The Activist Investor Blog
The Activist Investor Blog
How Activists Collaborate
Activist investors run in packs, right? Corporate lackeys accuse us investors of teaming up unfairly to take down noble, hard-working, and unsuspecting CEOs and their companies.
Well, we investors do collaborate on activist situations. We find strength in numbers. Together we have more impact on a company than we would individually.
A recent situation gives us a glimpse into how, exactly, this collaboration works. Pershing Square (PS) and Sachem Head (SH), two hedge funds, teamed to seek improvements at Zoetis (ZTS), the animal pharma company that recently spun-off from Pfizer. It looks like SH needed capital, and PS provided it.
Mentor and Protege
Scott Ferguson was the first analyst the Bill Ackman hired at his new PS fund in 2003. Ferguson left there in 2012, and a year later started SH as an activist fund.
SH built a formidable asset base of about $900 million as of September 30. Its portfolio includes Air Products and Allergan, both PS holdings. It also owns some Actavis, which just announced a deal to acquire Allergan.
The largest SH holding is ZTS. SH started buying in the first quarter of 2014, and now owns about 1% of the shares. The initial SH Form 13D filing does not reveal what it would like to accomplish at the company. Now that Actavis will likely acquire Allergan, PS’ partner Valeant in the potential Allergan deal might need another company to acquire. ZTS could fit.
Co-Investors, Too
At some point after SH started buying, SH and PS decided to work together on ZTS. According to the PS Form 13D filing, PS started acquiring shares in September 2014.
That filing includes the letter agreement between SH and PS:
❖PS will pay SH a fee of 10% of PS’ profits on up to $500 million that PS invests in ZTS, both in common stock and shares underlying derivatives (the “promote”)
❖They measure “profit” using the weighted average price for PS shares bought and sold, including the implied price used for pricing derivatives, of which there are several types
❖They measure profits on 12/28/15, or when PS sells its last shares, which gives them about a year or so to wring value from the investment
❖SH can trade in and out of its position only with PS approval.
They handle expenses in a slightly curious way. They will “discuss the possibility” of sharing expenses. If they agree, they will split expenses, with PS limited to paying $1.5 million to SH. Typically, investors will either cover their own expenses, or allocate them based on amount invested.
Who Owns What Now?
SH still owns its original 4.4 million shares, or 0.9%. It paid $131 million over time as it built the position. Those shares are worth almost $200 million today. SH also has its own derivatives on another 3.4 million shares. These add to its economics, but don’t add to its voting position.
PS has a more complicated position. It owns 5.5 million shares of common stock, paying $182 million in the two months since it started buying. PS also has various derivative positions that amount to another 37.3 million shares, which have an underlying basis of $1.4 billion. All told, PS has 8.5% of the company.
Together, PS and SH have almost 10% of the outstanding shares. In response, ZTS implemented a poison pill that limits them to 15%.
How Could It Work Out?
Suppose the shares gain 25%, either in a deal with Valeant, or through other activist efforts.
PS has $1.6 billion invested, so it would see a $400 million gain, good although not huge for the $18 billion PS. It pays SH 10% of the gain on $500 million of the investment, or $12.5 million.
SH has $200 million invested, and would see a $50 million gain. The $12.5 million fee does boost the economics for SH, but doesn’t seem like the principal reason to work with PS.
It seems to have an impact at ZTS, SH needs a bigger stake. The CEO might return a call and take a meeting with Ferguson and his 1%. The company will listen carefully to Ackman and Ferguson and their 10%. SH probably proposed ZTS to PS, and agreed to handle the activist heavy lifting.
Alternatively, PS wants a backup plan for its Valeant project. It knew of the ZTS position, and offered the promote to SH.
Note that PS and SH have not formed a group. They filed separate Form 13Ds, even as they obviously will collaborate. The company also will consider them a group for purposes of triggering the poison pill. It’s not clear why SH even needs to file a Form 13D, since it has under 5% of the outstanding shares.
Why not just invest alongside each other? SH could count on PS shares in any kind of proxy contest. Yet, having PS as part of the team, rather than cheering from the sidelines, probably has much more impact on the company.
Tuesday, November 18, 2014