October 26, 2022
Many investors follow activist investor positions and campaigns. Even though activist holdings are disclosed with a delay and the share price reacts quickly, it is often still a good idea to jump aboard the train.
The main reason for this was formulated a long time ago by Winston Churchill: “It is better to be the actor than the critic”.
Activist investors took this idea to heart and understood that while passive investing gains more and more followers, the only way to achieve above-average results is to actively influence and change reality.
Activists are very good at identifying something called the story structure. This term comes from the world of literature and movies.
Best investments are just like good stories or movies: with a three-part story structure (complication, development, resolution), important turning points, intrigue, drama, and surprises.
Let’s see if there is a story structure in shares of Freshpet and recently reported position by activist hedge fund Jana Partners.
Freshpet is in the midst of a significant CapEx program and capacity expansion. According to the company, despite product demand it is limited in sales growth because it is constrained by manufacturing capacity.
Company aims to more than double sales by 2025 (achieve $1.25 billion in sales) and attain an EBITDA margin of 25% percent, or $354 million.
The recent wave of SPACs tried to teach investors one interesting idea. The idea is that they can forget about the stock market for a while. Similar to what Warren Buffett says: that he invests as if the stock market will be closed for the next five years.
Many companies merging with SPACs tried to pitch investors a three or even five-year investment thesis. Some of these companies are growth companies, while others pitched stories of business transformation.
I think that the investment thesis for Freshpet shares a similar concept: forget about the stock market for a while, and once we build our manufacturing capacity, the stock will rise, be rerated and we will become cash flow generating company.
During September 2022 Freshpet shares were trading at a price of about $40 per share and it is safe to assume that this is the price activist hedge fund paid for them.
Since then the shares rallied by about 44%, so if you invest in Freshpet now you are paying an EV/EBITDA (FY 2025 Est) valuation multiple of x7.8 as opposed to the activist investor who paid x5.4. (we assume for simplicity purposes that Freshpet achieves these FY 2025 objectives and has a zero net debt by the end of FY 2025).
There is of course a possibility for an even rosier scenario such as a higher multiple and rerating of the stock (especially if the plans are executed and objectives are achieved). Assigning an EV/EBITDA multiple of x12, for example, would value shares at $89 per share which would provide an upside of 64% over three years.
There is also a certain upside possible with regards to inflation if one assumes that pet food is a stable and recession-resilient category and price increases are possible.
However all this is still based on the assumption that company achieves its stated 2025 goals.
As shares recently rallied 44%, we think that investing in Freshpet now is a relatively aggressive idea, and a more conservative investor would be better of passing on this opportunity.
We have identified a number of investment targets with an investment thesis of a similar type: value plus event plus corporate transformation/growth. Contact us for more information