In a market stuffed with price-shifting financial “Disruptors,” the proliferation of “activist investors” is a front-and-center catalyst we’re going to follow and cash in on.
We’re addressing activist investors today because one of the biggest noisemaking players in the biz is back in the news with his latest move.
I’m talking about Bill Ackman, the billionaire hedge fund manager who runs Pershing Square Capital Management LP. With $20 billion in assets under management, Pershing Square is an activist investor in publicly traded companies. And it was a top-performing fund last year.
Ackman’s latest target is Mondelez International Inc. (Nasdaq: MDLZ), a packaged-food giant and spin-off from Kraft Foods Group Co. with a $76 billion market value.
Unlike most spin-offs – which, as a group, tend to be market-beaters – Mondelez has frustrated analysts and investors by underperforming. Although the stock has accelerated a bit of late, the fact is that since the 2012 breakup, Mondelez shares are up only 20% – versus 50% for the Standard & Poor’s 500.
Companies like this are prime targets for activists like Ackman, former corporate raider Carl Icahn, Nelson Peltz or the late Kirk Kerkorian.
Investors of this ilk take big stakes in moribund or cash-rich companies and lean on management to make changes – pushing the “C-suite” execs to slash costs, boost buybacks or launch or raise dividends.
Investor activism is increasing.
That makes it a Disruptor that’s capable of generating meaningful wealth.
But you have to pick the “right” activist stock.
As I’ll show you today…
Activists Show You the Money
A 2012 study by London-based research firm Activist Insight found that mean annual net return of more 40 activist-focused hedge funds outperformed the MSCI World Index in the years following the 2008 global credit crisis.
In fact, activist investing was the top-performing strategy among hedge funds in 2013. Firms using that strategy generated average gains of 16.6% – nearly double the 9.5% average return of other hedge-fund players.
Remember, those are just averages. If you pick the “right” activist target, you can generate extreme profits. As I know myself.
Back in July 2013, for instance, I went on record and recommended Apple Inc. (Nasdaq: AAPL) at a point when many investors were writing off the iDevice King as a company whose best days were behind it.
I knew better.
Just weeks after my public recommendation, Icahn launched an activist campaign against Apple, using social media tools like Twitter and “open letters” to CEO Tim Cook as his “weapons” of choice.
The cash-rich Apple ended up enacting a dividend program and launched into aggressive buyback mode. It also generated stunning results with iPhone launches and a long-term commitment to an “ecosystem” strategy that will keep the company on a growth path for a long time to come.
From a split-adjusted recommendation price of $60.10 a share, Apple’s stock soared as high as $134.54, for a peak gain of 124%.
That’s a great result for any stock – but especially for the mega-cap shares of the most valuable company in the world.
And this story underscores the massive profit potential that comes with choosing the “right” activist stock.
Mondelez may not be a “right” stock. Sometimes the best trades are the ones you don’t make.
A Mouthful of Trouble
Ackman’s Pershing Square grabbed a 7.5% interest in Mondelez, worth $5.5 billion.
That’s a really big target to take down and digest. And the challenges facing Mondelez are also serve up some food for thought…
Although the company owns some great brands – like Oreo cookies, Trident gum and Cadbury chocolate – and has a big position in developing markets, Mondelez was supposed to be a high-growth proposition. It just hasn’t played out that way.
Consumer tastes have been changing. Given Mondelez’s product lineup of biscuits, cookies, crackers, salted snacks, chocolates, gums and candies, powdered beverages and coffee, I’m not convinced the firm is focused on growth areas.
The results bear this out. Mondelez’s categories saw growth slow from 6% in 2012 to less than 4% in 2013 to a wheezing 2% last year. In its most recent earnings report, per-share earnings fell 30.6% on a 9% drop in revenue.
So I’m not inclined to piggyback on “Ackman the Disruptor” on this one.
The principal reason is that I don’t believe you can make enough money on this trade for the risk you’ll be taking. I’m not convinced that if a buyer for Mondelez emerges the buyout price will represent enough of a premium over the stock’s current market price (which happens to be pretty close to its high) to make it worth my while.
It’s different for Ackman because he bought lower, used a ton of leverage thanks to options and forward contracts and stands to make a great return if the stock goes up between 10% and 20%.
A 20% return would be a great result for a short-term trade. But there’s no guarantee that will happen. Add in the attendant risk of the stock slipping back if no buyer emerges – or the fact that I might have to tie up my capital and hold onto the position for a long time, while additional value is created by Ackman and management – and you can see why a follow-on Mondelez trade isn’t for me.
But if you want to take a shot at this, here’s how I would play it.
I’d buy the stock here at around $46.25, and I’d buy the December $46 puts for about $2.45.
That way I can participate on the upside if a buyer comes in and be mostly covered on the downside if the stock falls back from now until the puts expire in December.
If a 20% premium bid for the company were to emerge here, the stock would go to $55.50.
The position I created would cost $48.70 – $46.25 for the stock plus the $2.45 per share for the puts. So I’d make $6.80 per share, or 13.95%, on my position.
Of course, the stock could go higher and I’d make more.
But it could go down, too.
If the stock falls, I’m covered and my loss would be limited to the difference between the price I paid for the stock – $46.25 – and the “protection” I get by owning puts with a strike price of $46. That amounts to a 25-cent-per-share loss, plus the cost of those puts of $2.45, for a total possible loss of $2.70 per share.
Risking $2.70 to make an unknown profit – but maybe $6.80 or more per share – isn’t my idea of a good piggyback play on account of the unknowns and what I can do with my capital elsewhere.
There are lots of Disruptor plays – many with activist investors – that are a lot better than the way this trade sets up.
The beauty of all those Disruptor opportunities is I’ll be telling you about them right here.
My colleague Michael Robinson – director of Venture Capital and Technology Investing here at Money Morning – also discusses disruptors often.
The ones he shares with his readers, of course, are mostly in Silicon Valley.
And just recently, he uncovered another tech market in Silicon Valley- and it offers windfall profit plays that dwarf those you can find in the Nasdaq and the NYSE. This “other” tech market is a playground of the rich – and it’s inhabited by the top venture capitalists, private-equity players and so-called “high net worth” investors.
That’s why Michael put together this short presentation to help explain this exciting new venture capital “partnership” to you all.