By The Sizemore Letter
For a staid old department store with a 111-year-old history, JC Penney Company (JCP) has been in the news a lot this year, though not for any noteworthy operational developments; the retailer continues its slow march into irrelevance, and it’s not likely to change course any time soon.
The headlines have mostly surrounded one particularly vocal shareholder, Bill Ackman of Pershing Square Capital, who owns about 18% of the company. Up until recently, Ackman was also on the JC Penney board of directors…until he resigned in a hissy fit after demanding that the company replace its CEO within 45 days. And this after Ackman’s choice for the job—former Apple (AAPL) executive Ron Johnson—ran the company into the ground.
Ackman likes to think of himself as a “shareholder activist” who shakes up complacent or self-serving company boards and unlocks value for shareholders. But to his detractors, he is nothing more than a corporate raider—a pirate in a suit that loots and leaves. JC Penney Chairman Thomas Engibous called him “disruptive and counterproductive.” And given Ackman’s recent behavior, it’s hard to argue with the chairman.
All of this brings me to Penney’s new “poison pill” provisions. After the Ackman experience, JC Penney never again wants to become the personal plaything of a hedge fund titan. For those unfamiliar with the term, a poison pill floods the market with new stock in the event of a hostile takeover. It makes it impossible—or at least very expensive—for a corporate raider to take over a company without management’s blessing. The Penney poison pill would kick in whenever an outside shareholder acquired 10% or more of the company’s stock.
And this is where the theater of the absurd starts. The poison pill is being called a “shareholder rights” plan by management. So, we have a “shareholder rights” plan being implemented to protect investors from “shareholder activists” like Ackman. If you’re a Penney shareholder, you must really feel special. It looks like everyone is looking out for your best interests.
Except that they’re not. Corporate raiders like Ackman—and some of his high-profile rivals like Carl Icahn and Daniel Loeb—are absolutely correct when they say that corporate managements tend to run companies for their own benefit rather than for the benefit of the shareholders. In business school they call it the “principal-agent problem,” but we don’t need to get bogged down in fancy terminology. Unless motivated by altruism or idealism, people tend to look out for number one first.
So if management are the “bad guys,” does that make Ackman & Co. the “good guys.”
If you believe that then you have no business investing. “Shareholder activists” may inadvertently help smaller shareholders by driving up the stock price after successfully engineering a reorganization of the company. But they do so for their own benefit, not yours. This is Wall Street…not charity.
So, now that I have sufficiently jaded your view of humanity, what are we to do with this information? Should we view poison pills favorably…or should we run away screaming when a company we own implements one?
I would frame it like this: If you’re investing in well-run companies, it generally won’t matter. Good companies with healthy prospects generally don’t need poison pill provisions. Yes, Bill Ackman made a mess of JC Penney. But JC Penney was already a company in terminal decline long before Ackman got his paws on it. Rather than waste your time and capital on an investment in Penney, you could have invested in a healthier rival like Wal-Mart (WMT) or Target (TGT)—both of which are monster dividend raisers and share repurchasers.
And Wal-Mart is a fine example of the next point I’d like to make. If your last name is Walton, then your livelihood disproportionately depends on the performance of Wal-Mart. The same would be true of Michael Dell and Dell Inc. (DELL). When your name is on the signage, the company’s destiny is your destiny; you can’t simply walk away. But outside investors—and particularly regular, individual investors—have the luxury of voting with their feet. If you don’t like the way a company is run, don’t waste your time in a shareholder proxy fight that you can’t realistically influence. Sell the shares and allocate your funds elsewhere.
Finally, while you should always assume that a large high-profile investor is investing for their own benefit and not yours, it doesn’t mean you can’t tag along for the ride. I regularly look at the trading moves made by my favorite money managers. But be careful here and choose your gurus and their picks wisely. Yes, Carl Icahn is a smart investor, and yes, tracking his trading moves can be insightful. But I would steer clear of some of his recent high-profile buys like Dell and Herbalife (HLF). Both have become battlegrounds for hedge fund titans, and as an individual investor you have a serious information disadvantage.
Disclosures: Sizemore Capital is long WMT.
