THE SUPERSTOCK INVESTOR PHẦN 7 docx

CHAPTER TWELVE Family Feuds Here’s another lesson to be learned from the ADT-Western Re- sources takeover saga we examined in Chapter 9: When animosity develops between a company and its major outside shareholder, the eventual result is often a takeover bid. In the case of ADT–Western Resources, the discord that developed between these two companies made it extremely unlikely that Western Resources would simply sit silent- ly on the sidelines as a passive outside investor.The two more like- ly scenarios: ADT would either attempt to sell itself to a third party (which it did) or Western Resources would attempt to buy ADT and remove its directors and top management (which it tried to do). Therefore, a useful rule of thumb is that you should pay close atten- tion when disagreements arise between a company and an outside “bene- ficial owner,” especially when these disagreements break out into a public squabble. Consider the following case study as another example. CASE STUDY: COPLEY PHARMACEUTICALS On July 27, 1998, two directors of Copley Pharmaceuticals (CPLY), a generic drug manufacturer, resigned. They did not go quietly. One of the directors, Agnes Varis, publicly blasted Hoechst AG, a huge German chemical and pharmaceuticals company that owned 51 per- cent of Copley. According to Varis, Hoechst had disrupted Copley’s operations by continuously changing its mind about what it wanted to do with its Copley stake. Hoechst, said Ms. Varis, “was demoralizing 149 Chap 12 7/9/01 8:56 AM Page 149 Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use. management and depressing shareholder value.” She complained that Hoechst “forced Copley to hire investment bankers and spend millions of dollars in fees and time of key Copley personnel who could have been developing new products and expanding Copley’s busi- ness.” She claimed that after forcing Copley to go through the process of hiring an investment banker, Hoechst decided it did not want to sell its stake after all. In a parting shot Varis added: “I’ll serve Copley’s shareholders better from outside the company. You can’t do anything inside.” Agnes Varis’s stinging public criticism of Hoechst AG was high- ly unusual. From time to time you will see private disagreements between officers or directors of a company and a major sharehold- er. Usually, these disagreements come in the form of structured let- ters, written by attorneys, that are “leaked,” filed with the SEC as a 13-D amendment, or simply released to the press. In most cases these disagreements arise between mutual fund companies or pension funds that hold sizable stakes in a company and that, for one reason or another, are unhappy about the direction the company has taken. Investment companies in particular have been taking a more active role in recent years to get corporate managements to take actions that will increase the stock price. It’s not unusual for an insti- tutional investor to take a stake in a company, sit with it for a while, and then fire off a letter to management suggesting the company take steps to “enhance shareholder value” or “maximize shareholder value.” Sometimes, the institutional investor will release the letter to the press, perhaps do a round of television interviews, and feign outrage over the manner in which the company has been managed or mismanaged. In reality, in most cases the institutional investor is trying to light a fire under a losing position—i.e., trying to bail out of a mis- take by bullying the management into taking short-term actions that could boost the stock price. For a while these public relations tactics seemed to work, but in recent years corporate management has learned that the best way to deal with institutional saber rattling is to simply ignore it. Institutions like mutual funds or pension funds are, for the most part, not equipped to get down into the trenches and force the man- agement of a company to put itself up for sale to maximize value. An institutional that owns, say, 5 to 10 percent of a company would be 150 PART TWO Identifying Takeover Targets Chap 12 7/9/01 8:56 AM Page 150 TEAMFLY Team-Fly ® more likely to send up a few threatening flares, see what happens, and then quietly liquidate its position on any runup in the stock as a result of the brouhaha. So, don’t take it too seriously when a mutual fund or a pension fund sends a letter to a company criticizing management and demanding that steps be taken to “enhance shareholder value.” Any management that has been paying attention to recent trends should respond with a polite letter thanking the institution for its thoughts, and then go back to running the business. This sort of publicity gam- bit usually won’t lead to a takeover bid. The situation at Copley Pharmaceuticals, as you will see, was quite different. The background of the Copley Pharmaceuticals- Hoechst AG situation following Agnes Varis’s public blasting of Hoechst indicated that the bitterness between Copley and its largest shareholder would probably lead to one of two outcomes: Hoechst would bid for the 49 percent of Copley it did not already own and throw out Copley management, or Copley would find a third party to buy the Hoechst stake and then acquire the rest of the company, which would effectively result in Copley throwing out its 51 per- cent shareholder. Copley Pharmaceuticals had gone public in October 1992 at $12.67 per share, adjusted for a subsequent 3-for-2 split. Copley stock went straight up, and in the fall of 1993 Hoechst AG arrived on the scene, offering to pay $55 per share for a 51 percent stake in Copley, proving that even a gigantic international pharmaceuticals compa- ny can act like a lemming under the right circumstances. It turned out that Hoechst had made its move right at the peak, and Copley shares began a long, downhill slide that took the stock down to the $5 to $6 area by early 1997. The drop in Copley’s stock price was helped along by the recall of one of its products due to contamination problems, and by shrink- ing profit margins and brutal price competition in the generic drug business. On the way down, Agnes Varis purchased additional Copley shares in the low $30s, proving that even corporate insiders can misjudge a company’s prospects and the future direction of its stock price. In September 1996, Hoechst publicly stated that Copley did not fit its “core” business strategy, and forced Copley to hire an invest- ment banker to look into the possible sale of the company. This move, CHAPTER TWELVE Family Feuds 151 Chap 12 7/9/01 8:56 AM Page 151 according to Varis, severely disrupted Copley, its management, and its employees. Nothing came of these efforts, and Copley shares lan- guished in the $5 to $6 area until Varis left the company and issued her public criticism of Hoechst. In August 1998 we noted that a “standstill agreement,” which prevented Hoechst from buying additional Copley shares, would expire in October 1998. What is a standstill agreement? Sometimes, when one company buys a sizable stake in anoth- er company, the purchase is subject to certain conditions. One of the conditions may be a limitation on any future purchases of stock for a specified period of time. Generally, these agreements will say that Company A cannot increase its stake in Company B beyond a certain percentage without expressed permission from Company B. That’s a standstill agreement. Whenever a big chunk of one company is owned by another, you should check the terms of the standstill agreement to see what the terms are and, most important, when the standstill agreement expires. You can find this information in a company’s 10-K report, which is the annual report filed with the SEC. When the relation- ship between a company and an outside beneficial owner is turn- ing testy and the standstill agreement is set to expire soon, it indicates that a takeover situation may be about to unfold. As a result of this research, Copley was recommended in the newsletter as an “additional idea.” In September 1998, Copley Pharmaceuticals was added to the superstock recommended list. The stock price for Copley at the time was $8 3 ⁄4. The news that Hoechst AG had decided to undergo a cor- porate restructuring was significant. In a situation like this, where a general corporate “housecleaning,” such as Hoechst was about to undergo, would take place, a decision was likely to be made about Hoechst’s 51 percent stake in Copley. Now, all of the pieces were in place for a takeover drama to unfold. Every relationship, even personal relationships, start out with high hopes. But when the relationship sours and both parties begin to get on each other’s nerves, it is only a matter of time before a sep- aration has to take place. 152 PART TWO Identifying Takeover Targets Chap 12 7/9/01 8:56 AM Page 152 When the relationship is personal, it may be a relatively easy matter to dissolve it. But in the corporate world things get a bit more complicated. The next time you see a story in The Wall Street Journal similar to this one, where a corporate insider resigns in a huff and criticizes management, the Board of Directors, or a major sharehold- er, and starts to talk about enhancing shareholder value or doing what’s best for the shareholders, you have encountered a Telltale Sign of new paradigm thinking. In situations like this the usual outcome is that someone, somewhere, will make a bid for the company in question because that is usually the only way to settle disputes where two parties that are inextricably linked no longer see eye-to-eye. It seemed clear to me that Hoechst or some third party would have to make a bid for Copley. Unfortunately—or perhaps fortu- nately, depending on how you look at it—it wasn’t clear to anybody else. Copley shares sank as low as $6 by October 1998, providing new paradigm thinkers, who were focused on the takeover possi- bilities by recognizing one of the Telltale Signs, an ideal opportuni- ty to buy more Copley shares at what would turn out to be bargain- basement prices. Late in 1998, I appeared on CNBC and predicted that Copley would become a takeover target. The stock ran up briefly, then sagged back and traded listlessly in the $8 to $10 range. In December 1998, with Copley trading at $8 7 ⁄16, there were rumors that Hoechst AG was about to merge with France’s Rhone- Poulenc SA. The rumors, if true, would create the world’s second- largest pharmaceuticals company. Remember, Hoechst had an- nounced a planned “restructuring,” and in fact Hoechst had already sold several of its noncore operations, including its paints business. Here is how we analyzed this rumor of a potential Hoechst– Rhone-Poulenc linkup in terms of Copley: As Hoechst is reinventing itself and moving to focus on pharmaceu- ticals while divesting itself of unwanted operations, Copley Pharm- aceuticals could become an issue to deal with. I would not be sur- prised to see Hoechst either bid for the rest of Copley and assimilate the company completely, or sell its 51 percent stake in Copley to a third party who might bid for the rest of the company. Given Copley’s book value of $5.30 per share, any time this stock drops down to the $6 to $7 area I would rate it as a strong buy. I think Copley has a good risk/reward ratio anywhere in the $6 to $9 range. CHAPTER TWELVE Family Feuds 153 Chap 12 7/9/01 8:56 AM Page 153 In February 1999, with Copley trading at $9 11 ⁄16, Hoechst had been selling off some of its smaller, noncore operations and we indi- cated that “the idea that Hoechst may simply sell its Copley stake to someone else has actually gained the upper hand over the past few weeks, as Hoechst has been selling off one small operation after another. Copley could be part of this trend.” And then we added: “The difficult matter in analyzing Copley is determining what this company might be worth. If you find that hard to believe, remember that Hoechst paid $55 per share for its original Copley stake!” As things turned out, that last statement was significant. It’s usually a lot easier to figure out that a takeover bid is com- ing than it is to determine the price at which the takeover bid will take place. In most cases, you will see a takeover bid take place at a pre- mium—sometimes a significant premium—to a stock’s 52-week high. In nearly all cases, a takeover bid will a carry a premium to a stock’s average trading price over the past 30 or 60 days. Only in rare cases, where word of a takeover bid has leaked and a stock has had a dra- matic price advance, will you see a takeover bid at virtually no pre- mium to the previous day’s closing price. And once in a blue moon, when word of a takeover has leaked so badly that the target com- pany’s stock has really soared, you will witness what is called a take- under—a situation where the takeover price is actually lower than the previous day’s closing price because advance word of the deal was so widespread that speculators got carried away and simply bid the price of the target company too high. In the case of Copley Pharmaceuticals, we had a buy limit of $11 1 ⁄2 on our recommendation. However, based on some apparent improvement in Copley’s earnings, and influenced by the fact that Hoechst had paid an incredible $55 per share for its original stake, it seemed that raising the buy limit on Copley to $13 would be a sound move. At that point, Copley was trading near $10 1 ⁄4. By April 1999, Copley had crossed $11 3 ⁄4. For the next several months, Copley trad- ed quietly between $8 3 ⁄4 and $10 1 ⁄2. Then in June 1999, a news item was the clincher. Copley was trading at $9 15 ⁄16 when Hoechst announced that it would spin off its Copley stake as part of Celanese AG, a Hoechst operation containing most of Hoechst’s chemical and 154 PART TWO Identifying Takeover Targets Chap 12 7/9/01 8:56 AM Page 154 industrial businesses. This was a curious move, since Copley did not fit the Celanese business model at all. This spinoff made it crys- tal clear that Hoechst would be willing to part with Copley at the right price. This move, which angered Copley shareholders, made it even more likely that some of Copley’s other major shareholders would try to take Copley private or sell it to a third party. For the next 2 months Copley traded quietly between roughly $8 1 ⁄2 and $10 1 ⁄2. Then, on August 10, 1999, Copley jumped 21 percent in one day, following news that Teva Pharmaceuticals of Israel had agreed to buy Copley for $11 per share in cash. As part of the deal, Hoechst AG also agreed to sell its 51 percent stake in Copley to Teva for $11 per share. Anyone who had bought Copley at $8 3 ⁄4 would have made a profit of 25 percent, based on this $11 takeover bid, in 10 months. Anyone who had followed the growing body of evidence that a takeover bid for Copley was brewing and had taken advantage of dips in Copley’s stock price to the $6 to $7 level would have done much better in percentage terms. And, to be perfectly fair and honest about this, anyone who paid $10 to $11 for Copley would have just about broken even as a result of the takeover bid. To repeat, the toughest part of uncovering takeover targets is not finding the targets themselves. The toughest part, especially when we are dealing with smaller companies, is trying to determine what the ultimate value of the takeover bid might be. When a certain industry is consolidating and a number of takeovers have already taken place, it is often possible to establish a benchmark value that will give you a general idea of what a com- pany would be worth in a takeover situation. In other industries, however, pegging a value is more difficult. In the end, Copley proved solidly profitable, although less prof- itable than anticipated. But the most important lesson to be learned from the Copley Pharmaceuticals saga is that the original analysis, based on the orig- inal evidence, proved to be accurate. The next time you see a public disagreement erupt between a company and its largest shareholder—especially if that sharehold- er is another corporation, and not an investment company—you CHAPTER TWELVE Family Feuds 155 Chap 12 7/9/01 8:56 AM Page 155 should think in terms of a potential takeover bid. The next time you see a public disagreement between a director and a company’s man- agement—especially if the director resigns and makes statements about protecting shareholder interests or enhancing shareholder value—you should think in terms of a potential takeover bid. In the world of the stock market, a family feud is often the first sign that a company is going to wind up being acquired. 156 PART TWO Identifying Takeover Targets Chap 12 7/9/01 8:56 AM Page 156 PART THREE Takeover Clues Chap 13 7/9/01 8:58 AM Page 157 Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use. This page intentionally left blank. [...]... later, this $7 stock was trading at $42 and had earned the honor of being the best-performing stock on the New York Stock Exchange for 1991! But the road from $7 to $42 was a tortuous one As is the case with most superstocks, the WMS saga was dotted with twists and turns that provided a number of bargain-priced buying opportunities but also tested the willpower of those who were attuned to the superstock. .. supposed to allow the company to accumulate cash to replace the machine when its useful life wears out in 10 years That is the purpose of the depreciation allowance The other effect of that $100,000 depreciation “expense” is to reduce the carrying value, or “book value,” of the machine on the company’s balance sheet At the end of the first year that $1 million machine will be carried on the books at its... feel for the reasoning behind the liquidation plan The oil and gas analysts were hopelessly confused They had never come across a voluntary liquidation and they did not know now to handle it Besides, Kirby was not on their radar screen; the TE Chap 13 Team-Fly® Chap 13 7/ 9/01 8:58 AM Page 171 CHAPTER THIRTEEN “Beneficial Owner” Buying 171 company was too small Their advice was to stay away from the situation... move together Other times there will be a brief lag—days or a week or two at the most—before the other stocks in the industry group start to move up in sympathy with the leader In recent years the lag time has grown longer, a phenomenon that has to do with the increased institutionalization of the stock market and the narrowing of analytical coverage discussed earlier Since institutional investors are... Buying 179 no institutional interest will often sit there for weeks on end, not participating at all in the general strength of other stocks in their industry group Eventually, the realization that other stocks in the industry are making new highs will filter down to even the smallest stocks in the group—but the lag time having grown significantly longer, presents an opportunity to individual investors... value.” There was a high possibility, then, that these properties were worth more than the stock market was giving WMS credit for Not only that, for WMS to even consider a plan to unlock the value of these properties could mean only one thing: WMS management believed they were worth more than the stock price was reflecting and were looking for ways to force the stock market to reflect that value Then there... him and asked him what the announcement meant The assets of this company,” he told me, “are worth way more than the stock is selling for They have properties with proven oil and gas reserves that are worth far more than book value They have other properties that are adjacent to major discoveries where they haven’t even started drilling yet, but they know the oil and gas are there They even have a small... liquid, large-cap stocks, they will pour their money into the biggest companies if they see something that leads them to believe they should be weighted in a certain industry group The mid-size companies will usually follow along quickly if the industry leaders are breaking out to new highs But, the smaller companies with no analytical coverage and Chap 13 7/ 9/01 8:58 AM Page 179 CHAPTER THIRTEEN “Beneficial... company will understate the actual value of its assets It can also work the other way If a company buys a piece of land for $1 million, based on a bet that this land will soon be directly in the path of a brand new highway, but then the Highway Department decides to build the highway someplace else, the land may not be worth $1 million anymore But the company may keep the land on the books at its historical... to the upside, virtually every other stock in that industry will eventually move up in its wake The reason for this tendency makes perfect sense Whatever bullish developments are inducing investors to buy the industry leader should also apply to other companies doing business in that industry Sometimes, there will be no “lag time” at all, and all of the stocks in the industry group will move together . this $7 stock was trading at $42 and had earned the honor of being the best-performing stock on the New York Stock Exchange for 1991! But the road from $7 to $42 was a tortuous one. As is the. recommended in the newsletter as an “additional idea.” In September 1998, Copley Pharmaceuticals was added to the superstock recommended list. The stock price for Copley at the time was $8 3 ⁄4. The news. shareholder value.” Sometimes, the institutional investor will release the letter to the press, perhaps do a round of television interviews, and feign outrage over the manner in which the company has been