by Dave Benoit)
If activist investors seem like they are all using the same playbook, it may be because many are at least reading the same book.
“The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success” has created a buzz among the activist community for laying out in plain English what the activists are often arguing for.
Hedge-fund managers, bankers and lawyers have all cited the book to explain the logic behind much of what activists are seeking, including the push to break up companies WSJ wrote about Wednesday.
Written by William N. Thorndike, and published in late 2012, “The Outsiders” won a mention in Warren Buffett’s annual report that year as being on the famed investor’s reading list.
The book is more geared toward the Buffett-type of long-term investor. It chronicles the experience of eight CEOs, including Mr. Buffett, Henry Singleton, John Malone and Katherine Graham, and the huge shareholder returns they created. The entire book is built the premise that CEOs should be scored on the numbers, like baseball players today. Take Jack Welch, for example: While Mr. Welch was a good CEO at General Electric, he ranks well below other CEOs based on shareholder returns, according to the book.
The central trait of the top chief executives, according to the book, is how successful they are at allocating capital.
Mr. Thorndike makes the case that chief executives have no greater role than to determine how to spend their company’s cash flow, whether reinvesting it in the business, spending it on acquisitions or returning it to shareholders. Those that do it best are like the best investors: They buy low and sell high and earn massive shareholder returns over the long-run.
That’s the point activists have seized upon. Activists talk of forcing a company to narrow its business lines and let management focus on core operations. Part of that is reinvesting in profitable businesses, while cutting off businesses the activists don’t see as worthwhile. They also push for share buybacks when they think the shares are undervalued.
Many of the CEOs in the book ran lean operations and gave great freedoms to their business heads.
One specific critique that has come up several times in recent activist fights: The elaborate corporate headquarters. Mr. Thorndike’s book mentions several of the CEOs had out-of-date and out-of-fashion headquarters devoid of central staff.
“Capital allocation ability tends to correlate with frugality and a flashy corporate headquarters is often a bad sign,” Mr. Thorndike said in an interview.
This came up again this week when Nelson Peltz’s Trian Management renewed its push to break up PepsiCo. Inc. The activist sent a 37-page letter to Pepsi’s board that included a critique of Pepsi’s New York headquarters.
“PepsiCo’s Purchase headquarters is one of the most extraordinary corporate centers in America. It sits on more than 100 acres in Westchester County. Nevertheless, management has recently committed to a $240mm renovation project,” Trian wrote. “These are dollars that could have been invested in the brands.”
Of course, not every company should be broken up. No activist is likely to knock on Mr. Buffett’s door telling him to stop selling Geico insurance, See’s Candies and running Burlington Northern Santa Fe railroad.
“This idea of stripping things down to the core makes sense in some cases,” Mr. Thorndike said. “In some cases, it’s possibly being carried to the extreme right now.”