The bull case for hedge funds, with Eric Jackson, of Ironfire Capital, and Paul Kedrosky, of Ten Asset Management
Last Update: Wed. Dec. 31 2008 11:35 AM
Wednesday, December 31, 2008
Saturday, December 27, 2008
By Eric Jackson
12/26/08 - 12:56 PM EST
The one group of investors that's been vilified more than any other by the business press and government officials alike in 2008? Hedge fund managers.
After years of rapid growth in terms of both assets and numbers of funds in operation, the hedge fund industry has taken a PR black eye this year. Media reports would have you believe that the industry is about to collapse in size, see its revenue drop dramatically through fee reductions and become heavily regulated to protect unsuspecting investors from another Bernie Madoff scam.
Hedge funds certainly make an easy target. They've had a bad year, along with every other retail and institutional investor. But the industry is about to grow dramatically over the next five years. This coming year will mark the beginning of the next wave of this industry's growth.
The 12 months of 2008 have proved an abysmal year, and every investor can't wait to be done with it. While hedge fund managers have done terribly, (with the exception of maybe Bill Miller) no one in the media seems to criticize the mutual fund managers or other wealth advisors for lousy performance.
It seems to be an unstated opinion in many articles that hedge fund managers should know better than other investors. One simple reason for this, a reason that draws endless attention and criticism, is hedge fund manager compensation. It's true that the best-performing fund managers over the last few years have been well compensated.
I don't have a problem if a hedge fund manager, the CEO of Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) or the head of risk management at Citigroup (C Quote - Cramer on C - Stock Picks) gets paid boatloads of compensation year in and year out, on two conditions: (1) they should only be paid well based on their direct contribution to the performance of their firms, and (2) that performance should be "real" performance, meaning that there is real value created, not some illusory accounting profit.
Hedge fund managers have an advantage over those who hold the types of positions mentioned above. First, as with a sales rep, you always know how a hedge fund manager is doing. With the exception of managers that dabble in private equity or illiquid assets, which are more difficult to manage on a daily mark-to-market basis, any hedge fund investor could get a daily report on how a manager is performing.
And hedge funds -- even the big ones -- are still small shops. If a fund has a good year or a bad year, its manager, whether it's Stevie Cohen or Bill Ackman, gets the credit or the blame. They don't get to punt responsibility to a foreign office or a snowstorm that kept away retail shoppers.
The second advantage hedge fund managers have over others when it comes to their compensation is that their performance is "real" at the end of each calendar year. Simply put, the market value of your portfolio this year gets measured against last year's market value.
Whether or not these profits were aided by leverage, hedge fund managers must perform in order to be compensated. While others can use their political skills to keep their jobs, hedge fund managers have to live with their fund's performance and the consequences that performance brings.
After a disastrous 2008, the big commercial banks are holding back recently injected capital from taxpayers to pay out year-end bonuses. However, few hedge funds (with the exception perhaps of the 10% that made money this year) will pay out bonuses.
What's more, many of the hedge funds that lost money for their investors this year adhere to "high-water marks." This means they have to make back their 2008 losses in 2009 before they are eligible for future bonuses. Investors get made whole and their managers only get bonuses when they actually deserve them. Citigroup investors sure wish they could get that kind of arrangement.
Hedge fund managers -- unlike mutual fund or other private wealth managers -- get paid for performance, not assets. Their incentives are perfectly aligned with their investors. They make calculated bets and expect to be highly compensated only when they succeed. This arrangement has attracted and will continue to attract talent. The best managers will migrate to hedge funds because they can be more successful financially.
They also accept the financial and reputational pain of performing poorly. Even with less leverage and more regulation, the hedge fund industry is still the best game in town for the most talented managers.
And it's also the best game in town for investors -- which is why the industry is set to begin its next wave of growth in the next five years. The most sophisticated investors still need help managing their money. They are not going to hoard Treasury bills forever.
Do you want to invest in a mutual fund manager incentivized to grow assets but not necessarily performance? Would you not, if you had the opportunity, want to invest in the best qualified money manager?
It's true that Bernie Madoff's Ponzi scheme has shaken the trust of investors in all money managers, and that will have a fallout effect on hedge fund managers. However, the hedge fund industry will be much bigger in 2013 than 2008.
Here are some other fearless predictions for the industry:
- The number of hedge funds will decrease by 30% between the start of 2008 and the start of 2010, but the assets under management will actually increase as investors seek out the best managers.
- This growth will come at the expense of the mutual fund industry and wealth management.
- The due diligence industry, which researches hedge funds and their managers, will quadruple in size. Today, there are few firms with expertise in this area (Due Diligence Consulting, Kroll and Backtracks are on a short-list of firms with expertise in this area). Investors will need to invest in hedge funds, but won't be able to rely on the Securities and Exchange Commission to conduct their due diligence. They won't mind paying for this work themselves.
- The "2 and 20" fee structure for the industry (under which hedge funds charge 2% annually for management fees and 20% for the share of the profits created) will persist. Investors will not object as long as they receive the performance they expect.
- Fund-of-hedge-funds will be most negatively affected by 2008. Larger institutional investors will become much more hesitant to invest in fund-of-hedge-funds over the next two years in the wake of the Madoff scandal for fear of criticism from their own investors. These types of funds will not go away, but there will only be so many people that can say, "I can get you into John Paulson's fund."
- There will be more hedge fund regulation from Washington but not to the extent that it kills the industry. What purpose would that serve the Obama administration? A greater administrative burden dealing with new regulation will become the new cost of doing business for hedge funds. It will make it harder for newer/smaller hedge funds.
- Hedge fund managers will become better risk managers and learn to perform without the benefit of leverage. Those with enduring strategies that can create value will grow.
Hedge funds are not going away. They're actually going to greatly increase in size over the next five years. The level of dissatisfaction in mutual fund managers and private wealth managers will cause investors to seek out better-performing investment vehicles for their cash. Although there will certainly be changes to the industry as a result of the events of 2008 -- including hedge fund failures in the next six months -- the future looks very bright for hedge fund managers and their investors because their interests are so well-aligned.
Sphere: Related Content
Monday, December 22, 2008
12/22/08 - 10:33 AM EST
YHOO , C , AAPL , HPQ (Cramer's Pick) , GOOG , MSFT
By Eric Jackson
The press has shown little mercy in criticizing Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) this year. And deservedly so.
The four reasons most often cited for the Internet company's missteps over the last four years have namely been the people at the top:
(1) Terry Semel;
(2) Jerry Yang;
(3) Sue Decker;
and (4) the Board of Directors.
They all received glowing press coverage when Yahoo! was riding the general ad market recovery and shift to digital ads in 2002 to 2004. But now they are being slammed in various business media for their actions, and in some cases inactions, that have since led to stagnation and decline.
It's normal to blame organizational failures on the leaders at the top -- consider Dick Fuld at Lehman Brothers, Vikram Pandit at Citigroup (C Quote - Cramer on C - Stock Picks) or even a market-maker like Bernie Madoff. Group leaders and their choices are, in the end, responsible for group actions and outcomes.
But there are four other reasons to account for Yahoo!'s decline in the past four years: (1) A lack of product leadership; (2) self-isolated leadership; (3) a culture tolerating non-performance; and (4) the use of a matrix organizational structure.
Each of these problems traces back to choices made, consciously or not, by senior leadership. Until Yahoo! recognizes and understands these issues, the company won't be changed. This is why the choice of the company's next CEO is so important.
The right CEO will see these issues clearly from Day One and change them; the wrong CEO will be oblivious to them. Unfortunately for Yahoo! shareholders, the people selecting the next CEO will be the people on the board who've missed the four reasons for the company's recent poor performance of late.
Even though they had moved on to exciting new jobs, they expressed regret about the current state of Yahoo!, especially since they felt that they had gained a lot from their time at Yahoo!. Each person agreed that the company was fixable and that the decision about who will be named as the next CEO was critical. Most were pessimistic that the company would achieve its potential.
Here are their top four reasons for Yahoo!'s decline:
1. Lack of Product Leadership
Google (GOOG Quote - Cramer on GOOG - Stock Picks) had search. Apple (AAPL Quote - Cramer on AAPL - Stock Picks) had the Mac. Yahoo! has always had a collection of multiple products, and that has been a blessing and a curse.
It's a blessing because -- unlike AOL, which had just the dial-up business -- Yahoo! has always had multiple revenue streams that were mutually reinforcing (e.g., home page, Finance, Mail, Search). It's never been a one-trick pony.
But the multiple products are a curse because, from Yahoo!'s founding, the company has had its fingers in a lot of pies, and that has hindered it from developing a corporate focus. Through Bubble 1.0 and Bubble 2.0, the Yahoo! M&A machine was always humming to suck up venture-backed firms at healthy valuations. Integrating them cohesively was a different story and left a string of disparate businesses under the Yahoo! roof.
Several former Yahoo! employees complained about the lack of vision and the lack of product leadership from the top executives to string all the pieces together. Said one, "I always wanted to know 'what's our North Star?'" They felt that there was a lack of focus from the executive team about what Yahoo! did that created value and what it should be moving toward to better create more value.
In their views, the next CEO needs to be great at products. The core of Yahoo! is a great user experience and great products. Discussions about undertaking a search deal with Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks), spinning off Asian assets, and closing the revenue-per-search gap with Google are secondary.
2. Self-Isolated Leadership
Several years ago, I worked with Dartmouth Business School Professor Sydney Finkelstein on building a consulting practice based on the research from his book Why Smart Executives Fail. He researched more than 60 one-time industry-leading companies that in the end drove off a cliff in terms of their performance.
These companies' executive team members always looked great on paper: the best business schools, the perfect career trajectory, many achievements to point to. Yet, these same people were responsible for bringing down their companies. One key reason for this -- common across all the failures -- is that the top executives got rid of or discouraged anyone around them who voiced a different perspective than theirs. This appears to have happened at Yahoo!.
According to those I spoke with, executives often didn't engage in detailed discussions with lower-level managers responsible for areas that were under-performing. "I would have liked to talk to them more," said one ex-Yahoo!. "I had one good conversation with [one Yahoo! executive] and one good one with [another executive] in [the last few years]. That's it. I know others tried to educate them on the issues. Nothing came of it."
There was not enough debate about key decisions made at Yahoo!. The last six months have seen a steady drain of senior talent. One employee contrasted that with how President-elect Barack Obama has selected key members of his Cabinet: "He's put former rivals around him in Clinton and Richardson, who definitely don't agree with him on some issues. You know they're going to speak up. You also could see any of them leading the country if necessary. We definitely don't have that depth of talent on the Yahoo! senior team."
One group that Yahoo! executives were not shy about consulting in the last four years: the consultants. "There were way too many consultants and too many planning sessions. We needed more execution," said a former employee.
3. Tolerating a Non-Performance Culture
It's obvious that every company has a unique culture. No one working there would be able to tell you step-by-step how it was created, and yet they all live and breathe it every day. The best cultures give that company an amazing advantage vs. its peers. The worst cultures hang around the company's neck and are next to impossible to shake.
"When I first started at Yahoo!, people cared. They'd challenge you if they disagreed. That changed," said one ex-employee. Another added, "Transparency about problems or mistakes used to be rewarded. Not anymore. There were some people who made mistakes and ended up getting promoted."
Over time, it appears most employees stopped pushing for the changes they wanted to see. When they tried and it fell on deaf ears, they backed down. "I think a lot of people also knew they wouldn't get similar jobs elsewhere and decided to keep quiet." The tone got set from the top, and it trickled down to permeate the organization.
4. Matrix Organizational Structure
One of the recommendations that Yahoo!'s consultants made a few years ago was to institute a so-called matrix organizational structure across the company. A matrix structure was popular about 10-15 years ago, especially in engineering-oriented companies. It seeks to overcome the complexity of a large global organization by assigning multiple bosses to employees in different geographies working on similar product or functional tasks. In other words, you report up to two or more bosses -- a product or functional boss and a geographical boss.
The intent of a matrix structure is that you understand what your local peers are working on as well as what your functional peers are working on globally. In theory, the company becomes tighter-knit, despite its size.
In practice, matrix organizational structures have greatly fallen out of favor in the last five years because they create confusion about who is responsible for certain actions. The "shared" ownership of tasks and projects across multiple groups and bosses means that it's difficult to go back and assign blame for and learn from failures. Whose throat do you choke? "It was hard to point out who specifically was responsible for mistakes because of that," said one former employee.
Thankfully, this structure has recently been done away with and products have now been centralized. Combined with the risk-averse culture described above, the legacy of this structure has been deadly for Yahoo!.
Yahoo! executives and directors aren't the first "smart" ones to fail. Otherwise, Professor Finkelstein wouldn't have a book full of stories on Enron, Worldcom and Webvan. The solutions for Yahoo! senior executives, based on the lessons in the book, are:
- admitting when you/the company have screwed up and dissecting the underlying reasons for the failure;
- encouraging others to admit their mistakes and learning from the mistakes instead of shooting them or encouraging them to cover up mistakes;
- surrounding yourself with other smart people who often will disagree with you in search of the best answer for the company; and
- demanding accountability from everyone in the company including yourself.
The rest of Yahoo!'s senior team and board will have to buy into a new approach as well, admitting their own past mistakes at the same time. This assumes they pick the right person to serve as Chief Yahoo!, and that remains a big question mark.
At the time of publication, Jackson's fund had no position in YHOO. Jackson owns a small long position personally.
Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. Sphere: Related Content
Thursday, December 11, 2008
By Eric Jackson
12/11/2008 1:59 PM EST
GeoEye (GEOY - commentary - Cramer's Take) operates three geo-spatial satellites that take images of Earth up to a color high-resolution of 0.5m. The company sells these images to governmental and commercial customers. Starting next month, these images will start appearing on Google (GOOG - commentary - Cramer's Take) Maps and Google Earth.
The stock trades at a major discount to its earnings potential next year and should appreciate considerably in the coming months. Yesterday, after the close, GeoEye announced a $144 million contract with its largest customer for 2009; this almost equals its trailing 12 months of revenue.
GeoEye is part of a duopoly in the U.S. with DigitalGlobe (a smaller, private and less well-capitalized competitor). GeoEye had been doing $183 million a year in revenue with 45% operating margins until six months ago, when the company gave up some market share to DigitalGlobe, which launched its newest satellite in the fall. GeoEye's revenue and earnings have recently dropped, as customers opted to use DigitalGlobe's newer satellite. The market has punished GeoEye's shares -- especially during the recent selloff of small caps -- taking the price from a 52-week high of $37.37 in January to below $19 yesterday, near its 52-week low.
A number of events are about to happen in the coming weeks -- beginning with yesterday's new contract news -- that should dramatically reverse the direction of GeoEye's shares.
Recall that the primary reason for GeoEye's stock slide this year was that its nearest competitor launched its latest and greatest satellite. In the geo-spatial imagery industry, higher-resolution images keep improving. GeoEye is now about to leap-frog DigitalGlobe's technology, as it launched GeoEye-1, the newest and most advanced geo-spatial satellite in space, in early September. GeoEye-1 will have the best images in its industry in full color for the next 18 months, until DigitalGlobe puts up its next-generation satellite. However, if DigitalGlobe fails to go public during that time, there is a possibility its launch gets delayed, and that would give GeoEye an even longer advantage.
BCC Research estimates that GeoEye's industry market is increasing from $1.9 billion this year to $3.2 billion by 2012. The key buyers of geo-spatial images are U.S. governmental agencies such as the National Geo-spatial Intelligence Agency (NGA) and Homeland Security. The NGA is GeoEye's largest customer, accounting for half of its revenue last year. The NGA also paid half the $500 million in costs to launch GeoEye-1. The agency is therefore expecting to continue to buy a significant amount of images from GeoEye in the coming years. The NGA's investment came, in part, from a presidential directive for governmental agencies to rely as much as possible on buying services and products from best-in-class companies, as opposed to replicating such services or products internally.
Earlier this fall, the Pentagon floated the idea of building and launching some new geo-spatial satellites of its own to supplement its reliance on GeoEye and DigitalGlobe. This plan was quickly quashed by Congress in November, because of budget concerns. This clears the decks for increased business for both GeoEye and DigitalGlobe in the coming six years.
In yesterday's announcement, GeoEye signed a service-level agreement with NGA, whereby NGA will pay $12.5 million a month up to $144 million in 2009. These payments are for planned purchases of images from GeoEye-1. There might be more. If the payments stay at just that level, they will represent a doubling of GeoEye revenue from NGA compared with 2008.
NGA still needs to certify the quality of the images from GeoEye-1. The images are at a high resolution now, but GeoEye is trying to make them even more finer-grained. This certification is expected to happen on Dec. 15 or slightly thereafter. Once that certification takes place, many other commercial and governmental customers for GeoEye's images will likely begin to strike their own deals and purchase the images.
GeoEye's trailing price-to-earnings ratio yesterday was below 9. Its forward P/E, assuming it does $250 million in revenue next year with 45% operating margins, is 3. Other satellite and space/defense companies trade currently at forward P/Es of 7 to 21.
The key reason why the stock has been at depressed levels since the launch is that it wasn't yet clear that the satellite was operating properly. Yesterday's announcement suggests that NGA is ready to spend money on the new images from the satellite once it certifies the images. NGA's planned spending next year almost equals GeoEye's 2007 total revenue of $183 million, after which the stock hit its all-time high of $37.37. That stock price was achieved prior to worries about delays in the launch of GeoEye-1 that depressed the stock.
The table has now been set for significant revenue and operating margins to accrue to GeoEye over the next 18 months, as NGA, Google and other commercial and governmental customers purchase these images. It is highly unlikely that a technical flaw will crop up this long after the launch. The customers who buy these images (e.g., governmental agencies and Google) are also much less affected by the broader economic malaise compared with most companies operating today.
Assuming GeoEye can double its sales and earnings by the end of next year and is rewarded with an increased price-to-earnings multiple more comparable to its related peers, I believe it could trade up to between $60 and $80 by early 2010, up from its current price of $19.
Days before GeoEye launched GeoEye-1, the company announced a relationship with Google. GeoEye would provide its images from GeoEye-1 to no other online portal except Google. Google is not under any restrictions, meaning it could still buy images from DigitalGlobe. No financial details about the agreement between GeoEye and Google have been released. The first hint of what those details might be won't come until early February, when GeoEye holds its fourth-quarter analysts' call.
However, here is what we do know about the relationship and about Google's interest in space:
- Google's co-founders (Sergey Brin and Larry Page) attended the September launch of GeoEye-1.
- Google's logo was on the side of the rocket that launched GeoEye-1.
Google will begin using images from GeoEye-1 on Google Maps and Google Earth in January and start paying GeoEye for them.
- GeoEye recently paid Google to get its help in improving their search tools so that GeoEye customers could more easily search GeoEye's inventory of images. (DigitalGlobe has no comparable search tools to offer its customers.)
- Google's first acquisition post-IPO was for a small company called Keyhole, which is now the basis for Google Earth.
- Larry Page has signed up to be launched into space himself in 2011.
- Google has recently been investing in building up its relationships with the federal government, to which it sells its Search, Apps and Earth products. Recently, Google was a Gold Sponsor of an NGA Industry Day, of which GeoEye was also a sponsor and DigitalGlobe wasn't.
- Google received special permission from NASA to land its corporate jets at Moffat Field near its Mountain View, Calif., headquarters.
When GeoEye-1 was launched in September, the company said that the NGA should certify the satellite's operation and sign off on a service-level agreement (outlining its planned imagery purchases from GeoEye) within 60 to 90 days. The service-level agreement with NGA was signed on Tuesday, and certification is expected within the week. Expect new customer announcements to trickle out, now that NGA has gone first. In February, GeoEye will hold its next analysts' call, at which time it should start to shed light on its revenue ramp-up with the GeoEye-1 satellite and on the expected revenue from the Google relationship.
Four remaining risks could negatively affect the stock:
- The satellite could suffer a technical error whereby it becomes inoperable. This is highly unlikely at this point but possible. A major malfunction would slash the company's future earnings dramatically. GeoEye has insurance for this scenario, but it would still not prevent a sharp drop in the stock price. This possibility always exists for the lifetime of every satellite.
- Management offers poor communication. I have been an activist investor in GeoEye since March. Its CEO and management team have done a poor job in managing the Street's expectations and communicating the GeoEye story. This still remains a problem area, despite criticism from me and from other investors. Management needs to win over the trust of institutional investors and hedge funds to see its price-to-earnings multiple increase.
- The company has had delays in filling the CFO position. In yesterday's announcement about its new contract with NGA, GeoEye disclosed that its current CFO would be leaving. There are many possible reasons for this, and I don't take it as a sign of problems. The company restated its financial statements recently. The board could have decided to make a change. What is important is that GeoEye hire a first-class CFO to fill the role before the next analysts' call in February.
- DigitalGlobe could move up the launch of its next-generation satellite sooner than 18 months from now. This is almost impossible. In fact, it's more likely that DigitalGlobe will delay their launch, given that it is waiting to go public to raise needed capital, and the IPO window appears to be shut for the foreseeable future.
In GeoEye, you are getting a world-class leader in a growing and recession-proof industry. Its stock has the chance to triple or even quadruple in the next 15 months. What's more, you're getting a call option on a potential buyout by its partner Google. Put it together, and you have a compelling entry-point at these levels.
[Eric Jackson's fund holds a long position in GEOY.] Sphere: Related Content
By Eric Jackson
12/11/08 - 09:59 AM EST
With the market's tumultuous last few months driving down the price of equities, activist investors around the world have seen their stock investments take major hits.
- Carl Icahn has watched the value of his Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) stake drop in half since May;
- Ralph Whitworth of Relational Investors recently resigned from the board of Sprint Nextel (S Quote - Cramer on S - Stock Picks) but kept his stake in the company, even as shares have dropped 80% this year;
- Chris Hohn of The Children's Investment Fund exited his J-Power position at a loss earlier this year, after his calls for change were beaten back by the Japanese utility. Some market-watchers suggest that after 10 to 12 years of growth as a strategy, investor activism is dead. Why? Poor returns, they say, and because the freezing-up of the credit markets prevents activist shareholders from calling on companies to lever up with debt to fund stock-buyback plans or increase dividends.
1. Obama will look favorably on pro-shareholder measures. Republican Securities and Exchange Commissioners have typically supported pro-management/Business Roundtable policies. Democrats have been much more supportive of shareholder activists. The Business Roundtable and other pro-management groups have portrayed shareholder-friendly measures -- such as making it easier to run alternative board candidates on the company's proxy -- as moves that empower fringe, or special interest, shareholders such as the AFL-CIO and Teamsters at the expense of plain-vanilla investors (retail or institutional).
Obama supports a different view and will likely equate more shareholder rights that promote better governance with better shareholder returns over time.
2. The new SEC Chair will sponsor several new shareholder-friendly measures. Obama will appoint an SEC chairman in the image of the last Democrat to hold that position, Arthur Levitt -- someone who will fight for openness, fairness and rights for all shareholders.
"Proxy access" was an initiative supporting the rights for shareholders to put forward alternate names of directors to be elected at the annual meeting proxy vote. Instead of having to fund a proxy contest themselves (vs. an incumbent board funding their re-election with the shareholders' money), "proxy access" would have allowed for these alternate names to appear on the company's own proxy and let the shareholders simply vote for the most qualified people to represent shareholder interests. This initiative died when the two Democratic SEC Commissioners retired and were not replaced.
Expect "proxy access" to return in the new administration in some form, helping to ensure the best possible people are serving as directors on our boards.
3. Valuations are on the floor. Activist investors are typically value investors who layer their activist efforts on top of a buy-and-hold approach to an undervalued stock. Value investors have been especially hard hit this year. Fortunately, the mass selling appears to have stabilized. While cheap should never be confused with value, it's likely that valuations will rise over the next 12 months and take the fortunes of activist investors with them.
4. A flight to quality in hedge funds will benefit activist investors. The hedge fund industry is going through a remaking of itself and will no doubt be a much smaller industry two years from now. The biggest and most successful ones will grow in a flight to quality. Activist investors with long and successful track records will benefit, even if their returns in 2008 are poor. Institutional investors can understand the activist strategy and how it's executed. It's not a black box and that is going to be helpful to activists in raising capital over the next few years.
5. Management and corporate boards will not want to be viewed as anti-shareholder. After seeing their market capitalizations decimated over the last 12 months, boards and management teams at public companies are sensitive to criticism. Lavish pay and executive perks are out. Assuming activists have legitimate arguments about actions that will unlock shareholder value, it will be much easier for them to get the ear of managements and boards in the next 24 months.
6. There will be a wave of industry consolidation. M&A has dried up in 2008 as corporate acquirers and targets kept their heads down in the foxhole. That's about to change. With valuations so low, there's never been a better time for stronger players to pick off the weaker ones in their industry.
At the same time, no board wants to make the mistakes that Yahoo! and Take-Two (TTWO Quote - Cramer on TTWO - Stock Picks) did this year by playing hard to get when a rich buyout offer came along. Activist investors will play a background role. For example, look for Bill Ackman of Pershing Square to push together Barnes & Noble (BKS Quote - Cramer on BKS - Stock Picks) and Borders (BGP Quote - Cramer on BGP - Stock Picks) (as he has a stake in both companies).
7. Activists have the longest lock-up periods of any hedge fund class, so they can put fresh capital to work. With hedge funds reeling from heavy redemptions, the funds in the strongest position this year are the ones with the longest lock-up periods. A lock-up is the amount of time a hedge fund investor must keep his/her money invested in the fund before being able to redeem.
Activists, at least the most successful ones, have among the longest lock-ups in the hedge fund industry, at 3-5 years. The logic for asking for such a lock-up is that activists understand that their hold period in a particular position might be many years, comparable to a private equity holding period. Unlike private equity, though, activist investors have their positions marked to market every day.
Activists know a six-month investment return in Sprint is likely to differ from a three-year investment return. With these long lock-ups, activists will be less affected by heavy redemptions this year than most other hedge funds. This means they'll have more money to put to work next year.
8. Limits on short-selling will benefit activists. As previously mentioned, the SEC is about to become more shareholder-friendly under the new administration. The agency also will likely seek to promote growth in the stock market. Short-sellers could come under more restrictions, promoting long-biased investors. Although no outright ban on short-selling will occur, a return of the uptick rule is likely. Any limits on short-selling like this will help long-biased investors like activist investors.
9. Activists will become more balanced on the long and short sides. Even though activists have typically been long-biased or long-only before 2008, the only investments that have made money this year are short bets. Activists will learn from this year's action to have a more balanced portfolio of investments on the long and short sides. Some activist investors like Greenlight Capital and Pershing Square have always taken this balanced approach. Expect others to follow their lead. This will improve performance and provide them with more capital to put to work in additional activist campaigns.
10. There's more to get "active" about than ever. Even post-Enron and post-Sarbanes-Oxley, 2008 has shown shareholders that there is more than ever to get outraged by in the actions and inaction of corporate boards.
Where was the oversight at Bear Stearns, Lehman, Citigroup (C Quote - Cramer on C - Stock Picks) and GM (GM Quote - Cramer on GM - Stock Picks) this year?
We hear a lot of CEOs and boards refer to a "perfect storm" occurring this year, an attempt to place responsibility for their companies' results on events outside of their control. Bob Rubin, director at Citigroup, recently said it wasn't realistic to expect a year ago that housing prices would drop as precipitously as they have. Although no omniscient board has yet been found, there are many that did an excellent job at protecting and growing capital in the last year.
As activists challenge the poorer-performing boards, the result will be stronger companies and better performance in the future. If these shareholder representatives are not questioned and are allowed to continue rubber stamping the will of management, we will have learned nothing from the debacle of the last 12 months.
At the time of publication, Jackson and his fun had no positions in stocks mentioned.
Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. Sphere: Related Content