When Private Equity Moves the Chains

Some companies' founders strive for years to bring them public, but in today's marketplace, it seems like more and more executives are thinking that exiting the stock market is a better plan. For example, consider Ultimate Software (ULTI), which will be taken private by a group of private-equity investors paying a 20% premium. But of course, those muscular hedge funds do more than buy whole companies to polish up -- sometimes they just take a piece of the action, and then aggressively push a new strategy. That's what the activists of Starboard Value just did with damaged pizza brand Papa John's (PZZA 1.87%).

In this MarketFoolery podcast, host Chris Hill and Motley Fool Asset Management's Bill Barker discuss what made software-as-a-service provider Ultimate a good pickup, and why its founder/CEO is happy with the deal, as well as what Starboard needs to do to reheat Papa John's. They also ponder a listener's question about which is the better dividend reinvestment stock, AT&T (T 1.10%) or Verizon (VZ 0.90%), and raise a glass to one of the more entertaining controversies to come out of the Super Bowl: The sniping match between Anheuser-Busch InBev (BUD 1.43%) and MillerCoors over corn syrup in beer.

A full transcript follows the video.

Check out the latest earnings call transcripts for companies we cover.  

This video was recorded on Feb. 4, 2019.

Chris Hill: It's Monday, February 4. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio today from MFAM Funds, it's Bill Barker. Happy Monday!

Bill Barker: Thank you!

Hill: It's a happy Monday for people in New England after last night's atrocity of a game. Maybe the most unwatchable of Super Bowls. We'll get to the Super Bowl, don't worry. We've got earnings. We've got some activism news. We're going to dip into the Fool mailbag.

We're going to start with merger Monday because it is, once again, merger Monday. In this case, Ultimate Software -- great name -- being acquired by a private investment firm for $11 billion. This is an all-cash deal. Shares of Ultimate Software up 20%. Good day for the shareholders. This is one that I don't think we've ever talked about. What does this company do, besides have a great name? This is one that you and your colleagues at MFAM Funds have known about, and I believe invested in for a while now.

Barker: Yeah. It's a happy Monday for shareholders of Ultimate. Two of our funds have been long-term shareholders of it thanks to Tony Arsta, let's give credit where credit's due, for his work on this company going back to at least 2014, probably earlier.

It's a payroll and human resources management company, which is geared toward middle-sized companies. It's had a great run. Of course, the employment numbers not just recently but going on seven, eight years now, have been very good. So, they've got more and more work to do. They're competing with companies; a better-known company would be Paychex in the space. They've been giving up market share to not only Ultimate, but some of the smaller players. The 20% premium that is on Ultimate's price today is, there are other companies like Paycom and Paylocity, which are two other very similar companies but smaller which are going up in sympathy as people think, "Well, if I can't get Ultimate anymore, maybe the things that are out there might be acquired." So, you've got those companies being up 2%, 5% today. 

Hill: Why do you think they agreed to be acquired? If, as you said, they've been doing a decent job of taking market share from Paychex -- just to put some numbers around this, Paychex is a $25 billion company. With this buyout, obviously, Ultimate software being valued at around $11 billion. It's not like they were dramatically smaller than Paychex. If they were gaining on them, I'm curious if they always saw this as the logical conclusion, that at some point, if the price is right, they'd agree to be bought out. I'm sure there are at least a few shareholders who are looking at this saying, "No! Even with the 20% premium, this was a train that was running well, and I wanted to keep riding it!"

Barker: I'm sure there were. It's a founder-CEO company. He's still there. He's been there for 20-some years. One of the things specifically about this company that it points to with some pride is the company culture and how they've ranked in some Forbes rankings of most beloved companies. I think they were in the top 10 a couple of times, in terms of employee happiness and admirability. I think they pointed, in their press release, to this being a way to maintain the company culture. 

If -- and now, I'm going to speculate -- if the founder wanted some sort of payday that he could realize through this, and yet maintain the company and the culture that he loved, and he's found a buyer that's willing to do that in a way that he didn't think could necessarily be done in the public markets, maybe that's the rationale. But that's speculation. 

Hill: Let's move on to a pretty boring company, I say "boring," unless you like making money. Second-quarter profits and revenue for Clorox (CLX 0.24%) came in solidly ahead of expectations. Shares of Clorox up 7% this morning. Unlike other companies in this space that we've seen, consumer products companies that have a lot of different levels to their portfolios -- yes, they've got some household cleaning products; yes, they've also got some food products, that sort of thing -- Clorox, unless I'm missing something, appears to be just in the business of cleaning stuff. 

Barker: Yeah, you're right, you're missing a lot. 

Hill: Oh, OK!

Barker: Yeah. 

Hill: Enlighten me, by all means!

Barker: [laughs] Well, the divisions are: cleaning; household, which includes charcoal, cat litter, and Glad bags; lifestyle is the fastest growing, they've got Brita water filters, dietary supplements, and some salad dressings. They're best-known, of course, their name being Clorox, and there are some other cleaning products, the Clorox brand goes on a lot of them -- Pine Sol, 409, Tilex, things like that. None of it is edible stuff, they're not in that part of the grocery store, but they've got a couple of brands that are completely dominant in their category. In terms of bleach, Clorox has 60% to 70% of the market, despite the fact that I can't understand how branding bleach makes it better. 

Kingsford Charcoal. Name two other charcoals. 

Hill: I really can't.

Barker: No, I told you to name two other charcoals.

Hill: [laughs] Uh...

Barker: $10. 

Hill: Isn't there one, SureLight or something like that?

Barker: You're just making up words.

Hill: I don't know! [laughs] 

Barker: SureFire, Quick...Light...Fires...

Hill: Something like that. Something with light, I know it's in there. 

Barker: No. It's Kingsford, and then everybody else combined has like 25% of the market. So, they're just completely dominant there. Of course, Fresh Step kitty litter is another one of their well-known brands if you happen to be a cat owner.

Hill: I just typed in charcoal brands into Google. 

Barker: No! You don't get $10 for googling something! 

Hill: I'm not trying to --

Barker: I get $10 from you for cheating!

Hill: [laughs] Not only have I not heard of these other brands, I want to know -- and after the show, we'll do a little bit of a deep dive into the branding of a charcoal called Jealous Devil. Have you ever heard of Jealous Devil?

Barker: No, but I'm not from that part of the country.

Hill: What part of the country?

Barker: I don't know! But I'm from the Kingsford Coal part of the country, which is most of it.

Hill: OK. As I said at the top, this is hard to get excited about if you're an investor -- and yet, it really does seem like one of those obvious investments, that unless you're someone who is at a point in your life where you're just thinking, "All I want are growth investments. All I'm looking for is the David Gardner Rule Breaker types," it really does seem like Clorox should, if not be a requirement to be in everyone's portfolio, it seems like you need a good reason not to have it in there. I don't own shares of it, but as you said, they're dominant in what they do. I believe they pay a dividend. It's up 20% over the past year for a choppy year for the market. And it's hard to envision a climate where people decide en masse to just stop buying cleaning products.

Barker: It is. I'll give you the bear case against it. It's that private label stuff, Clorox being an example. Why should Clorox be dominant five, 10, 15 years from now? If you buy Clorox bleach because that's what Mom bought when you were growing up, and you inherit a lot of consumer brands in that manner. Nevertheless, why not buy generic bleach? They're able to take that Clorox name and then put it onto some other things that you might trust, like hand wipes and things like that. It connotes cleanliness. But, trash bags, kitty litter, things that you know are under attack from private label, and stores are getting better at creating store brands. So, that's the reason to think maybe the next 10 years won't be as good as the last 80 for some of these brands.

But, to date, they're able to maintain relevance. I think that they can continue to pay a hefty dividend and buy back some shares, not have to take big risks, and focus on efficiencies that drive better margins. That's what the stock price today is reacting to, is a little bit of a turnaround in their margin story. 

Hill: Papa John's in the news this morning. I suppose it makes sense, given that yesterday was Super Bowl Sunday, traditionally the biggest day for pizza companies in terms of sales. Shares of Papa John's up 10% to 12% this morning after getting a $200 million investment from Starboard Value. For those unfamiliar, these are the activist investors who took a stake in Darden Restaurants about five years ago. Not all that surprising when you look at their track record, when it comes to activist investing in the restaurant space, that the stock would be up like this. 

Barker: Yeah. It's been pummeled by all of the missteps that it's made in the last two years, and the chaos, in terms of management and ownership, that continues to be there. It would be very fascinating to know what Starboard thinks is the right path. There are so many different ones, including rebranding, what do you do with the owner-founder and his ongoing stake? I'd love to hear them talk about it. 

Hill: I think they've done a pretty good job with the rebranding. They've clearly realized, "Well, we can't completely walk away from the branding. We can't do an AOL into Oath, we can't do a Tribune Media into Tronc." Not that those are great examples. But, the way that they've been advertising, dropping the John's and just focusing on the Papa part of it, and highlighting local franchisees in their commercials, I think they've done a good job with that. 

To your point about John Schnatter, that's really the issue they're going to have to deal with. He's still the dominant shareholder. He's not going away. He gave a comment that, and I'm quoting here, he's "evaluating legal remedies." He claims he made a better proposal to the company than Starboard Value did. I really hope that he's got a good friend nearby who can pull him aside and say, "John, just take the money. You're the biggest shareholder and your shares are now worth 10% to 12% more than they were last Friday. It's in your financial interest to let these people come in and do what they're going to do."

Barker: That's not a strategy, to go in with an investment, is, "We will find that friend, pull him aside, and say, 'get out of here.'" So, they have something else that's part of their strategy. I don't know what it is. There are so many different directions you can go with this. It's still much smaller company than you would think, given your knowledge of the brand. Of course, it's been bleeding market cap grotesquely, as far as shareholders would be concerned, for a while now. It's only a $1.5 billion company, and that's after going up 10% today. There's a lot of room for it to grow, but it needs a plan that it does not have today.

Hill: It absolutely does. You go back to what Starboard did with Darden Restaurants, they had levers they could pull with that business that they don't really have available to them in this business. Papa John's is Papa John's. Darden Restaurants at the time had a number of brands under the umbrella, including Red Lobster, and that was one of the moves by Starboard, was to sell that off. It'll be interesting to see how this plays out.

Our email address is [email protected]. Question from Brett Kelting at Wartburg College in Iowa. Brett writes, "After disappointing earnings results from AT&T and Verizon this past week, what do you consider a better buy for a long-term dividend reinvestment portfolio? Keep up the great work. I love the show." Thank you, Brett! Go Knights, the mighty Knights of Wartburg College. Thoughts on his question?

Barker: I don't have specific thoughts about AT&T vs. Verizon. 

Hill: They're currently sort of the Coke and Pepsi of the mobile space here in the United States. They have roughly the same market cap. Beyond that, I don't have strong feelings about the way either one of them is being run.

Barker: Right. I think they're both good long-term investments. Dividend reinvestment is a wise way to manage your money. Both will turn out to do well. I'm currently a happy user of Verizon's services, and a less happy user of AT&T's services. So, purely from anecdote -- which is worth nothing, I would say -- Verizon starts from a better spot in my head. What about you?

Hill: I was just thinking as you were talking about that about how investors would have done very well --

Barker: You don't still have Comcast, do you?

Hill: I do. And I was just going to say, Comcast. You would have done very well a few years ago reading all those stories about how hated Comcast was, and the terrible customer service, and all of that, and just buying shares then. The public sentiment against Comcast was pretty strong. And in general, that's been a business that has rewarded shareholders.

Just to touch on the dividend reinvestment, kudos to Brett for going that route. I think we do a good job on this show and at The Motley Fool in general of giving the advice of, "When you start a job, if there's a 401(k) plan, particularly if there's a matching component by your company, go ahead and get involved in that, because that's free money." You lock and load right at the start, and then you forget it. I think, in terms of locking and loading a financial mechanism, right behind that is dividend reinvestment, when you buy shares of a company and they're paying a dividend and you look at it and decide, "I could take the cash and maybe let that build up over time," but you could also just say, "No, plow that right back into more shares."

Barker: Yeah, the dividend reinvestment exposes, to a degree, the myth of what investor returns have been over the long term. That is, when you're looking at stocks, S&P 500, whatever, has returned, 10% over some huge period of time, all that data comes from an assumption that you are reinvesting the dividends as soon as you get them, which historically is an aggressive assumption for what investors actually do. To actually do that is going to get you a much better return over the long term than what investors typically do, which is spend the dividends rather than reinvest them. 

That's done through your 401(k) or through mutual funds. As stocks pay dividends, the mutual fund then reinvests those. Not always right on the day they get them, but reasonably soon. So, it's a great thing to implement throughout your investing life. You'll do much better if you're constantly reinvesting dividends than if you're spending them.

Hill: I don't know if we actually answered Brett's question.

Barker: No, but there are people who will. AT&T vs. Verizon, you have people that would love to answer that question that appear on this show. 

Hill: Absolutely. 

Barker: Who are they? 

Hill: I'm not sure.

Barker: They'll be on soon. 

Hill: [laughs] Let's wrap up with the Super Bowl, specifically the commercials. We were talking about this before we started taping. As a group, if you look at the stories that are being written and published today, there's obviously the traditional winners and losers, best ads, worst ads, that sort of thing. We got something this year, though -- and as a group, they were fine. There were definitely some good commercials, there were others that, like the game itself, were kind of boring and forgettable. 

But we got something this year that we don't often get, and that's a little bit of a feud post-commercials. For those who missed it, this is a feud in the beer industry. Let me give you a little bit of context here. Anheuser-Busch had a 60-second commercial featuring a medieval knight, a Bud Knight, if you will, who receives a shipment of corn syrup but says, "Look, we don't brew our beer with corn syrup. Let's go to the Miller Lite Castle." So, they go on this pilgrimage, they get to the Miller Lite Castle, and they say, "No, we already got our shipment. Try the Coors Light Castle." Anheuser-Busch, very plainly using their time to say, "Think what you want about our beer, but we don't brew it with corn syrup, and those people over at Molson Coors, they do." End of commercial. Molson Coors, not happy about this. Also not happy about this: the National Corn Growers of America.

Barker: The National Corn Growers and the lobbyists for corn have come out publicly. Has Coors responded in any way?

Hill: I've seen comments on their behalf. I haven't seen a direct quote from the company themselves. And we probably won't see one. If I'm advising them, I'm saying, "Look, the Corn Growers are sort of responding on our behalf, so let's just keep quiet about this one and go about our business."

Barker: Yeah, and Budweiser, I think there are a lot of confused viewers. Now, Bud tests all these things. This is one of their biggest movers of the year, is whether their Super Bowl commercials are successful, whether it's a strategy and a campaign that they follow through on. So, I'm sure they've tested this, but it's counterintuitive. I don't think of Bud drinkers -- maybe Bud Light drinkers are a little different -- as being overly concerned with the corn syrup content of their beer. Speaking as somebody who has had a few Budweisers in his day, unlike yourself. Your comment is not worth anything. Dan might have something more relevant from the anecdotal space than you, because you're sort of violent toward beer, really.

Hill: No, no, I'm not at all violent toward beer. I just don't drink beer.

Barker: Refuse to drink it. 

Hill: It's not even a refusal, I just don't like the taste. And, as I say from time to time, that's OK, I drink other things. I don't necessarily need to add beer to my repertoire. Dan, any thoughts on this? 

Dan Boyd: Oh, wow, a beer I don't like, it doesn't use an ingredient I don't like. I'm not wasting too much time thinking about this one, Chris.

Barker: But -- 

Hill: The ad was pretty entertaining.

Barker: Credit where it's due, Anheuser-Busch thinks about this a lot. I have been at investor meetings where there are hundreds of people in attendance, and they have taken their 20 minutes to talk about their company and use half of it to talk about their commercials in the Super Bowl. 

Hill: Wow, I thought you were being a little tongue-in-cheek there!

Barker: No.

Hill: The business of Anheuser-Busch genuinely looks at the Super Bowl commercials as a significant needle mover for their business? Or maybe not a needle mover, but an actual opportunity? Above and beyond just the branding and the, "Oh, that was a funny commercial!"

Barker: Certainly when it goes right. They've had many, many Super Bowl campaigns, and they have been able to follow through on them, launch a new campaign sometimes. You can think of the Budweiser frogs, there are any number of Super Bowl-related campaigns that have worked out, and it may not have been intuitive to all the viewers. It certainly wasn't intuitive to me that "Dilly Dilly" was something that would help you sell beer. They don't just throw stuff against the wall. They test this stuff. They're making a major investment during Super Bowl time. 

Boyd: One of the great things about "Dilly Dilly" is if I hear it in the wild, I immediately know that I'm not going to be friends with that person. It's extremely helpful. 

Barker: And yet, it was a successful campaign. Which may be retired at this point.

Hill: Well, they'll move on to this. We'll see how much of this taking shots at Coors Light -- 

Barker: Makes it at least as much sense as the Andy Warhol Burger King commercial. 

Hill: Yeah, that was lost on me. 

Barker: Does that make you want to go to Burger King? 

Hill: No, not really. Shout out to longtime listener, Jason Newman, for the Pringles commercial that he pointed me toward. I missed that during the game and then went onto YouTube and watched it, enjoyed that. I enjoyed the Hyundai commercial with Jason Bateman, as well. That was enjoyable.

All right, time to get out of here. You can read more from Bill Barker and his colleagues like Tony Arsta, who found Ultimate Software and made money off of it, by going to mfamfunds.com. Thanks for being here!

Barker: Thank you!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!