In recent years we've seen more and more activist investors try to obtain board seats and/or bring about change in companies with growth that's perceived to be stagnant. Statistics from HFR, a Hedge Fund Research company, show that activist hedge funds manage more than $129 billion in assets today, up from just $29 billion a decade prior.
Activist investors work their magic by purchasing a sizable position within a publicly traded company and then using their clout to (hopefully) effect change that'll increase the value of their holdings. Most investors welcome the presence of activists, as long as they aren't a major distraction -- but there's always the risk that they're only focusing on short-term gains, which in turn may not be in the best interests of shareholders. Ultimately, success is determined on a case-by-case basis.
However, one somewhat consistent point about activist investors is that they don't normally go after megacap companies. The reason? Large companies often have large contingents of passive owners via mutual funds and other institutional investors, meaning effecting change can be difficult. Artisan Partners, though, must have missed this memo.
Taking on the largest healthcare company on Earth
Artisan, a global investment firm that manages nearly $100 billion in assets, announced last week that it's urging other activists to push for Johnson & Johnson (NYSE:JNJ), a $289 billion healthcare conglomerate, to break up into three separate companies: a consumer health company, a medical device maker, and a pharmaceuticals company. Based on Artisan's numbers, doing so could unlock nearly $90 billion in enterprise value for shareholders.
Why would Artisan Partners make such a request? Despite the broader market rising more than 200% from its lows of March 2009 through its all-time highs set last year, Johnson & Johnson shares were up only around 100% over that same time period. Artisan claims that J&J's size and its overly high compensation structure for its executives are holding back its growth potential relative to its peers.
Of course, we've also seen challenges within each operating segment. For instance, medical device growth has been practically nonexistent on even an operating basis. Part of the blame can be placed on increased competition and commoditization within the space. The other issues relate to weakened global demand for procedures, such as in Europe, and both hospitals and consumers holstering their money due to uncertainties tied to the Affordable Care Act in the United States.
Within consumer health and pharmaceuticals the bigger issue recently has been J&J's exposure to overseas markets. A stronger dollar has been crushing foreign currencies, which means J&J is losing quite a bit when converting foreign currency back into U.S. dollars.
Artisan believes that all three segments would be best suited as separate entities. If you want steady cash flow and a dividend, there's consumer health. If you'd like a long-tail growth opportunity that's set to develop over numerous decades, then medical devices could be the answer. Or, if a dividend isn't a huge concern and you'd just prefer fast growth, then J&J's pharmaceutical segment might be your choice.
Don't bet on a break-up
But there's one key point worth keeping in mind: As of Sept. 30, 2015, per its 13F filing with the Securities and Exchange Commission, Artisan held 4,765,920 shares of Johnson & Johnson, which as of Friday's closing price were worth almost $498 million. This doesn't even equate to 0.2% of total ownership in J&J's common stock, meaning its chances of using its clout to effect change are pretty minimal at best. Hedge funds and investors who are purchasing J&J are typically looking for that above-average dividend yield, a lack of volatility, and strong business diversity, so persuading them to join the activist camp seems next to impossible in my book.
More importantly, it's not as if J&J is performing particularly poorly considering its size. It's working on a better than 30-year streak of adjusted full-year profit increases, it's one of only three remaining publicly traded companies to bear a AAA credit rating, and it's increased its dividend in each of the past 53 years, placing it among an exclusive group of companies known as Dividend Aristocrats. That's not exactly "activist-worthy" in my book.
Johnson & Johnson also has the ability to pull levers in order to improve its financial situation. Last month J&J announced that it would be laying off 3,000 employees in the medical device segment in order to reduce costs. Some of these cost-savings will be used for innovative purposes, whereas other dollars saved may simply help boost margins.
Along those same lines, don't forget that J&J is comprised of around 250 subsidiaries, meaning it has the ability to divest non-core assets, or slow-growing assets, as it sees fit. There are numerous "levers" J&J can pull, so calling for a breakup seems very premature.
What activism might win with J&J
If there is one minor victory that could be won from Artisan's call to action, it's a potentially higher shareholder yield.
Johnson & Johnson is already paying out $3 per share annually in dividends, and in October it announced a share repurchase program worth as much as $10 billion. Despite these lofty figures, J&J is also sitting on $18.5 billion in net cash, or more than $38 billion in cash overall. The company's management team has been pretty clear that it's looking for acquisitions at the right price, but it doesn't seem too keen on large acquisitions. This could imply that while not all of J&J's cash is disposable, at least some of it could be used to boost its buyback even more, raise its dividend at a faster pace, or perhaps pay out a special dividend. Again, there are no guarantees this will happen, but activists certainly have a strong enough argument with J&J's cash pile growing on a quarterly basis.
For long-term investors, I wouldn't read too much into Artisan's call to action. Johnson & Johnson's management appears unlikely to alter its current long-term strategy -- and that's probably a good thing, since it's a strategy that has worked for decades.