Human Capital Briefs

Bill Ackman Is Just Doing God's Work

September 09, 2013

Everybody has been piling on to hedge fund manager Bill Ackman lately. I'm not joining in. The man may have bitten off more than he can chew, dug himself in too deep, played with fire and gotten burned, or whatever other folksy metaphor you favor. But he's doing God's work. Or at least the market's.

Ackman's short-selling campaign against vitamin distributor Herbalife has blown up in his face, with the company's stock up more than 75% since he unveiled his position last December and some of his most prominent hedge fund competitors profiting from his misery.

Then there's JC Penney, where Ackman's push to remake the retailer under the leadership of former Apple Stores chief Ron Johnson has ended in red ink and recriminations. After 17 bold but financially disastrous months, JC Penney's board fired Johnson in April and reinstated his predecessor, Mike Ullman, as interim CEO. Last week Ackman wrote (and leaked) pair of letters in which he pushed for quicker action in finding a permanent replacement for Ullman and demanded the resignation of board chairman Tom Engibous. That led iconic Starbucks CEO Howard Schultz (who knows Ullman from Starbucks' board) to weigh in, telling The Financial Times that Ackman "has blood on his hands for being the one who brought Ron Johnson in" and arguing on CNBC that Ackman and Johnson had "ruined the lives of thousands of JC Penney employees and fractured shareholder value." (Update: Ackman quit JC Penney's board on Monday.)

Schultz may be right about that. But the choice of Johnson was a bold bet that didn't pay off — or at least didn't pay off in time. Sometimes that happens. And the whole reason Ackman jumped in at JC Penney in the first place is that the company's fortunes had been in decline. That's what activist hedge fund managers like Ackman do. They identify companies that they think could be worth a lot more than their share price indicates, and push for changes. Often these changes involve straightforward moves like spinning off subsidiaries, which Carl Icahn pushed Time Warner to do seven years ago and the company is finally getting around to now. Occasionally they get much more involved, as with Eddie Lampert's seemingly permanent (and not exactly successful) takeover of Sears and Kmart. And sometimes, when they think a company's stock is overvalued, they sell it short and try to convince the rest of the world that they're right.

Here's the thing. On balance, this stuff seems to work. That's the finding of a big new study by Harvard's Lucian Bebchuk, Duke's Alon Brav, and Columbia's Wei Jiang, which shows that companies targeted by activist hedge funds as undervalued markedly improve their operating performance in the subsequent five years. What's more, the authors write:

These improvements in long-term performance, we find, are present also when focusing on the two subsets of activist interventions that are most resisted and criticized — first, interventions that lower or constrain long-term investments by enhancing leverage, beefing up shareholder payouts, or reducing investments and, second, adversarial interventions employing hostile tactics.

It is of course a bit disturbing to see that five years is now considered the "long term." It also doesn't follow from Bebchuk, Brav, and Jiang's evidence that more hedge fund activism would necessarily be a good thing. The very rarity of such interventions helps make them successful. If there were thousands of Bill Ackmans out there, the results of their activism would presumably be far less impressive. But Ackman's current struggles illustrate why his extremely hands-on brand of investing will never become common. It involves going way out on a limb — and limbs (tree limbs, at least) are liable to break or get chopped off.

Now it is true that Ackman's behavior over the past couple of weeks has been petulant in the extreme, and Bill Cohan's epic Ackman profile in April's Vanity Fair makes clear that the guy is not always fun to hang out (or go biking) with. But a normal, well-balanced person would never go into this line of work. And it does appear to be useful work. Which is more than be said of a lot of other financial-market endeavors.

Hedge funds are often criticized as short-term speculators. Some are, some aren't. The particular brand of investing that Ackman and a small number of other hedge-fund managers practice is best described as medium-term. Ackman is no Warren Buffett, who holds on to companies for decades, but he's not obsessing over day-to-day market moves or quarterly earnings reports, either. He started developing his famous case against bond insurer MBIA in 2002, and had to wait till 2009 for it to pay off. At JC Penney, you could argue that it was the rest of the company's board that was too short-term-oriented to give Johnson's big plans a chance to play out (I'm not going to argue that, because things really were going terribly, but Ackman was on the long side of that particular disagreement). If you're concerned that a lot of mischief is wrought by Wall Street's obsession with short-term shareholder returns (and I am), Bill Ackman and his fellow activists really aren't the problem.

 

This blog first appeared on Harvard Business Review on 08/12/2013.

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