Corporate Raiding: A Revisionist Interpretation Of Icahn's Bid For Clorox

| About: The Clorox (CLX)

They have been called everything from corporate gadflies to barbarians at the gate. Their efforts to empower shareholders over under-performing, often somnambulistic, boards have been maligned as "short-sighted" and "self-serving". And their attempts to accumulate beneficial ownership and contest these boards have been challenged in a variety of ways: poison pills, staggered boards, plurality voting standards, and denial of proxy access, to name a few. While some of these corporate defenses are certainly legitimate in giving target companies time to think out a takeover and/or proxy fight, often they are value destructive. Accordingly, these defenses are on the decline for a reason: see here, here, and here.

Before analyzing Carl Icahn's strategic campaign at Clorox (NYSE:CLX), it is time to set the record straight. A review of the academic research, while not completely in agreement, reveals that shareholder activists (i.e. "corporate raiders") mostly have a positive and significant effect on value creation, especially in the area where M&A is concerned (like it is for Clorox).

Activists have a unified purpose: to grow shareholder value. According to a 2008 study: "The abnormal return around the announcement of activism is approximately 7%, with no reversal during the subsequent year." 62% of the stocks monitored experience positive abnormal returns in the (-20, 20 day) time window. An impressive 25% of the stocks even experienced 17.3% or greater stock market returns.

Moreover, in the long-term, ex-post evidence confirms the rationality of the market: the target companies reveal improvements in operating performance and payouts. These changes are due to the accountability imposed by the activist and the subsequent reductions in agency problems on free cash flows.

Contrary to accusations of "short-termism", the majority of activist hedge fund managers also engage with management for no less than a year. 17 months after the 13D filing, long-term abnormal returns are around 10.5%. According to my own research, risk-adjusted returns also tend to be around 20% higher when the activist is hostile. Brav, Jiang & Kim find a similar result indicating that proxy fights may be an appropriate way to enact corporate change when communication breaks down.

Finally, activism that aims for a sale tends to generate the highest abnormal stock returns. Measured 17 months after the 13D filing (pdf), long-term abnormal returns are around 25% for a company that completes a takeover. My own research, again, is roughly consistent with this finding. While Icahn's activism on Clorox can ultimately be an exception, it is important to keep the record in mind when analyzing his activity.


Analysts have been doubtful of Carl Icahn's efforts to get Clorox, the iconic consumer goods company, to sell itself. Icahn owns 9.51% of Clorox and is running a proxy contest to replace the entire board. If elected, he stated that he would continue to pursue the sale and back-stop the auction with a $78/share bid financed half in cash and half in senior unsecured notes.

It may be difficult for Icahn to convince shareholders to side with him, despite similar past successes at ImClone, Biogen (NASDAQ:BIIB), and Genzyme (GENZ). For one, 4Q profits for Clorox declined less than anticipated and the company is expensive. Icahn's own bid values the company at of 18.3x earnings--a multiple exceeding that of the acquirers he has referenced. As the activist previously stated, he is betting partly on the synergistic value.

A previous author argued that Clorox should reject the bid, because the company has tremendous untapped potential in emerging markets. My rebuttal is that it has tremendous accretive value to companies already operating in those emerging markets. While Clorox is an expensive stock, it is a great brand that can help another great brand take over a significant part of the market. Keep in mind that Clorox grew its market share during the economic downturn, a success largely due to its respected household products.

Unilever (NYSE:UL), in particular, has recently acquired a detergent company and a brand like Clorox could help them gain market share over, say, Colgate-Palmolive (NYSE:CL). The consumer goods industry is highly competitive and all of the six strategic buyers that Icahn cites are major leaders. Should one of those leaders make a bid, it is a good possibility that the others would follow suit for fear of the ramifications. Absent a single bid, however, shares will likely fall far below the price that even Icahn is asking for. A successful Icahn proxy contest would likely bring about an effective sale process.

Running my own analysis, I find that Icahn's offer is at around a 6.1% free cash flow yield to next year's probable results. The derivative of COGS year-over-year growth is likely negative. While I predict COGS to increase by about 2.1% to $3,020 million from 2011 to 2012, I also predict that rate to decline to about 0.8% over the following year. Clorox also spends 9.5% of its revenue on advertising. Much of these costs could be contained if the bleach-maker were to sell itself.

While I rate the company somewhere between a PERFORM and a BUY based off of the fundamentals, from an M&A and activist perspective, I believe that Clorox provides a significant growth catalyst for other companies. By effectively letting shareholders vote for the auction process, Icahn is liberating the brand to maximize its value and options.

In conclusion, there are records and then there are fictions. The record is that Icahn has been successful in strategic activism and the strategy has been successful in general. The fiction is that the "corporate raider" moniker applies to Icahn (i.e. it presents a misleading image of his success). Hopefully, Clorox does not go Yahoo! over the latter.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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