company values into consideration when taking a position.

2. Activists are short term players and operate as short term shareholders - generally implying cutting capex/R&D expenditures rather than making long-term investments at the business level.

3. Activists usually employ financial engineering to juice returns, regardless of what it may mean to the long-term health of the target firm.

All in all, I tend to agree with Warren Buffett - I'd rather work with management teams I trust and invest in great businesses I know than have to work hard myself on installing a good management team that can make a business great again. It seems also that communicating your firm's strategy and intentions clearly from the outset is incredibly important - Jeff Bezos always stressed long-term free cash flow for Amazon, Prem Watsa always reaffirmed the 20% return on equity hurdle rate for Fairfax, and Buffett set a 15% long term return on equity hurdle for Berkshire. In doing this, they helped to self-select long-term shareholders and avoided attracting shorter-term investors.

What is your take on activist investing? I would love to hear your thoughts on the discussion/articles above!

DEPARTMENT OF GENERAL FINANCE

- The yield of an empire (Jamie Catherwood)

- Value Investor interview: Brent Beshore (Seeking Alpha)

- Becoming Warren Buffett, the man, not the investor (New Yorker)

- Rare Charlie Munger & Li Lu interview (Gurufocus)

- KKR group eyes KFC, Pizza Hut in potential mega-deal (Pitchbook)

- Saudi Aramco is said to postpone IPO (NYT)

DEPARTMENT OF TECHNOLOGY

- Elon Musk wants to take Tesla private, but does the math work? (NYT)

- One investor wants Tesla to stay public (below - NYT)

- ARK Invest's open letter to Elon Musk to keep the company PUBLIC (Cathie Wood)

- Saudi wealth fund said to be considering $1B investment in Tesla rival (Pitchbook)

- Pitchbook thinks Uber should divest its Self Driving Unit

- Why can't Europe do tech? (Bloomberg)

DEPARTMENT OF STARTUPS

- Sonder (Airbnb rival) raises $85M to take on high end short term rental market (Pitchbook)

- Boxed raises $111M to ship groceries to customers at wholesale prices (Pitchbook)

- Root Insurance raises $100M for a $1B valuation to use customer's mobile phones to track driving habits and save them money on car insurance (TechCrunch)

- Getaround, a peer-to-peer car rental service, raises $300M (TechCrunch)

- Latch, a smart lock system that allows access control from smart phones, raises $70M

DEPARTMENT OF PODCASTS

- Brent Beshore with Patrick O'Shaughennessy on investing in small private family owned businesses (over 12,000 deals reviewed, 125 site visits, and 7 portfolio companies)

- BiggerPockets 293 - retire early and do what matters with real estate (Chad Carson)

- The Investors Podcast - momentum investing with Dr. Richard Smith