Wednesday, February 9, 2011

Is Shareholder Control Beneficial?

I perused a recent paper about the optimality of shareholder control, and though it didn't generate any interesting conclusions, it raised a good question. The recent issue with St. Joe Company comes to mind. The institutional shareholders are making a move to take control of the board and to steer the company in a completely different direction.

The board and the management of the company have only themselves to blame for being in the cross hairs of savvy institutional investors like Fairholme Fund and Greenlight Capital. They made a huge bet on development in the Florida Panhandle, centered around the binary event of whether or not a new airport would be built. The airport is built, but it turns out to be only a very small piece of the puzzle, and the board and management took an expensive and unhedged way to place this bet. Unfortunately for them, Fairholme drank the Kool Aid when they bragged in one of their annual reports about the unrealized value in all the Florida land their investment owned. Now, we'll see what shareholder control does in this case.

The recent case of Sears comes to mind. Much was made, rightly so, of the fact that the management simply couldn't run or merchandise stores very well. Shareholders voted with their feet and sold the stock. The story then became the value of the underlying prime real estate that Sears owned or controlled. Meanwhile, another terrible cast of executives were busy fiddling while Kmart burned slowly. Enter hedge fund manager Ed Lampert who took control of Sear merged it with Kmart, while confusing both sets of customers, who were distinct segments of consumers. Years later, Sears' repeated experiments with soft goods have failed miserably, but we didn't need to a change of control to know they couldn't execute. The appliance and home and garden segments are still the reason most people enter the store. An iconic brand of American retailing seems on the precipice of going the way of Woolworth, W.T. Grant and Montgomery Ward. Last year ended with Sears comps down 6% for December and 3.8% for the year. The environment in Sears stores is positively funereal. Most of the analysts have downgraded to neutral or under perform, with a few sells. Has shareholder control been beneficial in this case? I don't believe so.

Most institutional shareholders are good at what they do: constructing and managing portfolios, which is a very profitable business where mediocrity is rewarded since most money managers under perform their indices. Running a business, other than money management, is something that seems to be outside of their comparative advantage. St. Joe will be another good data point on the question of benefits of shareholder control.

Monday, February 7, 2011

Fairholme Stops Standing Still on JOE

There is a flurry of news today about St. Joe Company (JOE), a subject of a few posts a while back, first triggered by the informative presentation by Greenlight Capital. Into the argument came Bruce Berkowitz and the Fairholme Fund, owners of almost 30% of JOE, who poo-pooed all the arguments brought forward by Greenlight. Well, it appears today that Fairholme has finally awakened from its romance with the stock and has come out swinging MMA style.

CNBC reported today that Fairholme will seek to nominate Bruce Berkowitz and Charles Fernandez, directors of the company and executives of Fairholme, to the positions of Chairman of the Board and Vice-Chairman, respectively. CNBC reports that Fairholme will seek to dramatically shift the business model, including cutting the expense structure, perhaps stopping some planned asset sales, and looking for partnerships and new acquisitions.

A Morningstar analyst who has been quite bullish on the company, and who carries a $40 fair value on the stock, is fearful that momentum now being built up in the company's value-creating activities will be blunted by the Fairholme moves. It's hard to see what he means by this, as it's clear that some progress has been made--the company is not hip deep in a peat bog any more. However, to characterize anything JOE is doing as "momentum" seems a real stretch. Institutional investors control about 65% of the shares, and so it would seem that the Fairholme play should be a fait accompli barring the ability of the company to divide the shareholders, which would seem unlikely.

It's good to see Fairholme waking up, and its initially glib, dismissive attitude to the Greenlight Capital report has now been replaced by a sense of urgency. It should be good for the shareholders, once their plans are made more specific.

Thursday, February 3, 2011

Another Foreign Policy Debacle in Cairo?

Between our global intelligence apparatus and our Foggy Bottom brigade at the State Department, events in Cairo and elsewhere in the Middle East, have taken us by surprise and we are reacting, in our usual manner: ready, fire, aim. Newspaper headlines trumpet, "US Breaks Away From Mubarak." To whom will we go?

President Mubarak made some courageous moves, unfortunately they were almost a generation ago. Making peace with Israel was a historic moment, and his staying free from assassination was a preoccupation for many years. Unfortunately, in the intervening thirty years, he did almost nothing to build up the economic infrastructure in Egypt, and the educated, multicultural elite and middle class have largely emigrated. That's done and dusted. A second wave of emigration would be the angry, disenfranchised and under skilled twenty somethings.

In a parallel to Pakistan, the Egyptian army does hold some cards here. Who will they throw their support to, and what will they ask in return? Just as in Iraq and Afghanistan, exiled Westernized Egyptians are returning and holding press conferences touting themselves as Presidential wannabes. But surely we've learned in both Iraq and Afghanistan, these medicines are often worse than the disease. Let's not overreact and buy into one of these solutions.

We also don't really know who's in the streets and where the money is that's supporting and fomenting the unrest. Some newspapers have suggested that we don't have to worry about fundamentalists in Cairo. No? Tell that to all the dead, wounded and exiled Coptics. Our European allies are absent in the crisis as usual.

President Mubarak must become more visible, clear and strong about his plans--going or not going? Clear transition plans, expressed with visible presence from the military, legislative and cultural leaders. He has to become engaged, and we should work with him, even as an interim solution. Saying that we are cutting him loose in the absence of a well thought out alternative will be a repeat of our other foreign policy failures.