This is going to seem off topic for diginomica readers, but it is vital for several reasons, the most important of which is that, based on our research, a relative few people understand the implications.
ERP vendor, SAP, has a tiger by the tail. Elliott Management, an activist shareholder, has decided that SAP’s stock is undervalued and needs its magic touch. The details of what Elliott Management wants to do are unclear as discussions have been kept private between SAP’s board and Elliott Management and some of the actions that Elliott has looked for in the past are in the public domain as it relates to SAP although details are sketchy. If you haven’t already, see this prior piece that provides additional context.
Activist shareholders, as the name implies, agitate for specific changes. While you and I might own a few hundred shares in a firm, we must be content to be passive investors. It’s the investors with a substantial ownership position in a company that have a chance of influencing the board and management. This is why an activist shareholder takes a material equity stake in a firm and may expand that position as part of a campaign to get its recommendations heard. On occasion, a proxy fight is initiated when an activist’s agenda meets resistance.
Elliott Management has demonstrated that it can use different income creation techniques. At the extreme end, it has used litigation to get full value from sovereign bonds in which it invested. It can put companies up for sale. It can block acquisitions. It can push out executives. It can also take a more passive approach to its investments. How will the SAP investment go? There may be some clues from past Elliott Management deals.
SAP isn’t the only firm getting the Elliott Management treatment. In 2017, Fortune magazine noted:
In the past five years, Elliott has launched activist campaigns at more than 50 companies—19 this year alone (2017)—in at least a dozen countries.
Elliot Management is well known to boards of directors globally. In recent years they have taken positions or requested changes at numerous firms, among the most notable tech contingent, are BMC, Compuware, Novell, EMC, Cognizant, Citrix and now SAP.
In reviewing prior deals, some common themes emerge. Elliott Management frequently:
- Starts off its campaign with an investment of 1% or more of the target firm’s stock.
- Sends a letter or presentation to the board of the target firm which it may or may not make public.
- Angles to get its chosen representatives on the board.
- Tries to get other shareholders (e.g., institutional investors) to back its change agenda.
- Outlines several initiatives that are designed to enhance shareholder value (e.g., share repurchases, dividends, spinoffs, sale of the company, etc.).
- Makes recommendations regarding operational improvements.
- Takes its earnings and moves on.
But Elliott can also:
- Get a CEO or Chairman ousted.
- Block a company sale.
- Take the company private via its own (or another) private equity transaction.
Through it all, Elliott will try to get a significant return on its investment. Some prior deals have netted the company 60-100% ROI in a relatively short time frame. The main point to understand is that Elliott Management does deep research before taking a position, often over years and with considerable due diligence. It is the prior work that allows it to target a company with a high degree of precision and, as a result, usually get its way.
A Review of Three Prior Deals
There are three prior deals with which readers should acquaint themselves to understand better the kinds of conversations Elliott has with the leadership of its target companies. We've selected three deals, Citrix, Cognizant and BMC. In each case, Jesse Cohn, head of activism at Elliott was the lead, as is the case with SAP. Each provides a slightly different perspective on how Elliott Management pursues its campaigns.
The Citrix action started with this open letter published on BusinessWire:
We believe that Citrix can achieve a stock price of $90 – $100+ per share by the end of 2016. This outcome – which represents an increase in stockholder value of approximately 50% – is achievable because Citrix has leading technology franchises in attractive markets but has struggled operationally for years. As a result, today Citrix’s operations and product portfolio represent an opportunity for improvement of uniquely significant magnitude.
In an early commentary, Brian Madden penned a piece titled. Everyone needs to calm down about this Elliott thing. Citrix had it coming in which he said:
Put Elliott aside and ask yourself “What does Citrix do that is really awesome?” The answer most people will say is XenDesktop and XenApp. Others will say NetScaler, but it’s mostly because they’re using it with XenApp and XenDesktop. You’re not likely to hear GoTo, ShareFile, and XenMobile, and you’re definitely not going to hear Podio, ByteMobile, or Cloud.com (or whatever that turned into within Citrix).
For its part, Citrix was already contemplating at least some of the actions that eventually unfolded. For example, the eventual sale of GoTo was already h the cards. Madden goes on to discuss in broad terms how Elliott views its targets:
In each case, Elliott was troubled by a company’s loss of focus on their core competencies. For example, Elliott made an offer to buy Novell, stating that the company "has attempted to diversify away from its legacy division with a series of acquisitions and changes in strategic focus that have largely been unsuccessful.” What of that isn’t 100% true? Elliott offered $5.75 per share for a total of $1 billion, which Novell rejected. To be clear, Elliott didn’t want to get into the software game and run Novell. They wanted to own Novell for just long enough to pare it down and sell it at a profit. Novell rejected the offer, but later sold to Attachmate for $2.2 billion while Elliott was still a shareholder. Mission accomplished.
As part of the settlement, Jesse Cohn secured a seat on the board; assets were sold and, over time, economies were made. Sure enough, the actions Elliott wanted to see bore fruit. Despite the ax being taken to the company, Citrix share price today out performs that of SAP. Cohn still sits on the board which suggests Elliott thinks there's still more to come.
Along the way, there were some hiccups - not least the try out of two CEOs that didn't deliver.
The Citrix story is one that demonstrates that:
- A non-combative approach to an activist investor need not be painful.
- Elliott's pick of leadership isn't always correct in the circumstances.
- Activist investors are sometimes needed to get an otherwise great company to focus on what makes it great, and, by doing so, benefit everyone.
- Regardless of past success, fresh eyes viewed as an opportunity for honest reflection can be the right Rx.
On Monday, Cohn unveiled his largest new stock bet of the year, disclosing a $1.4 billion stake in IT consultancy Cognizant Technology Solutions Group and a plan for the $36 billion market capitalization company to improve its performance.
Elliott believes Cognizant shares are being held back by the company's focus on growing revenues over profit margins and a reluctance to increase stock buybacks, or offer a dividend, as it's grown into a major player in the IT services business with over $13 billion in annual revenues. Prior to Monday, Cognizant shares were off over 10% year-to-date, underperforming the S&P 500 Index. Teaneck, NJ-based Cognizant's shares rose nearly 7% on Elliott's activist position and its plan to improve performance.
What did Elliott Management want? Again, Forbes reports:
The hedge fund's recommendations boil down to having Cognizant initiate a dividend that will offer shareholders a yield of 1.5% based on Friday closing prices, and a commitment to return 75% of its annual U.S. free cash flow through share repurchases. Because Cognizant's balance sheet carries $4 billion of cash and little debt, Elliott is also asking Cognizant to buy back $2.5 billion in stock by mid-2017, funded with $1 billion in cash on hand and $1.5 billion in new debt financing.
Cognizant decided not to fight Elliott and complied with many of Elliott’s demands. The Economic Times of India reported:
In February 2017, the company complied to Elliott’s demands, committing $3.4 billion in share repurchases and dividends over two years; embracing automation, rationalising staff and shifting focus towards higher margin digital business. It also brought in new board members designated by Elliott Management.
From 2019, it will also return 75% of its US free cashflow to shareholders either through share buyback or dividends.
In a liveMint story, Frank d'Souza, then CEO Cognizant was quoted as saying:
We engaged with Elliott, we talked to them, we also used that time to re-engage with many shareholders, not just Elliott, and we took the input from all of these guys, and that’s why from the time Elliott published the letter, which was late November 2016, to the time we announced the accelerated shift to digital, which was February 2017, in a relatively short period of time, we were able to get it done because we had been doing the foundational work for much of the second half of 2016.
Elliott Management made approximately a 50% gain on the shares it used in this deal.
Instead of classifying the Cognizant experience with Elliott as a risk, D’Souza said:
From a “learnings from Elliott” standpoint, we had a constructive conversation with a shareholder that had ideas about how we should run the business and we arrived at a conclusion point that I think was good for all of our shareholders and were in the best interests of the company in the long run. So, that’s not my definition of a risk.
This story is instructive as it shows:
- Not all dealings with Elliott Management have to be prolonged or difficult.
- That Elliot Management knows when a company needs to shift from growth-at-all-costs to a mature firm that needs to start returning capital to shareholders.
- That Elliott has done other deals of roughly the same investment level as the SAP deal.
Every reader should familiarize themselves with the move Elliott Management tried with systems software provider BMC Software. In 2012, Elliott Management tried to shake things up at Houston-based BMC software.
Within just a couple of months:
- BMC had expanded the number of directors on its Board of Directors.
- Added two potential board members to the slate of those to be considered for board positions by Elliott management
Within a year or so, BMC was taken private via a private equity deal. Bain Capital and Golden Gate Partners led that deal. Since then, the company’s ownership has shifted some more as Bain Capital, and Golden Gate Partners sold their position to another private equity firm KKR in 2018.
The BMC Playbook
If you are in SAP customer, employee or partner you need to click on this link and read Elliott management’s board presentation to BMC Software in 2012. As you do, you may find yourself substituting the letters “BMC” with “SAP”.
Starting around slide 11, Elliott lays out its case for why material change is required at BMC Software. First, they claim that the stock has been underperforming. Second, they argue that the company has destroyed shareholder value. Third, they argue that the company has two businesses.
When we get to slide 25, Elliott summarizes its chief concerns:
- Management has failed to execute
- Poor stewardship of stockholder’s capital (includes a discussion on ineffective M&A)
- Failure to fully optimize operations (includes discussion on a lack of meaningful organic growth)
- Competitive landscape is changing
- Strong need for new directors with relevant experience and new ideas
When we get to slide 45, we see the specific items that Elliott wanted BMC to implement (i.e., “Unlock EMC’s strategic value”). These included:
- Install four new board members that Elliott Management believes would move the company in the right direction
- Explore the sale of the company to another technology firm
- Explore the sale of the company to private equity firms
- Take on more debt and return cash/capital to shareholders via dividends or stock repurchases
- Identify and implement operational improvements that will generate approximately 10% increase in operating margin. Improvement areas could include:
- offshoring R&D
- reduction in management ranks
- faster rationalization of acquired companies
- improvements in workforce productivity
- refocus the company on major growth opportunities in the market
Does Elliott leave when the stock price initially pops up?
After reviewing many deals, the answer to this is a surprising “NO”.
If that sounds illogical, then read on. The mere fact that Elliott Management has taken an equity position in a company sends a signal to other investors that change is on the way and that those changes could trigger the stock to rally in time. As a result, the stock price increases before (and in anticipation of) future changes are implemented.
This phenomenon is so common that Elliott even uses this to its advantage when angling for more change within a firm. When Elliott Management made a presentation to the Arconic board, the fact that Arconic’s book value jumped $3 billion and its share price increased 35% upon the news of the investment show that Wall Street agrees with Elliott that changes are needed.
A similar thing has happened with SAP’s shares. CNBC reported that SAP shares:
...rose by more than 12 percent, their biggest daily gain since November 2008. SAP’s shares have underperformed rivals Oracle, Salesforce and Microsoft in the past 12 months. It trades at a forward price/earnings ratio of 21, compared to 58 at Salesforce, an all-cloud outfit, and 25 at Microsoft.
Readers must understand what this means:
- Wall Street thinks SAP could do a lot more to improve shareholder returns on their investments
- Wall Street seconds Elliott’s opinion/actions
- Elliott is not going to walk away with just this short-term stock price bump.
While we anticipate a relatively smooth transition, about which we have more to say in a follow-up story, it is worth noting that Elliott doesn't always get the outcome it thought. For example, the Arconic transaction has been fraught with trouble. While that deal was not led by Cohn's team, it reveals how messy things can become.
The Alcoa/Arconic deal is still ongoing after several years, and maybe the most troubled. Bloomberg BusinessWeek sets the tone of this protracted and gone awry deal in an excellent article earlier this year. They write:
Elliott Management Corp. spent years pushing for changes at Arconic Inc. and its pre-breakup predecessor Alcoa Inc., arguing a better management team could steer the company toward higher profit margins. It was successful in removing many leaders, but less so in achieving a higher stock price.
Unlike so many of the other Elliott Management deals, this one, so far, has not been a full success. Bloomberg states:
Elliott promised a share price pop on the back of margin gains that haven't been so easy to achieve.
A review of prior dealings by Elliott Management is instructive. It shows a firm that is:
- Capable of doing lots of very large deals simultaneously
- Capable of doing many things (e.g., litigate, proxy fights, forcing/halting sales, etc.)
- Not afraid of taking on any company, board or executive
- Willing to partner with other investors
- Aggressive, disruptive or participative depending on how the target’s board reacts to them
Contrary to what some have speculated, a rise in SAP’s share price does not mean Elliott Management will move on from SAP anytime soon. Additional actions by SAP will be necessary for Elliott Management and other shareholders to realize the totality of the gains they expect.
SAP has already responded to Elliott. You can see that from what was said at the Q1 FY2019 earnings call which marked a substantial shift from its position at last years’ Capital Markets Day. Expect to hear more at SAP’s upcoming Q2 FY2019 earnings call.