By IRWIN LIPNOWSKI
A corporate raider, described in more recent parlance as “an activist shareholder,” is an individual who buys a significant stake in an underperforming company in an effort to overhaul its operation. Should a corporate raider be considered a hero or a villain?
Corporate raiders are often vilified in the media because of the bully tactics they employ to persuade, cajole and (ultimately) coerce change. Their dogged persistence closely resembles that of a pit bull terrier. The changes they seek typically involve positions on the board of the target company, the replacement of the CEO, a drastic reduction in the remuneration of senior managers (whose salaries and stock options may bear no relation to the company’s underperformance), or the sale or spin-off some of the company’s assets.
At the same time, activist shareholders have been celebrated as champions of the ‘little guy’ – like Robin Hood – helping the powerless shareholder who feels robbed by vastly overpaid senior managers. The proclaimed mission of the activist shareholder is to unlock the value of mismanaged publicly-traded companies–companies that may be bloated with moribund bureaucracies and pervasive waste. In the process, the activist shareholder often reaps enormous rewards.
The financial vehicle that is generally deployed by activist shareholders is a hedge fund. In recent months two billionaires have been engaged in a titanic struggle involving an American company, Herbalife, listed on the New York Stock Exchange under the symbol HLF. The protagonists are Bill Ackman, whose hedge fund is Pershing Square Capital Management, and Daniel Loeb, whose hedge fund is Third Point Capital.
Herbalife distributes nutrients and weight-loss products using multi-level marketing (MLM). MLM closely resembles a pyramid scheme. Consumers of Herbalife’s products are encouraged to become distributers and to recruit additional distributors (underlings) who will, in turn, recruit underlings lower down the chain. Distributors can earn money from underlings who are below them in the pyramid in the line of their recruited distributors.
On December 19, 2012, flush from his triumphant battle against the directors of Canadian Pacific Railway, Bill Ackman launched an audacious media blitz attacking Herbalife. During a three and a half hour presentation at the Ira Sohn Foundation’s Investment Research Conference, Ackman disclosed that beginning in May 2012, his hedge fund had ‘shorted’ over 20 million shares of Herbalife because its business model was an illegal pyramid scheme. Ackman called for the Federal Trade Commission and the Security and Exchange Commission to investigate the legality of Herbalife and predicted that Herbalife’s shares would ultimately become worthless. Anticipating the claim by cynics that Ackman’s presentation was fuelled solely by greed, Ackman pledged that all the profits earned by his firm from shorting Herbalife would be donated to the Ira Sohn Foundation to fund research in pediatric cancer, with a guaranteed minimum contribution of $25 million. Herbalife’s share prices, which had closed at $42.50 on December 18, 2012, began to slide, sinking to $24.24 on December 24, 2012 as investors in Herbalife panicked and sold their shares in response to the Ack-attack.
In order to short 20 million shares of Herbalife, Ackman had to borrow these shares from his broker, sell them at the market price that prevailed at the time, and then purchase 20 million shares at some future date to repay the broker for the borrowed shares. If Ackman were able to repay his loan by purchasing 20 million shares at a cost sufficiently below the proceeds from his sale of the borrowed shares, he could cover all the brokerage fees and interest charges associated with the transaction and still earn money. Otherwise, he would suffer a loss. Only Ackman and his broker know when and at what price the 20 million borrowed shares were sold. On May 1, 2012, Herbalife shares traded at $70.75. The claim commonly made in the media, that Ackman placed a billion dollar bet, is based on the implicit assumption that he sold the borrowed shares at a price of $40.
Herbalife’s prayers, as its stock was in freefall - were answered when a calm and savvy saviour–in the form of a billionaire hedge fund manager, Daniel Loeb–miraculously appeared.
On January 9, 2013, Loeb dismissed Ackman’s claims as “preposterous” and disclosed that his hedge fund, Third Point Capital, had just purchased more than an 8 per cent stake in Herbalife. His rumoured average cost was $32 per share. Loeb’s announcement sent Herbalife shares soaring to their pre-Ack-attack level. Shortly thereafter, another billionaire hedge fund legend, Carl Icahn, announced that he was investing in Herbalife without disclosing the value of his investment. Icahn’s announcement further accelerated the ascent in Herbalife’s share price.
The battle of the billionaires is by no means a ‘zero-sum game’ in which one party’s loss is another party’s gain. It is quite possible–and based on their records, quite likely–that all of the billionaires will profit from their investment, whether ‘short’ or ‘long’ on Herbalife. The only party that will benefit for sure is the Ira Sohn Foundation fund to support research in conquering pediatric cancer. Ackman will donate $25 million regardless of the outcome.