Activist Investor May Unlock Significant Value for Extreme Networks Shareholders

Oct.28.10 | About: Extreme Networks, (EXTR)

Corporate America has a problem. It has too much cash. Hang on… having too much cash isn’t bad, right? On the contrary, in fact. It seems like a nice problem to have.

But shareholders of companies that have massive wads of cash have a point in arguing that the executives should put the money to better use, rather than it earning next to nothing in the bank or in low-yielding investments.

Typically, investors want that money put towards growing the business instead, usually via acquisitions or by returning it to the shareholders.

But American companies aren’t listening. There is, however, a solution for everyday investors – and a company that could be primed to hand out a big windfall.

Getting Fat on $3 Trillion

U.S. corporations are currently sitting on a massive $3 trillion in cash. And the number is growing daily.

Lean companies are posting stronger earnings and cash flow, which is consequently generating even more more cash. And with interest rates so low, some companies are leveraging their balance sheets and taking on more debt in order to buy back shares or make acquisitions.

Additionally, private equity funds have about $500 billion on the sidelines looking for investments. Half of that money is due to be returned to investors over the next five years, so fund managers need to put that cash to work if they want to earn their hefty fees on the investments and profits.

And there’s one area in particular that is receiving a ton of cash.

Activist Investors: Keeping CEOs on Their Toes

Over the first nine months of the year, global mergers and acquisitions totaled $1.75 trillion – up 21% over the January-September period in 2009.

That’s a boon for large financial institutions like Goldman Sachs (NYSE: GS) and Morgan Stanley (NYSE: MS), who are often charged with brokering the deals. And with new laws forcing banks to separate their trading from other operations, firms like these are especially motivated to boost their investment banking revenue in order to replace the profits from proprietary trading.

Unfortunately, though, some CEOs feel the need to spend investors’ money on acquisitions, regardless of the value they receive for their purchases.

However, there is a remedy for this. And it comes in the form of activist investors. These are the individuals or institutions who own 5% or more of a company – and the ones who speak up to ensure that CEOs and other company executives remember their fiduciary duty to shareholders.

Activist Involvement = A Windfall for Investors

For example, when Charles River Laboratories (NYSE: CRL) said it would acquire WuXi PharmaTech (NYSE: WX) for $1.6 billion, hedge fund Jana Partners had something to say about it.

Jana owns over 7% of Charles River’s outstanding shares and thought the price for WuXi was too expensive for a company whose growth was slowing. Other institutional investors sided with Jana, too, and through its activist intervention, Jana forced Charles River’s management to scrap the deal and instead buy back $500 million worth of stock.

It’s far more common, however, for activists to force companies into a sale, thus handing shareholders a windfall in the process.

Take Cypress BioScience (Nasdaq: CYPB), for example. With the stock then trading at $2.50, activists forced a sale and received offers of $4 and then $4.25 per share.

Or when Carl Icahn famously bought ImClone Systems below $30 per share, he became Chairman of the Board and then sold the firm to Eli Lilly (NYSE: LLY) for $70 per share.

And with so much cash sloshing around, more activists are pressuring companies to unlock shareholder value and explore their acquisition options. So who’s next?

Head to Santa Clara for This Activist-Driven Buyout Candidate

I believe Extreme Networks (Nasdaq: EXTR) is likely to be acquired in the near future.

The Santa Clara-based networking infrastructure company is undervalued and activist investor Ramius is trying to do something about it. After a fight, the company and Ramius recently came to an agreement to add an independent member to the board of directors.

I wouldn’t be surprised to see Ramius urge the new board to put the company up for sale in the near future – a move that would unlock significant value for shareholders.

There’s a lot of cash looking for a home, which is brewing up the perfect storm for mergers & acquisitions. And increasingly aggressive activist investors will push for deals to get done.

Result: Shareholders will benefit.

Disclosure: None. Investment U expressly forbids its writers from having a financial interest in any security they recommend to our subscribers. All employees and agents of Investment U (and affiliated companies) must wait 24 hours after an initial trade recommendation is published on online - or 72 hours after a direct mail publication is sent - before acting on that recommendation.

Disclaimer: The Oxford Club LLC/Investment U and Stansberry & Associates Investment Research are separate companies, and entirely distinct. Their only common thread is a shared parent company, Agora Inc. Agora Inc. was named in the suit by the SEC and was exonerated by the court, and thus dropped from the case. Stansberry & Associates was found civilly liable for a matter that dealt with one writer's report on a company. The action was not a criminal matter.