Monday, June 26, 2017

Activist Investors or Opportunists?

Is this whole game stacked against the small investor?

Recently an article in Reuters mentioned that an "activist" hedge fund bought a big chunk of Nestle stock and demanded changes.   And the changes they are demanding are not necessarily good for the company, but good for the hedge fund.

Nestle is a staid and slow-moving old-line company more interested in long-term plans than short-term gains.   Their profit margin target is "only" about 15% and the hedge-fund people want it to be 18-20%.   They also want to strip off some assets, such as a stake in L'Oreal, and also double the amount of debt the company has and use this money to buy back stock.

Gee, what would that do to the stock price?   Yup, it would cause it to spike.   The problem is, loading a company with debt over the long haul will depress profits, as the company now has to service a larger debt load and pay more interest.   Oh right!  We don't count interest in "EBTIDA" because, well because we'd rather not.

So the "hedge fund" buys the stock, forces changes at the company that spike the stock price temporarily.   They then sell their stock (no doubt after the shouting guy tells you on TeeVee to buy it, now that the company has been "reorganized") and then the long-term effects of the staggering debt start to be felt.

The problem for Nestle isn't that they are not buying back stock and taking on debt.   The problems for the company are the same as anyone in the food business today:
1.  There is a HUGE price war going on in the supermarket business and prices are dropping.

2.  Packaged foods as a segment are suffering as people migrate toward fresher, healthier fare.

3.  As the population ages, the popularity of candies and junk foods starts to drop off.

4.  The world is headed for another recession.
In order to stem this tide, Nestle needs to come up with newer, healthier products, and also be able to compete on price.   This is not easy to do.  For a company whose prime product is instant coffee in an era of artisan brews, it is time for a product mix change more than anything else.

In other words, given current market conditions, Nestle is doing pretty well and not "under-performing."  What it needs isn't some smoke-and-mirrors debt financing of a stock buy-back, which is just re-arranging the deck chairs on the Titanic, but rather a serious re-work of its product line and production efficiency.

The latter is the hard part of any business.  It takes talent and expertise to get down to the nitty-gritty of a company and figure out how to boost sales, cut costs, and increase productivity.   It doesn't take any talent to take an old-line company, load it up with debt, and then allow shareholders to reap a short-term gain as a result.

But sadly, that is the nature of business today.   Someone with a lot more money than you and me can threaten a company by purchasing a large stake in it, and push through poorly thought-out short-term changes that serve only to profit the hedge fund investor.   Long-term planning is out the door.   How the long-term shareholders, the small investors, the employees, and even the customers benefit from any of this is dubious at best.

What is odd to me is that the very thing Nestle is criticized for, namely moving slowly and methodically, is what we should be applauding in the business world.   What the world needs more of is methodical thinking.  What we need less of are financial stunts that create apparent wealth on paper (and real wealth for a select few) but no real changes in the marketplace.