by Cydney Posner
Here is a link to an excellent story in the Sunday NYT that takes a more in-depth look into the consequences of hedge fund activism –not just on the company, but also on the community where the business is located. As the author notes, the “tale of Timken and the activist investors might seem like a Michael Moore-style good guy/bad guy narrative of Wall Street greed. But the players in this drama are not black-and-white caricatures. The reality is more nuanced and reveals the pressures executives and money managers, not just workers and residents in local communities, face in today’s economy.”
The story describes the efforts by hedge fund activists to break up Timken, a company that makes steel and bearings located in Canton, Ohio. Over the years, including during deep recessions, the company made significant capital expenditures in state-of-the-art equipment, even though it meant lower short-term profits and less return to shareholders. But these investments “paid off in the long run, allowing Timken to innovate, dominate the market for high-margin, specialized steel, and stay ahead of rivals in South Korea, Japan and Germany. A chunk of the resulting profits has been poured back into Canton, a city of 70,000, in the form of good wages for unionized steelworkers or donations to local schools, the Canton Museum of Art, and the new downtown arts district.” Because the steel business is “notoriously cyclical,” in addition to using the company’s balance sheet for capital investment, the company’s management (largely family) was wary of and has avoided incurring significant debt.
All of those factors that had made the company successful for 115 years were anathema to hedge fund activists, who frequently believe in incurring debt to finance acquisitions, dividends and large stock buybacks. The hedge fund activists targeting Timken teamed up with a public pension fund, which was, appropriately, looking to enhance the value of its public employees’ retirement fund. The pension fund had long championed good corporate governance and “helped neutralize” the appearance of a “Gordon Gekko” scenario. With the hedge fund arguing that splitting the company into two “pure plays” would “unlock value,” and the pension fund emphasizing the CEO’s $9M pay package and family domination of the board, a battle ensued. The activists won in a non-binding vote, but ultimately the board felt compelled to authorize the spin-off.
Now, Wall Street is viewing the two resulting companies as appealing acquisition targets, and management and the surrounding community are concerned about the potential ripple effects if buyouts were to occur: “If TimkenSteel is swallowed by a larger competitor,… the mills in Canton won’t grind to a halt anytime soon. But an owner from another state — or country — is unlikely to be so committed to keeping jobs in Canton, let alone backing a downtown arts district or local high school.” Even if they are not acquired, “the separation is likely to make both firms more vulnerable over time. [According to a professor quoted in the article,] [n]ot only will they both be less financially nimble than before,… the steel maker in particular will lack the scale to invest and innovate the way it could under the old corporate structure. Foreign steel makers in Asia and Europe are vastly larger, and face much less pressure for short-term results, enabling them to pour more money back into their businesses. ‘In the microcosm of Timken, you can see the larger forces playing out in manufacturing in America. [accordng to the professor] It’s not classic greed, like ‘Barbarians at the Gate.’ But we’ve set up financial markets in a way that’s injurious to long-term investment and industrial companies. We’ve got a financial system in the U.S….where [public employees] have to protect their pension funds by hurting manufacturing in Ohio.”
The activist hedge fund had soon “unloaded its entire position in both Timken and TimkenSteel. All told, [it] acquired its stake at about $40 a share and sold at $70, reaping a 75 percent gain — $188 million — in just over two years.” In addition, new management of the spin-off appears to be eschewing the very factors that helped build the company in favor of the “activists’ playbook”: an investor presentation reflecting management’s new plans for capital allocation indicated that “[p]ension fund contributions drop from nearly a third of cash flow to near zero, while capital spending is roughly halved. And instead of using 12 percent of cash flow to buy back stock, share repurchases will consume nearly half of cash flow over the next 18 months. In other words, less cash is being invested in the business or earmarked for benefits to employees, and more money is going to investors.”
There is much more in the NYT story. Highly recommend.