Hedge fund manager Daniel Loeb (Trades, Portfolio) was unhappy. His second-largest holding, Agribrands, an animal feed manufacturer, was about to be sold for less than its real value and, what’s more, it would be sold for a dollar less than he had paid for his shares. What could he do?
Loeb’s struggles are another example used by Tobias Carlisle to explain his Acquirer’s Multiple strategy in the book, "The Acquirer's Multiple: How the Billionaire Contrarians of Deep Value Beat the Market." Briefly, the Acquirer’s Multiple is a strategy based on the ideas of Benjamin Graham and what Warren Buffett (Trades, Portfolio) has called “fair companies at wonderful prices.”
Loeb was a relative newcomer in the late 1990s, with a hedge fund that had grown from $3.3 million to about $200 million in five years, a tremendous achievement, but not enough to have much clout in boardrooms.
He was facing off against Agribrand CEO and Chairman Bill Stiritz, a legend because of his leadership of Ralston Purina in the 1980s. Stiritz profitably sold off many pieces of a “messy” conglomerate and bought back a lot of stock. Operating earnings soared 50 times and, according to Carlisle, Stiritz had increased the value of the company more than 100 times.
In winding up his tenure at Ralston Purina in 1997, he spun off two last businesses, Agribrands and Ralcorp (a cereal and grocery business). At the same time, he had himself appointed CEO and chairman of Agribrands as well as chairman of Ralcorp.
His wanted Ralcorp, with its better businesses, to acquire Agribrands, which had a huge stockpile of cash. If Agribrands could be pulled into Ralcorp at a discount, Stiritz would have had the resources he needed to build a second empire. The problem, though, was outside shareholders would have been treated unfairly.
By Loeb’s reckoning, the Ralcorp offer of $39 per share meant $420 million for the whole company, which had $160 million in cash on hand. It also meant the offer had a net value of $260 million ($420 million minus $160 million). Because Ralcorp and Stiritz would pay off $10 million in debt, the price would effectively rise to $270 million. For that, Stiritz was getting a company that generated $90 million per year in operating earnings.
When $90 million is divided by $270 million, the Acquirer’s Multiple works out to less than three years' worth of cash flow. The price-earnings ratio (which is the inverse of the Acquirer’s Multiple) was also low at 7.9 times.
Loeb’s Third Point Partners owned 4% of Agribrands’ stock, not enough to get the attention of Stiritz; as Carlisle wrote, “Stiritz is intent on merging Agribrands’ cashbox into Ralcorp’s businesses at a big discount to its true value.”
Earlier in 2000, Loeb’s friend and fellow hedge fund manager, Robert Chapman Jr., had faced a similar dilemma with American Community Properties Trust. In a last-resort effort, he had taken on the company’s chairman, CEO and son of the founder, who Chapman alleged was trying to drive down the share price so the insider family could buy the assets at a fraction of the asset values. With no leverage and no response from management, Chapman set out to publicly shame the company.
The strategy worked and Loeb decided to do the same with Agribrands. He had worked out the Acquirer’s Multiple to identify information few investors knew of. As part of that discovery, he confirmed the sales price was far too low and that Stiritz was putting his personal interests ahead of shareholder interests.
Loeb launched his public criticism campaign and, as Carlisle reported, he “wields the pen like a flamethrower.” Like Chapman, he boosted his stake to more than 5%, which triggered the need to file a 13D form with the Securities and Exchange Commission. That form provided a platform to explain publicly what the problem was with the Ralcorp offer for Agribrands.
Rather than be pilloried further, Stiritz announced in December 2000 that Agribrands would be sold to Cargill rather than Ralcorp. The shares would be sold at $54.50, which was $15.50, or 36%, more than the original offer.
Thus, Loeb made a great deal of money and became infamous in the investment community; he continued to use this technique to take on “remote” boards of directors and insiders who refused to heed the needs of shareholders. In the process, he became a billionaire in just five years.
In 2013, David Einhorn (Trades, Portfolio) of Greenlight Capital and Carl Icahn (Trades, Portfolio) of Icahn Partners teamed up to do the same with Apple (AAPL, Financial), albeit in a friendlier way (CEO Tim Cook agreed to meet with them). Still, the two activists were determined to see Apple do something with the $150 billion it held in cash. Einhorn insisted it was too much for a company with just $60 billion in fixed assets.
Einhorn and Icahn were also using the Acquirer’s Multiple to identify hidden value and liabilities in Apple, and they wanted the cash returned through a $150 billion buyback. Icahn believed a $150 billion buyback would increase earnings per share by 33% and push the share price up 150%--to $150. At the time, the Acquirer’s Multiple was 7 times and the price-earnings ratio was 14 times.
Their persuasion was effective. Apple announced in early 2014 it would buy back $40 billion worth of stock, and that it would return another $130 million through increased buybacks and dividends. The stock, which had been trading at about $56 in May 2013, jumped to $100 and by the end of 2013 had reached $120, double what it had been a year and a half earlier.
Carlisle wrote:
“Apple is a good example of the power of the Acquirer’s Multiple, which identifies this type of stock, undervalued with a depressed value. It offers two ways to win. An activist emerges to improve the value and rapidly close the discount, or mean reversion acts on the price to push it up gradually in the meantime.”
As noted in earlier digests, Carlisle is trying to build support for a contrarian perspective on value investing. He is making the case that deep-value investing can be a viable strategy for earning above-average returns, and that prominent investors are using this strategy.
His tool for finding deep, and sometimes hidden, value is in the Acquirer’s Multiple. This metric is calculated by dividing a company’s enterprise value by its operating earnings. It allows an investor to compare the total cost of a business to the operating income flowing through it.
The author got the metric from the corporate raiders of the 1970s and 80s and calls it an “industrial-strength PE multiple.” While most investors focus on profits, corporate raiders, activists and Carlisle use the Acquirer’s Multiple to find what he calls “treasure hidden in plain sight on corporate balance sheets.”
(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
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