The Chinese Zodiac says 2011 is the Year of the Rabbit. According to tradition, it’s supposed to be a period of relative calm and diplomacy, where people should opt for negotiation, rather than forcing an issue.
It would be nice if that happened. But don’t expect it to occur in the stock market.
I believe confrontation between executives and shareholders will take center stage in 2011, as activist investors increasingly get in the faces of underperforming management teams.
But a little rumble here and there is good news for investors, as history has shown that this tactic ultimately drives the shares of those companies higher. And here’s where the scraps will occur in 2011…
The Activist Investor Objective
If you’re unfamiliar with investor activism, it’s when a large shareholder (who owns 5% or more of a company) files a 13D document with the SEC, insisting that the company’s management make changes. Those changes can include…
- The sale of the company.
- Non-performing businesses or assets shut down or sold.
- Seats on the board of directors.
- Instituting a share buyback or special dividend.
- Firing the CEO or replacing members of the board.
- Reining in executive compensation.
As 2010 comes to an end, we’re already seeing a few high-profile activist investor situations. And it’s no surprise to see one of the most prominent activists, Carl Icahn, right in the mix…
The Activists Investors Have Jumper Cables for These Stocks
Icahn has made several tender offers for Lions Gate Entertainment (NYSE: LGF). His goal is to streamline the movie distributor and eventually merge it with Metro-Goldwyn Mayer.
And Lions Gate shares have responded by climbing from a 52-week low of $4.81 in early February (shortly before Icahn got involved) to over $7 today.
But it’s not the only instance of activist involvement…
- Massey Energy (NYSE: MEE): In early December, activists including the California State Teachers Retirement System (CalSTRS) pushed the CEO out the door. He was blamed for the company’s poor safety record, which resulted in a deadly mine explosion earlier in the year. The stock popped 2.4% the day the announcement was made.
- Fortune Brands (NYSE: FO): Shares have jumped over 20% in two months since activist investor Bill Ackman suggested the company split up its diverse businesses. This month, the company said it will spin off the home security and golf segments in order to focus on its lucrative spirits division.
And in 2011, I expect investor activism to rise further. Here’s why…
Three Reasons Why the Activists Will Be Out in Force in 2011
There are a few compelling reasons for activists to up the ante next year. Among them…
- Corporate Cash: There’s approximately $3 trillion sitting on corporate balance sheets. With so much cash on the sidelines, shareholders aren’t going to be content seeing it earn a measly 0.5% in the bank; they want companies to acquire businesses that will fuel growth. And that’s where activists come in. They’re intent on capturing some of it by forcing the management teams of underperforming companies/stocks to do more to unlock shareholder value.
Take some of the market’s major players, for example…
- Microsoft (Nasdaq: MSFT) is sitting on $44 billion.
- Google (Nasdaq: GOOG) has $33 billion in its coffers.
- Apple (Nasdaq: AAPL) has $26 billion in the bank.
- In the healthcare space, Pfizer (NYSE: PFE) and Johnson & Johnson (NYSE: JNJ) boast $23 billion and $22 billion, respectively.
- Occidental Petroleum’s (NYSE: OXY) nest egg is $3 billion.
It would mean nothing for most of these companies to drop a few hundred million here or a few billion there to acquire a company that will help them grow earnings in the future. Meanwhile, it would be a windfall for shareholders of the acquired companies.
- Success Breeds Success: As activists like Icahn and Ackman score big victories, they and others will be emboldened to try to repeat those successes.
- Rally-Grabbing: The S&P 500 is up around 11% year-to-date. But investors in companies that haven’t participated in the market’s rally won’t want to be left behind again. They’ll take steps to ensure that management teams work harder to make them money.
So who are some of the likely candidates to benefit from investor activist involvement in 2011?
These Activist Investor-Driven Stocks Could Soar in 2011
Expect the usual suspects in the activist world to be front and center of the headlines next year, with their presence all over the following stocks…
- Lions Gate Entertainment: On the rare occasions when Carl Icahn doesn’t get his way, he doesn’t go away without a fight. I suspect he’ll gain control of Lions Gate in 2011.
- JC Penney (NYSE: JCP): Bill Ackman already owns more than 16% of the company. JC Penney has more than $2 billion in cash and owns over 400 of its 1,100 stores. Many on Wall Street believe Ackman will push the company to return some of that cash to its shareholders. Bill Ackman’s also known for his savvy when it comes to real estate, so some are speculating that he might push JC Penney to sell some of the real estate on which its stores currently sit.
- Endologix (Nasdaq: ELGX): The company makes medical devices, including the Powerlink System used to repair abdominal aortic aneurysms, which are fatal in over half of all cases if left untreated. Powerlink is a minimally invasive method of repair, versus the standard procedure of opening up a patient, moving organs around and repairing the aorta.
Activist investor Elliott Associates owns 12% of the company and has an excellent track record of investing in undervalued companies.
Not only that, earlier this year Covidien (NYSE: COV) bought ev3 – a device maker that treats vascular disease – for over six times its revenue. It’s very reasonable to believe that Endologix could fetch the same price tag from a company that wants a business growing at a 20% clip per year.
If Endologix hits the 2010 sales consensus of $66 million, it could easily garner a price tag of more than $8 per share, roughly 25% higher than the current price.
2011: The Year of Activist Investors
In conclusion, expect to see many stocks get a boost from activists in 2011. And it’s well worth tracking these guys, since the stocks they get involved with historically outperform the broader market by 21% per year.
Get in the know and you can get a slice of these gains, too. I’ll be spending 2011 tracking the movements of all the heavy-hitters in my Activist Trader service.
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