Having an influential activist investor on your side could potentially help increase the value of one of your stock holdings -- if the investor is capable of enacting various types of strategic or financial changes.
In this clip from Industry Focus: Tech, Motley Fool analyst Dylan Lewis and contributor Evan Niu, CFA, discuss a few possible scenarios that investors commonly see.
A full transcript follows the video.
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This podcast was recorded on Oct. 21, 2016.
Dylan Lewis: We're doing a show on activist investors. Really, this started with an email from one of our listeners. Earlier this week, I heard from Mark S. He asked, "Recently, there have been some rumors that Mentor Graphics (MENT) may be looking to be acquired. The company is a major supplier of CAD tools that are used by integrated circuit designers, and as such are a crucial supplier for all the semiconductor companies. Should I as an investor or user be concerned about their looking around?"
Prior to getting back to Mark, I did a little homework to see what some of the circumstances surrounding that sale were. There was a Fortune article posted a few days ago. "Mentor Graphics company, a company that makes software for designing semiconductors, is working with Bank of America to explore strategic alternatives, including a potential sale, according to people familiar with the matter. Mentor has been under pressure since activist hedge fund Elliott Management Corp reported an 8% stake in the company last month and said shares were deeply undervalued." That seemed like a good point to launch into a discussion about how investors should feel when activists get involved in a company that they're invested in.
I think, before we get too far into this conversation, let's just take a look at what an activist investor is. Evan, what do you have?
Evan Niu: They're usually just in it for the money. Activist investors basically pick up a bunch of shares, enough to get a pretty meaningful stake in the company, to the point where they can get board seats, they can get the ear of management, they can actually really get in there and try to have some influence because they have that big stake in the company. Certainly, it's easier to do this for a smaller company, because it doesn't take as much money to buy a big stake. If you want to buy 10% of a giant company versus a small cap, I think it's a little more reasonable for the small cap. In this case, I'm not too familiar with Mentor specifically, but I know they're pretty small.
Lewis: They're a $3 billion company.
Niu: Right. So, it's not too hard for an activist investor, if they think that shares are undervalued, they can pick up a pretty sizable stake for not too much money and try to make some change, make some money.
Lewis: And what are we typically talking about when we say changes? You see the term "strategic alternatives" thrown around a lot in those types of press releases.
Niu: Usually, they just want to maximize the value. That can take a couple of forms, like actual changes to the business, if they think there are problems with the way the company is run. If they think there's problems with management, sometimes they'll try to oust management and get better people in to run the company. Other times, they might have better input on capital structure. Big investors tend to think more about -- at the Fool, we always talk about how you have to distinguish between investing in the company and the business of the company. There's two aspects of it. And management is mostly focused on the business, whereas investors are more focused on investing financials. Of course, all companies try to look at both. But some companies aren't really good at looking at the financially deep stuff, for things like capital structure, capital allocation. So in some cases, where management isn't as good at focusing on those things, I think activist investors can really help in that sense.
Lewis: Yeah, add some value, bring in some of that more financial expertise. Some of the other things you might see activist investors push for, we talked about capital allocation, something they need, buybacks, dividends realm, maybe spinning off specific segments, trying to drive value there. But really, at its core, activist investors see a company that isn't being properly valued, and think that they have a way to boost the value through some sort of strategic action.