Extreme Value Hedging: How Activist Hedge Fund Managers Are Taking on the World

Chapter 2

Nuts and Bolts

How Activists Became Who They Are Today

From Value Investing to Proxy Contests and Other Activist Tactics

Before investors become activists, they have to first find the businesses they want to invest in, or as many of them like to put it, “target.” That in itself is no small task considering the vast universe of public companies from which to choose.

Prior to pressing management to make changes, activists typically first buy stocks of companies they believe the stock market and Wall Street analysts have undervalued or ignored.

There are thousands of investors that make these kinds of passive investments every day. They are known as traditional value investors. In essence, these investors seek out stocks that are trading at a discount to the value of all their underlying assets, including debt and cash. Companies become pickings for value investors for a number of reasons. The stock market may be overreacting to bad news at the company, or perhaps a particular management team is not operating its business to optimal capacity. Most value investors today, whether they are mutual fund or hedge fund managers, are not activists.

In some circumstances, particularly with remnants of many high-flying Internet bubble companies of the late 1990s, a company has no or little debt and its cash reserves exceed its stock value. These companies, where the cash on the balance sheet is worth more than the whole company, are really extreme examples of value stocks and they ...