ValueAct Capital was founded in 2000 with the primary intent to manage the capital of its three founders and a restricted number of individual investors that were personally know to the founders. The three original founding partners –Jeffrey Ubben, George Hamel, Jr. and Peter Kamin — established the firm in San Francisco in a red brick building (with ValueAct etched in golden letters over the door) on Pacific Avenue and now have an office in Boston as well. Both the offices now manage a combined 5 billion dollars plus in assets for some of the world’s prominent institutional investors including foundations, college endowments, fund-of-funds, and also ultra-high net-worth individuals and family offices.
Natural Born Investor:
Mr. Ubben, the CEO and the CIO of ValueAct Capital, definitely has the investor’s pedigree: his father Tim Ubben founded Lincoln Capital Management in 1962, a growth investment firm in Chicago, and by the time he retired from it in 1999 the assets under management were at an impressive 50 billion dollars. Paying homage to his father’s influence on him, Mr. Ubben once quipped that “I grew up doing quarterly-earnings-change analysis in high school”. Interestingly, as his father left the business with the internet bubble still expanding, Mr. Ubben started his firm after it burst.
After procuring an MBA from the Kellogg School of Management from Northwestern University (also the senior Mr. Ubben’s alma mater), Mr. Ubben started his foretold financial career by joining Fidelity Investments in 1987. Mr. Ubben’s innate knack for investing was evident as within four years he was running the Fidelity Value Fund. He grew the fund from a healthy 500 million dollars to over 5 billion dollars in assets.
Mr. Ubben left Fidelity Investments in 1997 serendipitously realizing that managing a $5 billion fund with money pouring in and constant additions to some 150 odd positions was “a recipe for mediocrity.” He went west joining Blum Capital Partners in the Bay Area where he not only met his investing mentor, Dick Blum, but also his future investment partner, Mr. Hamel.
At Fidelity, Mr. Ubben had become familiar with value investing all the while fighting off the firm’s growth orientation and portfolio managers eagerly offering participation in the then restaurant-IPO boom. Even though Peter Lynch’s influence on Fidelity and Mr. Ubben were apparent (minus Mr. Lynch’s penchant for owning hundreds of stocks in his fund – it is said that it was easier to ask Mr. Lynch what he did not known), it was Mr. Blum’s investment style that most impacted Mr. Ubben and provided the framework for his ValueAct Capital.
The Strategy: “Strategic-Block” Investing
Mr. Blum’s methodology of “strategic-block” investing — taking big stakes in troubled businesses and working closely with management to mend discrepancies — forms the cornerstone of ValueAct Capital’s investment strategy. It was earlier on at Blum Capital that Mr. Ubben realized the potency of “strategic-block” investing through the investment that the firm made in Kinetic Concepts, which made high-end therapeutic beds and injury-healing apparatuses. Within a year Blum Capital, which owned 10% of the company and 60% of which was still owned by the founder, took a plan to the CEO to go private as it was undervalued in the public market. Mr. Ubben went on to stage a 900 million dollars LBO which cemented his belief in Mr. Blum’s strategy.
ValueAct Capital utilizes the same strategy focusing on companies which have recurring revenue streams in stable industries and for which they can identify simple (not easy) steps that can generate incremental shareholder value irrespective of the market. The firm takes an active approach in dealing with the board of directors and management. For Mr. Ubben it is de rigueur to know the management and the company inside out before making a full commitment.
Mr. Ubben uses a “farm-team” concept before fully committing to a company. Initially making a small investment for duration of three to six months, ValueAct Capital buys enough time to fully understand the company and its business practices. During this time period Mr. Ubben follows the stock to see if it pops quickly and the valuation gets too high, or if there is a loss of conviction on the attractiveness of the stock and if there is a general disinterest by the management and/or the board to develop a positive relationship. By then ValueAct Capital reaches a decision to either commit a 10% stake in the company with strong ties to management or to just move on (the latter usually to the dismay of shareholders who are tired of mediocre performance).
However, Mr. Ubben points out that seldom does one find great businesses at great prices with great management and hence, an activist approach with the goal of changing management is at times required. Mr. Ubben looks for leadership which is of the utmost importance in transforming a company’s misfortunes. First and foremost, he looks for intellectual honesty in management wherein they do not sweep the real issues under the carpet but are willing to confront them head on. Mr. Ubben also emphasizes that a contrarian bent in management is necessary as it shows confidence and not the generic herd mentality so many companies are inclined to.
Mr. Ubben’s style of shareholder activism differs from other activist managers’ in that he eschews the usual “buy shares today and tomorrow throw a hissy fit” mentality. He believes that this attitude only discredits activists and makes board members wary of their intentions.
(Contrast that to the illustrious activism of Mr. Icahn’s firm Icahn Partners. There were rumors in 2011 that these two disparate activists might join forces to invest in Motorola, but that it was highly unlikely as the two have not supposedly even met each other.)
Mr. Ubben’s intention of activism is to get credibly involved by buying the business or going on the board to help new or current management to lead the business and to extend the run of a successful investment. He cites the example of ValueAct Capital’s involvement in Mentor Corp. where he facilitated and oversaw the handing over of the torch from the founder to the next generation of professional management which resulted in the biggest value creation for its shareholders.
The firm is usually one of the largest shareholders at each of its core company investments and at any point in time the portfolio consists of ten to eighteen core company investments. ValueAct differs from typical ‘activist’ investors that often try to bring changes by acting in a hostile manner. As mentioned before, the firm believes in building consensus among management and board members to bring in the desired changes to maximize shareholder wealth. This approach to activism has resulted in impressive gains: Between 2000 and 2010, ValueAct Capital has returned 13.5% compounded annually, net of fees, versus a flat return of 0.36% for the S&P 500 during the same time period. As impressive as these returns are, one has to further keep in mind that these were achieved by starting the fund at a time when the internet bubble burst and the US economy went into a recession to be followed by the 911 tragedy – many new funds did not survive these series of events.
The firm aims to invest in companies that it believes are fundamentally undervalued and tries to acquire significant stakes in a limited number of companies. ValueAct Capital typically makes three to four new investments in a year with an average holding period of three years and is holding about 20 different equity investments in its portfolio. The investment size usually varies between $50 and $500 million and the firm acquires significant stakes either through open-market purchases or negotiated transactions. Market capitalization for a target company rarely exceeds the $15 billion ceiling and the company never shorts a position.
ValueAct Capital also looks for a minimum free cash flow “coupon” of 10%, i.e. EBITDA minus incremental working capital minus real capital expenditure, divided by enterprise value, combined with a 10% growth rate. Then the fund makes projections for three years and expects an annual unlevered return of 20%. The most difficult part, according to Mr. Ubben, is to find companies that can sustain 10% growth, which often leads them to mature companies with recurring revenue streams. However, Mr. Ubben is open to sacrificing the mandated rate if he is able to find a significantly higher “coupon”.
The ValueAct Capital research team screens companies to identify potential multi-baggers that may be temporarily out of investors’ favor, or may be undergoing significant restructuring. Such companies tend to be mispriced for a variety of reasons including changes in management or ownership, perceived unfavorable business conditions, poor financial performance or many other factors. The firm believes these conditions drive valuations lower for fundamentally strong companies. ValueAct Capital seeks to engage the company’s board and implement strategies that would unlock shareholder value in future and remove the mispricing in valuation.
The fund focuses on industries that are evolving slowly and are duopolies or have three primary players, and tracks companies with solid fundamentals. Mr. Ubben prefers companies with great intellectual property and service businesses — technology, life sciences and business. Many technology based industries tend to be mature with recurring revenue accounting for a higher percentage of sales, while companies with more predictable revenue streams should concern themselves with leveraging, dividend yield and cost cutting rather than growth. However, Mr. Ubben eschews pure technology plays and the accompanying risk of competing disruptive technologies, which frequently leads ValueAct Capital to invest in software or instrument companies that have a significant service element present.
Before getting heavily involved in a company, Mr. Ubben gives due consideration specifically to a scenario that involves selling the company. This in no way is the primary factor, however it is a strategy to protect ValueAct Capital’s investment especially when it is a board member as one can get significantly illiquid being on the board. Mr. Ubben believes in the free cash flow generation capability of a business and that any asset’s worth is determined by its ability to generate sustainable EBITDA, which eventually creates free cash flow for active investment consideration.
As far as risk mitigation is concerned, Mr. Ubben points that ValueAct Capital’s investment methodology is geared towards substantially lowering risk by investing only in quality businesses that are (1) somewhat immune to “external shocks”, such as union involvement or industry cycles, and (2) that are growing and returning at around 10% per year. These two primary factors (which are built in the investment strategy itself) naturally make their investments safer. Together with portfolio diversification, across industries, Value Act Capital has done well to protect its capital from the claws of markdowns.
Furthermore, Mr. Ubben explains that ValueAct Capital stays away from cyclical and commodity sectors because investing in these sectors, as opposed to only high-quality businesses, involves being “right on the money” twice, i.e. on the buy and on the sell. On the other hand, buying a high-quality business necessitates only one transaction of buying it at the right price without having to worry about the timing of the exit strategy.
Mr. Ubben also deliberately avoids the retail sector, as it requires recreating the demand every day; the financial services sector, for it’s a spread business that lacks real free cash flow; and the industrial sector due to its high capital demands and long-term cost structure.
ValueAct Capital investments are there for the long-haul and a typical investment horizon can last three to five years, the firm tries to arbitrage the public market’s time horizon. Most big players like mutual and hedge funds are not willing to suffer short-term pain for long-term gain since money can move fast if performance falls. As a result, most big players are focused on low volatility rather than long-term capital appreciation. However, once Mr. Ubben latches onto a target, he’s not worried about headline risk and keeps accumulating at every dip because he’s focused on the end game.
The Other Founders:
George Hamel, Jr., co-founder and chief operating officer at ValueAct Capital, graduated with a BA from the University of Wisconsin at Madison. Prior to founding ValueAct Capital, Mr. Hamel was a partner at Blum Capital Partners for four years and was primarily in charge of client services, development, and reporting. During his four years at Blum Capital Partners, he achieved a stunning five-fold growth of the firm’s assets under management. Mr. Hamel had accomplished a similar feat four years earlier as a partner with Private Capital Management, Inc. The firm’s assets under management grew seven-fold during his tenure where he was responsible for client development and administration, regulatory compliance, reporting, and trading. Mr. Hamel was also the president of the investment subsidiary of Signet Banking Corporation previously and was a financial consultant at Merrill Lynch.
Peter H. Kamin, the third founder and partner at ValueAct Capital, retired from his post in 2011 after more than a decade at the firm. Prior to co-founding ValueAct Capital, he had founded and managed Peak Partners LP. Mr. Kamin also has served as a Co-Manager of the U.S. private and public equity market activities at The Morningside Group from 1987 to 1992. Mr. Kamin was an Equity Analyst at Fidelity Management and Research from 1983 to 1986.
“My father tells me the reason I generate the returns I do is that I see things other people don’t see. But that’s not exactly the case. I spend my time trying to figure out what the person selling stock to me is afraid of. If I can understand what he’s afraid of and it’s either irrational or overdone, that’s where you can find opportunity.”
“Peter’s greatest influence, which still pervades Fidelity, is that you pick up the phone and call companies. At the end of the day, if you haven’t spoken to a few companies in existing positions or on new ideas, you go home a failure. That’s a good discipline – you should spend your day talking to operators, not to Wall Street.”
“I went to work with Dick Blum at Blum Capital Partners in 1995 because he the idea of strategic-block investing, which is sourcing ideas in the public markets, committing to a long-term time horizon, and working directly with the companies to fix things.”
“We try to focus on businesses that are so good that they’re hard to screw up, but many times when management seems to be trying to do just that.”
“Intellectual honesty is probably first. I want the person who is going to address the elephant in the room.”
“I’m catching a falling sword in almost every situation I’m in, and I’m trying to figure out if it’s falling from the second floor or the 10th floor.”
“Much of what you see today is “buy shares today and tomorrow throw a hissy fit.” The focus is on shortening time horizons by being your own catalyst.”
“It’s a very powerful situation when you get risk capital in the boardroom. Most boards are just guessing what shareholders really want and many directors haven’t ever written a check to be part of the company. I feel a sense of urgency that typical directors might not when I see a company being led poorly.”
”I’ve learned from experience to avoid acquisition-driven stories during the actual acquisition-growth phase – big problems always come of that.”
“Much of what you see today is ‘buy shares today and tomorrow throw a hissy fit.’ The focus is on shortening time horizons by being your own catalyst.”
“That’s a problem for me, because that style is transparent and could discredit all activists. Boards can say activists are just worried about making their quarterly or monthly performance numbers, and there’s something to that, frankly. Writing a nasty letter is going to lose the pop it has now – the activism is going to have to have more integrity than that. Activists are going to need the capital base, experience and credibility to follow through – by buying the company or going on the board to help fix it – if steps aren’t being taken to address their concerns. You’ll need to be more than a yeller and screamer whose biggest asset is that you don’t care what anybody thinks about you.
“Our idea of activism is to get really involved and help new or current management lead the business and extend the run of a successful investment. The more of our portfolio we can have in great assets with great management where we’re helping control the capital decisions – that’s nirvana. It’s obviously not always a lovefest – we’re trying to generate 20% returns, so we have to challenge every company we own with new ideas or they’re not going to stay on that 20% curve.”
(On his decision to fight Acxiom’s board): “I approached the board in the spring of 2005 with our concerns about management’s ability to run the company and made a case for why it made sense to have a shareholder in the board room. They came back and said they didn’t think it was right ever to have a large shareholder on the board. I knew then we were in trouble. It told me this was an entrenched, founder’s board that was not going to make the transition necessary to avoid being a structural underperformer. I had no recourse at that point but to offer a premium for control that would allow us to bring in a new management team and realize the potential of the business.”
(On leadership of a target): “Intellectual honesty is probably first. I want the person who is going to address the elephant in the room. It drives me crazy when you meet with management and there are real issues and they act like they aren’t there. Also important is a contrarian bent, a confidence to go against the prevailing trend. You generally don’t want people who are saying this is what we should do because this is what others are doing. You want people who are spending when others are not, and taking chits off the table when everybody else is putting them on.”