12 February, 2010
Many investors ask themselves if it is possible to predict which companies will be targeted by activist investors. The motivation to do so is understandable. First, once activists are on-board, they will actively influence company and will do all in their power to make sure business value is reflected in the share price.
In addition, disclosure of share ownership by activist investors and large hedge funds is moving the shares of company up. Identifying future targets can give investors an extra edge and improve returns. As British economist John Maynard Keynes said:
“Successful investing is anticipating the anticipations of others”
Can this be done with activists? And if yes, how?
The possible solution suggested by research firm Activist Insights in one of their reports is a correct step in the right direction. Researchers from Activist Insights found few significant factors that might help investors predict future targets of activists. Among these factors are recent share price performance, company’s return on equity, institutional ownership and presence of hedge funds that are known for activist campaigns.
However, I believe this is not enough for intelligent investors. The reason being that reverse engineering the features of companies activists target is an exercise in “retroactive” data mining. These factors and features certainly point one in the right direction overall. But it is not these factors and characteristics themselves that attract activists or hedge funds.
It is the other way around: activists and hedge funds are attracted to a company, and it happens that it possesses certain characteristics. Without going into the definition of what is value, activists are still investors, and mostly value investors.
So, it is not surprising that shares of the companies they target do not perform well. Return on equity factor is even more problematic: who would pick companies based on a low return on equity factor? If one has to use this factor at all, then one should pick companies with high, not low return on equity.
To make a long story short, even if you decide to use these factors in your decision-making process, actual implementation is very problematic.
The question then is what really attracts activist investors? How is it possible that despite all of market efficiency, a small pack of activist investors and hedge fund managers continue to come up with great investment ideas? Why these opportunities do not disappear?
I think that great investment managers are also good storytellers. Many believe that making good investments requires excellent skills in the analysis of financial accounting statements, building complex and detailed valuation models, forecasting future profitability of companies and otherwise analyzing numbers “to death”.
In my book “Story Investing” I argue that best investments are just like good stories or movies: with three-part story structure, important turning points, intrigue, drama, and surprises. One of the highlights of the approach is the proposal to develop both a historical we well as future narrative for the company and its share price. It is not only a question of providing verbal and common-sense explanation of the numbers.
I think activists are especially good at identifying this three-part story structure of complication, development and resolution. It allows them to develop a sound investment thesis for the company. And of course, they aim to jump aboard the train at the beginning of the resolution part.
I believe shares of ASICS Corporation (TOKYO: 7936) should be very attractive to a private equity buyers or activist investors.
First, shares trade at a reasonable valuation EV/EBITDA (FY 2018) multiple of 13.7.
Second, it is currently valued at a significant discount to competitors such as Nike, Adidas and Puma. ASICS Corp’ Price to Sales (P/S) ratio is only 0.79 compared to this peer group which trades at about 2.85 on average.
Third, over the past seven years ASICS Corporation grew its sales by only 11% cumulatively while these competitors grew sales by 60% on average.
And the share price performance, unsurprisingly, is a complete disaster compared to these peers: ASICS Corporation shares returned only 12% cumulatively (without dividends) for the seven-year period compared to average cumulative share price return of 330% during same period for competitors (Nike, Adidas, Puma). TOPIX Index rose by about 100% during this period.
EBITDA margin is also very low compared to competitors. And in addition to all this, ASICS has a clean balance sheet with low net debt.
So far, looking at these characteristics, it is obvious that ASICS could be on the radar of private equity funds, activist investors or just plain value investors.
But the most important part of the investment thesis I believe are not company’s characteristics but developments over the past few years in the retail space and opportunities they present. The amount of store closures over the past few years was unprecedented. There are excellent opportunities to grow the business for retailers who can adopt and take advantage of this situation. It seems that now is exactly such moment of opportunity for ASICS, and it will be a big mistake not to take advantage of it and implement a more aggressive growth strategy.
Activist investors or private equity owners can push the company in this direction.