Deal Professor: Shareholder Activism at Arconic Points to a New Wave

by admin March 1, 2017 at 1:12 am

Mr. Kleinfeld’s path to a rebuilt Alcoa had been anything but puppies and rainbows. Alcoa recovered from the 2008 financial crisis, but its stock price since he took the reins has lagged aluminum peers by almost 20 percent and the Standard & Poor’s 500-stock index by 150 percent.

Still, much of that poor stock performance against peers is attributable to that horrific first year in 2008, and Alcoa has outperformed aluminum peers since.

Enter Elliott Management. The hedge fund announced that it had taken a stake around the time Mr. Kleinfeld announced the company split.

At first, the hedge fund’s strategy could well have been to push for the same split. Company spinoffs are, after all, a stock trick of hedge funds, providing an event that will likely spur a stock increase, allowing the hedge fund to sell and profit.

The separation announcement brought peace for about a year as Elliott was allowed to put three independent directors on the Arconic board.

Now, however, war has erupted as Elliott has nominated five directors to replace the company’s board. The activist investor has called for Mr. Kleinfeld to be fired and replaced by Elliott’s own handpicked chief executive, Larry Lawson, who led Spirit AeroSystems Holdings.

How did things get so bad?

From the public record, Elliott’s grievance appears to lie entirely with Mr. Kleinfeld. The hedge fund paints him as a dilettante who is more interested in being at the World Economic Forum in Davos, Switzerland, or meeting with President Trump than in running a business.

Arconic, meanwhile, has disappointed on quarterly results both as a spinoff and before. Elliott complains of high corporate spending, like a corporate marketing campaign that plays off the 1960s cartoon “The Jetsons” and an expensive headquarters in Lever House on Park Avenue in Manhattan. (The company inherited the building in the split.) While Arconic is spending too much, Elliott says the new Alcoa is busy cutting costs.

The hedge fund also contends that Mr. Kleinfeld has overspent on acquisitions that have not borne fruit, while ignoring the development of a domestic Chinese aluminum market as a competitor. And Arconic’s margins are lower than a competitor, Precision Castparts.

Arconic has a response and its own set of facts. In investor presentations and elsewhere, the company has argued that Mr. Kleinfeld took over a troubled company and created the Arconic business through acquisitions. Moreover, this business is dependent on personal relationships that he has established through his global profile.

As for those pesky margins, Arconic says it is focused on increasing profit margins and has a plan, while comparisons with Precision Castparts are inapt because Arconic is an array of different businesses.

In addition, all the directors of Arconic currently support Mr. Kleinfeld, including the three Elliott-nominated directors. And finally, Arconic’s stock has been on a tear since the spinoff last November — up more than 54 percent. To be sure, some of that may be a result of the “Trump bump” rally in the stock market, but as Arconic argues, “the separation has enhanced the respective businesses and unlocked substantial value for shareholders.”

If your head is spinning right now, join the club.

This is the new shareholder activism. The low-hanging fruit, and tricks like selling the company or spinning off a business, are drying up.

Instead, a few shareholder activists are now trying something much harder — actually digging into the operations of a company and working to turn it around.

This is more like private equity than shareholder activism. And these investors are new at this, but this is the wave of future activism, to the extent that it persists. In part, this explains the recent shareholder activism trend of putting up candidates for chief executive, which is happening right now in situations involving the railroad operator CSX and the retailer Tiffany’s.

As for Arconic, ordinary shareholders will get nowhere trying to puzzle through these new battles. Each salvo back and forth contains a nugget of information, but not a bigger picture.

If you want that broad view, then perhaps the best thing is to ignore the chatter about expensive headquarters and Davos and focus on the business. And it seems to be a business that continues to fall short of Wall Street’s forecasts. Last quarter, its first as an independent company, Arconic reported adjusted earnings of 12 cents a share, a penny below the consensus estimate.

The weakness may not be enough to justify ousting Mr. Kleinfeld, a man who has been with this business a long time and is executing on a split that Elliott supported.

Still, it is hard to see him surviving. Most chief executives who fight vicious shareholder battles are unable to hang on — and even those who win such a contest depart shortly thereafter, as did Ellen Kullman at DuPont.

That’s the price chief executives pay for their high compensation — in Mr. Kleinfeld’s case as much as $18 million in recent years.

If Elliott wins, it will then have to do the hard work of working with a new chief executive to execute on the company’s strategy, something these investors may or may not have the skills to do.

And so, that is where Arconic seems to be heading — toward a referendum on its chief executive that most outsiders cannot understand, and a future that involves uncertainty.

Expect more of these types of situations as shareholder activists increasingly try to become turnaround experts, and shareholders try to puzzle through whose judgment is best.

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