THE BLOG
07/23/2013 03:32 pm ET Updated Sep 22, 2013

Sharknado and the Tide of Activist Investors

At last week's "Delivering Alpha" investor conference, financial sharks delighted the audience and business media with tales of conquest. While the Chinese identify 2013 as the year of the snake, for many this July may be remembered as the month of the shark. This is not just the month where Syfy channel's improbable hit disaster film "Sharknado" terrified audiences with imaginary sharks carried by stormed fed waves attacking attractive Los Angelites. It also is a month where genuine sightings of real 200 foot great white sharks returned to Cape Cod beaches 40 years after Jaws frightened bathers out of the water.

Moving from beaches to boardrooms another form of sharks are the prominent, often successful financial sharks of forty years ago -- now recast as activist investors. Nelson Peltz charmed the entertained audience as he offhandedly attacked PepsiCo's high performing winning model saying it had lost its fizz while Carl Icahn charmed the attending analysts as he condemned Dell creator Michael Dell's generous buy-back offer claiming the board was "Scaring the Dell out its shareholders." (Pretty good puns for "Icahnic" raiders hunting for Peltz).

With such blood in the water, CEOs like News Corp's Rupert Murdoch have recently resorted to "shark repellent" introducing a poison pill defense as his two businesses get their footing following the split of the newspaper and entertainment groups.

In the case of high performing PepsiCo or Dell where its founder Michael Dell has the best offer out there. Dell, knowing his business is no religion, has freed himself of founder's nostalgia before transforming the firm five times in the past and is the best bet to lead the next leap and public markets are too impatient, just ARAMARK, J. Crew, and Harrahs/Ceasars had previously concluded to undertake sweeping strategic overhauls. Given the steep declines in the PC market some such as CNBC's Jim Cramer say Dell has little chance of success, but let Michael Dell assume the risks with the management buyout. Even proxy advisory firms such as ISS say that the management buyout is the best deal not Icahn's.

Despite their swagger, these sharks do not always get it right. Bill Ackman's Pershing Square fund has lost badly in shorting Herbalife while attacking it as a Ponzi-scheme with the stock subsequently soaring 80 percent while Icahn took the opposite bet amidst nasty media slap-down exchanges. Ackman similarly forced destructive leadership changes at JC Penney which had to be reversed with Mike Ullman brought back in as CEO after the stock had fallen by 30 percent this year under short-term replacement CEO Ron Johnson's assault on the once-loyal JCP customer base.

Peltz, with a massive stake in the underperforming bakery and confectioner Mondelez, a Kraft spinoff, has conducted a misguided campaign for PepsiCo shareholders to spend $70 billion to buy it. To pay for this, he has suggested heaving off Pepsi North America -- shattering the global brand consistency and managerial back office synergy as he encouraged in the Kraft/Mondelez split where brands like British confectionary maker Cadbury were splintered between Cadbury, Kraft, Mondelez, and Hershey.

This is parallel to the operational and marketing disaster which plagued Hilton for roughly forty years of brand confusions when misguided owners split the domestic and international companies into rival chains in 1964 until they were sensibly reunited in in 2005. Similarly, the Gallup Organization and Ritz Carlton went to enormous efforts in the 1980s to reunite splintered global brands. Food producer Del Monte still suffers confusion in global markets with brands controlled by separate companies in the US and \Del Monte fresh produce and nine other Del Monte foods companies internationally.

Furthermore, enormous integration challenges of this $70 billion would be highly daunting. There would be likely antitrust challenges where performance would deteriorate with stalled strategic direction through the uncertainty. Just as importantly, Mondelez is largely anchored in slower moving western markets with sweet treats. By contrast, the salty snacks of PepsiCo's Frito-Lay division, salty snacks which complement its drinks and ride the back of PepsiCo's strong global beverage infrastructure throughout high growth markets in China, Russian, India, and the middle east. In China for example, PepsiCo enjoyed organic volume growth of 17% in beverages, and 47% in snacks. This tight complementary snack and beverage distribution system is why it would also be shortsighted to spit the interwoven beverage and snack divisions.

In the U.S. PepsiCo has built 9 of the top 40 trademarks in retail with brands like Gaterade, Tropicana, Quaker Oats, Frito Lay, and Pepsi. Peltz complained kids don't drink soft drinks like the Pepsi generation used to - that's fine, they can drink Gaterade, Ocean Spray, Izzy, or Aquifina the world' # 1 bottled water with 15 per cent of the market. Overall, under Indra Nooyi, PepsiCo has seen consistent double digit returns over the past decade well balanced between beverages (9 per cent) and snacks (14 per cent) while doubling its marketing budget and yet still increasing its margins due to process streamlining.

Peltz' pronouncement last week was ironic as it followed, by a day, PepsiCo's stock hitting its all-time high. Clearly, his concern is not raising PepsiCo shareholder value, but unloading his disappointing $1.23 billion Mondelez stake into the hands of presumed greater fools --- current PepsiCo shareholders. This has confused some in the financial press.

We still need financial capitalists with large stakes in enterprises to complement the prevailing model of managerial capitalism. Savvy financiers such as Warren Buffet and distress investor Wilbur Ross work with management to rebuild value of underperforming assets. Similarly, Patriarch Partners CEO Lynn Tilton has revived 75 businesses from near death, saving 120,000 jobs with a long term portfolio of brands ranging from : American La France; MD Helicopter and Dura Automotive to Stila Cosmetics; Spiegel, and Rand McNally. A new generation of activist investors fund players like Jim Chanos of Kynikos, Dan Loeb of Third Point investors, Dinakar Singh at TPG-Axon, and Jeffrey Ubben of Value Act. They function as genuine "white knights", rather than short-term oriented "sharks."

Chanos not only rang the alarms accurately and first on Enron and Worldcom but has certainly shown prescience in his longstanding prediction of a slowed Chinese economy. Singh forced needed leadership change at SandRidge Energy where the firm's market value had fallen by 80 per cent after strategic stumbles and questionable land deals. Ubben, patiently and wisely guided Martha Stewart Omnimedia through wrenching legal, branding, and financial trauma. He now offers to be a wise, quiet partner for Microsoft's Steve Ballmer. Dan Loeb just announced he is selling his stake in Yahoo after forcing a sweeping highly effective long past due leadership change with Marissa Mayer --- the stock price has doubled in under two years.

The lessons are clear. First, no role is guaranteed to be noble and pure as manipulative short-term investors and self-dealing insulated management are twin dangers that may survive despite all the governance reforms. Second, investors and media must not fall victim to the sloganeering of activist investors hawking their own book but cloaking it in good-governance-speak. Third, boards, through chairs or lead directors need to more effectively join with management in public discourse, explain their strategic positions to investors and other parties or only one side of the story will be told by media savvy activist investors.

Perhaps the greatest lesson of all is not that both sides are right in these disputes, but that, generally, only one party is right. Figuring which side is right requires genuine homework rather than falling victim to flamethrowing PR campaigns.

There has long been an historic tension between the captains of industry and commodores of finance. Industry leaders ranging from Thomas Edison, Walt Disney, and Henry Ford to Ross Perot, Steve Jobs, and Motorola's Chris Galvin complained bitterly how they had been shortchanged by Wall Street shortsightedness.

Fifty years ago, Pulitzer Prize winning business historian saluted the triumph of the "visible hand" of managerial capitalism as it rose in novel ascendance over the financial and dynastic capitalism by the middle of the 20th century. Financiers, rather than bootstrapping entrepreneurs hired the talent that built the once great Pennsylvania Railroad, ATT, General Motors, and US Steel only to be hobbled by poor management in later decades.

Both financiers and CEOs can be noble or deceptive. Truth to analysts and media, too often, is lost in the belief that truth is always balance splitting the difference between parties in conflict instead of truly determining who is right and who is wrong. In the words of Ayn Rand: "There are two sides to every issue: one side is right and the other is wrong, but the middle is always evil."