{"id":2955,"date":"2017-05-29T07:30:48","date_gmt":"2017-05-29T12:30:48","guid":{"rendered":"http:\/\/flevy.com\/blog\/?p=2955"},"modified":"2017-05-10T14:45:47","modified_gmt":"2017-05-10T19:45:47","slug":"interview-with-author-and-hedge-fund-manager-jeff-gramm","status":"publish","type":"post","link":"https:\/\/flevy.com\/blog\/interview-with-author-and-hedge-fund-manager-jeff-gramm\/","title":{"rendered":"Interview with Author and Hedge Fund Manager Jeff Gramm"},"content":{"rendered":"<p><em>Editor\u2019s Note:\u00a0This is an interview originally conducted by Nitiin A. Khandkar of\u00a0<a href=\"http:\/\/bqinvesttraining.com\/\">Beyond Quant InvestTraining<\/a>\u00a0and published\u00a0<a href=\"http:\/\/bqinvesttraining.com\/interview-jeff-gramm-author-hedge-fund-manager\/\">here<\/a>.<\/em><\/p>\n<p><em>This author has also\u00a0published\u00a0several financial models on Flevy, including the\u00a0<a href=\"https:\/\/flevy.com\/browse\/business-document\/worlds-first-research-report-cum-financial-model-customizable-121\">World&#8217;s First Research Report-cum-Financial Model<\/a>\u00a0and a\u00a0<a href=\"https:\/\/flevy.com\/browse\/business-document\/premium-financial-model-bse-ltdbombay-stock-exchange-2437\">BSE Ltd. (Bombay Stock Exchange) Financial Model<\/a>.<\/em><\/p>\n<p style=\"text-align: center;\">* * * *<\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Our guest today, is\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Jeff Gramm<\/span>, who runs Bandera Partners, a long-oriented, value-driven hedge fund based in New York City, USA and also teaches value investing at Columbia Business School. Jeff authored the highly acclaimed \u201c<span style=\"font-weight: bold; font-style: inherit;\"><a style=\"font-weight: inherit; font-style: inherit;\" href=\"http:\/\/amzn.to\/2obFP75\">Dear Chairman<\/a><\/span>\u201d, a book focused on Shareholder Activism, which shares key insights into activism initiatives by leading investors such as Benjamin Graham, Warren Buffett, Carl Icahn, Ross Perot and Daniel Loeb.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">\u201cDear Chairman\u201d has been praised by luminaries including Warren Buffett, Carol Loomis, former SEC chairman Arthur Levitt, former Fed chairman Alan Greenspan, FedEx CEO Fred Smith, and Charles Schwab, chairman of the Charles Schwab Corporation.\u00a0<\/span><\/p>\n<p>The interview is in podcast and transcript formats.<\/p>\n<p><span style=\"font-weight: bold;\">Podcast of Interview with Jeff Gramm<\/span><\/p>\n<p><iframe src=\"https:\/\/www.audiomack.com\/embed\/song\/bqinvesttraining\/interview-of-hedge-fund-manager-jeff-gramm-by-beyond-quant-investtraining\" width=\"100%\" height=\"150\" frameborder=\"0\" scrolling=\"no\"><\/iframe><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><span style=\"font-weight: bold; font-style: inherit;\">Transcript of Interview with\u00a0 Jeff Gramm<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">1. Hi Jeff, how are you? Could you please share your professional background, something about your hedge fund, and how you decided to write a book on Shareholder Activism?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><img decoding=\"async\" class=\"alignright size-medium wp-image-2957\" src=\"https:\/\/flevy.com\/blog\/wp-content\/uploads\/2017\/05\/gramm-225x300.jpg\" alt=\"gramm\" width=\"225\" height=\"300\" srcset=\"https:\/\/flevy.com\/blog\/wp-content\/uploads\/2017\/05\/gramm-225x300.jpg 225w, https:\/\/flevy.com\/blog\/wp-content\/uploads\/2017\/05\/gramm.jpg 768w\" sizes=\"(max-width: 225px) 100vw, 225px\" \/>Jeff: Sure. So, after college, I played music for a few years \u2013 not very successfully \u2013 before going to business school at Columbia.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">I was lucky enough to take Joel Greenblatt\u2019s Security Analysis class<\/span>, and it really resonated with me. I had never heard of value investing, and this idea of scouring the markets for 50-cent dollars was very appealing. Fortunately for me, we were in the midst of a great hedge fund boom. I went to school in 2001 and that was a boom time in the hedge fund business. I took an unpaid internship during school at a distressed debt hedge fund owned by Mellon bank. They hired me after business school, and I worked there until I left with my boss to be his junior partner at a startup hedge fund called Arklow Capital. I left Arklow and founded\u00a0<a style=\"font-weight: inherit; font-style: inherit;\" href=\"http:\/\/www.banderapartners.com\/\">Bandera Partners<\/a>\u00a0with my partner, Greg Bylinsky, in 2006. Bandera is a concentrated value investing fund. We own about 15 stocks, with 3 or 4 of them accounting for a large percentage of our portfolio. We\u2019re very small \u2013 we\u2019ve about $155mn in assets.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">As for deciding to write the book: I started teaching investing at Columbia Business School in 2011, and the students were always asking for book recommendations. Instead of recommending books, I\u2019d give them articles, speeches, and\u00a0<span style=\"font-weight: bold; font-style: inherit;\">I gave them these 13D shareholder activist letters, which I thought were useful for teaching purposes.<\/span>\u00a0<span style=\"font-weight: bold; font-style: inherit;\">In those letters the activists often spell out their investment thesis, why they like the stock, and they also explain the reason why they think the company is under-managed.<\/span>\u00a0After a few years of this, I figured there must be a book collecting those activist shareholder letters, and when I couldn\u2019t find one, I thought, \u201cwell I can do that myself.\u201d From there, it really evolved into the narrative history of activism that became \u201c<a style=\"font-weight: inherit; font-style: inherit;\" href=\"http:\/\/amzn.to\/2obFP75\">Dear Chairman<\/a>\u201d. I never really had the time to do it, as I have a full-time job as a fund manager. But I was requesting these original letters from shareholder activists, and every time I got one, it inspired me to keep pursuing the idea. One day I came to work, and\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Warren Buffett had sent me a copy of his 1964 letter to American Express<\/span>, and that lit enough of a fire under me to force me to finish the book.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">2. Nice to hear that, Jeff. What in your view gave rise to shareholder activism in the US? The Ben Graham versus Northern Pipeline case dating back to 1926, as documented in your book, is probably the first shareholder activism case in recent times, in the US. However, shareholder activism seems to have taken off only after the 1970s or 1980s. What could\u2019ve caused the hiatus in activism in the intervening period?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: Well, as long as there have been public companies, there have been active, engaged owners looking out for their own interests.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">The very first public company, the Dutch East India Company was chartered in 1602 and saw various uprisings from unhappy shareholders.<\/span>\u00a0In America, there were active investors in very early banks, toll roads and railroads. So,\u00a0<span style=\"font-weight: bold; font-style: inherit;\">activism didn\u2019t begin with Benjamin Graham.<\/span>\u00a0What makes him interesting and special is that\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Graham\u00a0was among the first professional investors with underlying clients to employ shareholder activism as part of his investment strategy.<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">We all think of the 1980s as the start of activism and corporate raiding, but that\u2019s not true.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">There was a period of robust shareholder activism in the 1950s called the<\/span>\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Proxyteer movement<\/span>. The second chapter of my book is about a famous battle over control of the New York Central railroad.\u00a0 As you can see in my book, much of the history of shareholder activist interventions is driven by the evolution of the investor base of public companies. These activists get all the attention and headlines, but the voting shareholders behind the scenes play a huge role in my book. And they\u2019re key characters in my book.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">In Benjamin Graham\u2019s time, most public companies had concentrated shareholder bases comprised of founders and strategic investors.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">When he targeted Northern Pipeline company, for instance, the Rockefeller Foundation owned about 25% of the company, and Graham spent considerable energy appealing directly to them.<\/span>\u00a0By the Proxyteer era, share ownership in the US had diffused into the hands of individual investors. Proxy campaigns in this period were like political campaigns \u2013 newspaper advertisements, appearances on TV news shows, that kind of stuff. The Proxyteer period did not last that long.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Starting in the 1960s, share ownership began to re-concentrate in the United States, this time into the hands of fiduciary investors like pension funds and mutual funds.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">A shareholder activist today has a different job \u2013 he\/she needs to appeal to those sophisticated institutional investors as opposed to individual holders. That\u2019s why hedge fund activists of today are very smooth, presentable and quite politically adept.<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">3. Okay, these are quite interesting perspectives, Jeff. All the activists covered in your book are quite influential. Which of the activism cases covered in your book, is the most significant in your view, and caused the biggest change, in favor of minority shareholders?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: Well,\u00a0<span style=\"font-weight: bold; font-style: inherit;\">to me, Ross Perot\u2019s intervention at General Motors ($GM) was the most significant.<\/span>\u00a0This is also the best chapter in the book, it\u2019s the most fun chapter. This was the mid-1980s, and corporate governance in the US at that\u00a0<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">point was bleak. Passive shareholders were exploited by corporate raiders, and hostile raids, as well as by corporate management teams which were paying greenmail to activists or executing their own management buyouts. Big institutional investors were very touchy after several years of mistreatment, and then the Ross Perot saga happened.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Ross Perot was a legendary businessman who sold his company to GM, and then joined the board as the largest shareholder. Investors were thrilled with the idea of Ross Perot injecting some life into GM\u2019s board. Instead, what happened is, he instantly clashed with CEO Roger Smith, and GM eventually paid Perot $700 million to get him off the board. Institutional investors who had seen GM begin to falter, had seen Toyota and Honda emerge as formidable threats, were shocked that a struggling company like GM would use so much precious capital just to weaken its board of directors. One large pension fund manager said, \u201c<em style=\"font-weight: inherit;\">We\u2019ve been asleep at the switch.<\/em>\u201d Those big pension funds revolted against GM and a bunch of other public companies in the 1980s.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Hedge fund activism as we know it today is possible because of this big awakening of large, passive, institutional investors.<\/span>\u00a0The hedge funds get the attention, but in order to make their activism work, they have to appeal to the big pension funds. Before Ross Perot, big pension funds were extremely trusting of incumbent boards and management and that began to change in the 1980s. Perot was a big turning point.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">4. Why do hedge fund investors in particular, engage in activism, rather than simply exiting the stock? Are mutual funds too known to be as aggressive in activism?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff:\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Activism can be a really useful tool to unlock value at public companies.<\/span>\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Carl Icahn\u2019s early career as an activist showed how interventions at undervalued companies often resulted in quick, bonanza results.<\/span>\u00a0The bargains are fewer and farther between today, but in a way, this encourages more activism. It\u2019s a very competitive world. Hedge funds are trying their best to get an edge that allows them to outperform.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">For many funds, actively engaging with public companies, rather than just exiting the stock when they struggle, is a core strategy.<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Mutual funds are not known to be as aggressive, but it\u2019s not unheard of to see mutual funds lead activist interventions. It does happen a fair bit, particularly the older, established value mutual funds.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Most of the value investors I work with understand that activism is a valuable tool that comes in handy when dealing with underperforming companies.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">If we simply exited every stock that did not perform up to our expectations, I think all of our returns would suffer.<\/span>\u00a0There are just these inherent structural problems with how public companies work, and with how incentives are misaligned between the CEO, the board of directors and the outside shareholders. Even well-operated companies, are rarely managed perfectly. The very first chapter in my book is a classic example, in which Benjamin Graham intervenes at Northern Pipeline company to force them to distribute excess cash.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Lots of public companies allocate capital extremely poorly, and it would be a shame to just exit our position in a good, cash-generating company because of their poor capital allocation. Why not try to get involved and make a case for improving that aspect of the business?<\/span>\u00a0<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">5. Fair enough, Jeff. That sounds like the right argument in favor of activism. Strategic investors add value to the money they invest, by utilizing their contacts, experience, and knowledge of market, with a view to brightening the investee\u2019s prospects. As opposed to strategic investors, hedge funds or retail investors are primarily financial investors. Strategic investors are capable of actually running the business. In contrast, a hedge fund can never probably run the business in which it has invested, with the same acumen or expertise as the founders\/managers may have. I\u2019d say that it is the strategic investors who have the first right to be activist shareholders. Would you concur?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: Well, I\u2019m not sure. You have to remember that like we just talked about:\u00a0<span style=\"font-weight: bold; font-style: inherit;\">a lot of activism, perhaps even the majority of it, focuses on capital allocation rather than strategic direction or operations.<\/span>\u00a0And that makes a lot of sense, because\u00a0<span style=\"font-weight: bold; font-style: inherit;\">investors are supposed to be experts in allocation, while lots of great operators are not necessarily skilled at deploying capital.<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Secondly, even if a hedge fund manager is not an industry expert, that does not mean he or she cannot lead a successful intervention by adding qualified industry experts to a company\u2019s board of directors.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">This can be the best of both worlds \u2013 where you have qualified investors with experience, which is a strategic value-add for the company that also really puts the shareholders first.<\/span>\u00a0But you do make a great point. I should also point out that all these lines are blurring in the industry. I\u2019ve seen plenty of hedge funds that advertise their experience as strategic, private equity investors. You just see a lot more operationally focused hedge fund activism where they are not uninformed. But I think on a more fundamental level, I\u2019m not sure anyone has the first right, or doesn\u2019t have the right to be an activist shareholder if they own shares and are not happy with performance.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">What really determines success will be the quality of their ideas and the activist\u2019s ability to persuade the rest of the shareholder base that those ideas merit support.<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\"><span style=\"font-weight: inherit; font-style: inherit;\">6. The overt intent behind activism is to increase returns for shareholders. However, which of the broad types of<\/span>\u00a0<span style=\"font-weight: inherit; font-style: inherit;\">activism, viz., corporate governance, maximizing shareholder value, board control \/ representation \/ removing<\/span>\u00a0<span style=\"font-weight: inherit; font-style: inherit;\">directors, is more prevalent, as per your research? Are activists focused more on maximizing shareholder value<\/span>\u00a0<span style=\"font-weight: inherit; font-style: inherit;\">and board control?<\/span><\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff:\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Activist investors are, at their core, economic actors out to make a profit for themselves.<\/span>\u00a0So, their main objective is for their investment to increase in value, it\u2019s not just to win control of the board for the sake of control.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Lots of proxy fights \u201cfail\u201d in the sense that the activist does not win board representation, but at the same time, they \u201csucceed\u201d when management co-opts their arguments to win the support of shareholders.<\/span>\u00a0You see this dynamic quite often, and it often has positive effect on the stock.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">One that comes to mind is Sardar Biglari\u2019s fight against Cracker Barrel ($CBRL).<\/span>\u00a0Biglari ran multiple campaigns to unseat Cracker Barrel\u2019s board.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">He never won; he lost all the proxy fights \u2013 but he really got managemen<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><span style=\"font-style: inherit;\">t to focus on shareholders and begin to cut out some of the bloat in that business. Despite the fact that he technically \u201clost\u201d the proxy fights, the stock more than doubled.<\/span>\u00a0So, what\u2019s important is that he made a huge profit on his shares of Cracker Barrel. Shareholder activism that is purely motivated by governance concerns rather than actual investor profits has historically been pretty insignificant.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">7. Jeff, of late, activism seems to be on the rise in Corporate America. As per FactSet Insight, the number of activist campaigns went up from 221 in 2010, to 377 in 2015 before tapering off to 316 in 2016. Since 2010, the Dow Jones Industrial Average has almost doubled. Is the rising activism led by investors who feel they\u2019ve not been able to participate in the stock market rally?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: That\u2019s an interesting question.\u00a0<span style=\"font-style: inherit;\">Historically speaking, you often will see blooms of activism during long bull markets.<\/span>\u00a0You saw this in the 1950s as well as in the 1980s. I don\u2019t think it\u2019s led by investors who feel left out, I think in some ways it\u2019s fed by typical animal spirits and bullishness on corporate prospects, as well as importantly, the financial health of those activists.\u00a0<span style=\"font-style: inherit;\">If the activists have some success at the beginning of the bull market, they build up a big war chest as the market progresses.<\/span>\u00a0The long bull market in the 1950s really deepened the pockets of a lot of the early Proxyteers, and that allowed them to go after newer and bigger targets in the late 1950s. This decline in the activism that we\u2019re seeing now \u2013 the recent tapering in activism, I wonder if it has more to do with hedge funds under-performing and feeling less buoyant, which would support that point.\u00a0<span style=\"font-style: inherit;\">Beginning in about 2015 when you saw that peak, a lot of the major activists began to suffer pretty terrible performance and I\u2019m sure that influenced the overall number of proxy fights.<\/span>\u00a0This all speaks to the inefficiencies of the stock market. In an ideal world, activism would ebb and flow based purely on opportunities in the market, when stocks are cheap, or when there happens to be some kind of bloom in bad governance, but that\u2019s not how things always work. So, I think it has less to do with investors feeling left out. The recent decline has more to do with a little bit pain on the part of these activists.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">8. Of the activist campaigns in 2016, as much as 75% was against companies with less than a billion dollars in market capitalization. Why do you think activists target small companies only, while letting the big fish off the hook?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: Well, that\u2019s a good question too, and I thought about that some. On the one hand, you have so many more small companies, a lot of it just has to do with the numbers. With so many small listed companies, that it naturally follows that you see more activist campaigns in that segment of the market. That being the case,\u00a0<span style=\"font-style: inherit;\">I do think that corporate governance and the quality of corporate directors improves as companies get larger.<\/span>\u00a0The longer I\u2019ve been doing this, the more I believe that,\u00a0<span style=\"font-style: inherit;\">in general, larger companies tend to have higher-caliber directors, and that means better governance.<\/span>\u00a0Of course, this doesn\u2019t prevent corporate governance disasters from happening, and you still have fundamental structural problems that we talked about, that make the job of being a director very hard.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><span style=\"font-style: inherit;\">But in many very small companies, it goes beyond structural problems \u2013 to the fact that a lot of them are just horrifically governed, and you do see things that indicate really bad behavior.<\/span>\u00a0Sometimes you see blatant self-dealing, and the kind of promotional scams that you don\u2019t see as often at larger companies. And of course,\u00a0<span style=\"font-style: inherit;\">it\u2019s easier to be an activist in a very small company, because it takes a lot less capital to establish a material ownership stake.<\/span>\u00a0It\u2019s a lot easier to be a successful activist if you have a material position in the underlying company.\u00a0<span style=\"font-style: inherit;\">With very small companies, there\u2019s just a lot more investors out there that have the means to do that.<\/span>\u00a0With a really big company, like if you\u2019re going to activist on Microsoft ($MSFT), it\u2019s going to be really hard to be successful and to have any credibility, it would help to have a least a material position and you know, who has the money to have a material position in a company like Microsoft? \u00a0\u00a0\u00a0\u00a0<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">9. Yes, absolutely, Jeff. Does activism take place in poorly managed companies, or even in companies generating decent RoE and dividends? If yes, why? Whole Foods Market ($WFM) is currently in the crosshairs of activist hedge fund Jana Partners which took a nearly 9% stake in the company and suggested it should consider putting itself up for sale. Even Amazon was reportedly interested in acquiring $WFM. What are your views on this? Do you think $WFM is a fit case for a sale?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: You raise a good point here \u2013\u00a0<span style=\"font-style: inherit;\">we don\u2019t only find shareholder activism in woefully underperforming companies.<\/span>\u00a0Even Apple ($AAPL) was targeted by two prominent activists, Carl Icahn and David Einhorn, during a period when the company delivered just stunning financial performance.\u00a0<span style=\"font-style: inherit;\">I think the most common feature among activist-targeted companies\u00a0<em style=\"font-weight: inherit;\">is<\/em>\u00a0a poor performing stock price.<\/span>\u00a0If the chart of the stock looks like a descending line, that bodes well for an activist being able to tap into the discontent among the shareholder base.\u00a0<span style=\"font-style: inherit;\">But there are some exceptions. Companies that are performing well, like Apple, can still get targeted for their capital allocation choices.\u00a0<\/span>We\u2019re seeing this right now at General Motors ($GM), where David Einhorn is calling for a restructuring of the share classes and Mohnish Pabrai is taking an opposite point of view, and saying that he\u2019d be happy to see them scrap the dividend altogether. You know, GM has not performed better, in recent memory. It\u2019s probably been since the sixties since they\u2019ve been doing this great. So,\u00a0<span style=\"font-style: inherit;\">you\u2019ll still see activism even in companies that are doing well.<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">As for Whole Foods, I haven\u2019t closely followed the Whole Foods drama, but it is an interesting case.\u00a0<span style=\"font-style: inherit;\">Whole Foods is a fine business, but the competition in the US has really caught up to it. If you go to any of its major markets, there are lots of equivalents of Whole Foods, often with more competitive prices.<\/span>\u00a0So, I\u2019ve always been a little bit afraid of the stock because I thought they were over-earning, that those operating margins needed to come down. Many of their strategic initiatives haven\u2019t worked out, and shareholders are concerned that the clock is ticking and that management is squandering a wonderful brand and reputation. But I\u2019m not close enough to the situation to know how dire things have gotten, or whether it makes sense for shareholders to try to find a buyer for the company.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">10. Ross Perot once said, \u201c<\/em>The activist is not the man who says the river is dirty. The activist is the man who cleans up the river\u201d.\u00a0<em style=\"font-weight: inherit;\">Do you think activism is generally positive, and in the interest of all stakeholders? Do you think the rising activism has the potential to even disrupt normal business operations of companies which face such activism?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: It\u2019s interesting that you use the word \u201cstakeholders\u201d. In the US, the word \u201cstakeholders\u201d when it is applied to public companies, usually means the employees, the community, as well as shareholders.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Clearly, shareholder activism in the US, and public company governance in general, has forsaken the community.<\/span>\u00a0Companies move all the time just for economic reasons.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">We just saw this when Jamba Juice ($JMBA) moved [from Bay Area] to Texas.\u00a0<\/span>GE is leaving Connecticut where it\u2019s been forever.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">When shareholder activists get involved, they\u2019ll often cut local charitable spending<\/span>, as we saw with DuPont ($DD). They were targeted by shareholder activists, and they received a lot of criticism for how much they spent on charitable causes in their hometown, Wilmington. It\u2019s not as black and white with labor, but often activism drives the kind of \u201cefficiencies\u201d that pressure labor costs.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">All of this said, while\u00a0<span style=\"font-weight: bold; font-style: inherit;\">I do think there are cases of bad activism<\/span>\u00a0\u2013 and there\u2019s a chapter in my book, on BKF Capital ($BKFG), that really shows shareholder activism at its worst, when misguided shareholder activists destroy the company \u2013 I do believe that the pervasive threat of activism that we have in today\u2019s markets is\u00a0a positive force that puts some necessary accountability in the system.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">If you\u2019re on a corporate board today, you know that shareholders are looking over your shoulders.<\/span>\u00a0I think that is a very good thing for the system. We\u2019ll continue to see cases where activism goes wrong, where shareholders have wrong ideas for the long-term direction of the company. But the fact that they have a voice and the fact that the directors know that they have to answer the shareholders, that\u2019s incredibly important. I think if that\u2019s missing, the system can really stagnate.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">11. There are advocates and opponents of activism. Usually, activists are interested in opposing those key decisions of the management, which they feel are detrimental to the interests of minority shareholders. But are activists really looking at protecting other minority shareholders, or concerned primarily with their own interests?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: We talked about this a little bit earlier.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">One of the key themes in my book is that activists are concerned primarily with their own interests.<\/span>\u00a0The system works best when their interests are aligned with all other shareholders, but when that is not the case, look out!<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">There are several examples in my book of\u00a0<span style=\"font-weight: bold; font-style: inherit;\">activists who use pro-shareholder rhetoric to get control of the board, but then once they are in charge, they happily screw the other holders over.<\/span>\u00a0We always must remember that\u00a0<span style=\"font-weight: bold; font-style: inherit;\">shareholder activism is not a broad movement to make small, incremental improvements in public company governance. It is a powerful tool, employed by opportunistic investors, to overhaul specific boards of directors.<\/span>\u00a0When activist investors are doing this, they\u2019re looking out for their own interests and profits. When they are aligned with other shareholders, that is great. And that\u2019s usually how it works. Big passive institutions play a big role in this, and it hurts your credibility with them if you screw shareholders. But when activists are not aligned with other shareholders, it can be problematic. Historically, when activist investors have gained total control of public companies, they have not always acted appropriately to minority investors.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">You saw this across a lot of different markets. You saw this in the 50s with the Proxyteers, in the 60s with the\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Conglomerators<\/span>\u00a0and the 80s with the\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Corporate Raiders<\/span>. We see it with the hedge fund people too. We talked a bit earlier about Sardar Biglari earlier. I have tremendous respect for him as an operator, but after he got control of Steak n\u2019 Shake, which is a restaurant chain, he began to pay himself enormous sums of money. I just saw yesterday that he made $32.5mm last year from Steak n\u2019 Shake, which he has renamed Biglari Holdings ($BH). That\u2019s a tremendous amount of money for a small company CEO. I saw someone tweeted that\u00a0<span style=\"font-weight: bold; font-style: inherit;\">it\u2019s more than the CEOs of McDonalds ($MCD) and Chipotle ($CMG) combined!<\/span><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">Alright. Yes, that\u2019s very unfortunate when small company CEOs start paying themselves salaries which are simply not justifiable.<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: Yeah, once they have control of companies, there\u2019s a lot that the management teams can do to enrich themselves, if they want to.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">12. Is activism the prerogative of only institutional investors? Should retail, individual investors too come together and actively oppose such decisions of the management or even the hedge funds, which they strongly believe are not aligned their interests? Along with hedge funds, retail investors apparently played a role in DuPont\u2019s defeat of Nelson Peltz of Trian Fund Management in the proxy fight in 2015. What are your views on that particular conflict involving management, hedge funds and activist investors?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: That\u2019s a great question. As much as I love democracy, and I love the idea of mom and pop investors wisely voting their proxies, it\u2019s very hard for retail investors to have their voice heard.\u00a0 The stock market is dominated by huge institutional investors like Vanguard, Blackrock, CalPERS, and TIAA-CREF, who hold a very large percentage of public company shares. It\u2019s pretty rare that proxy fights are so close, like in Trian-DuPont, where retail votes swing the outcome. But that said,\u00a0<span style=\"font-weight: bold; font-style: inherit;\">if you are not happy with a management team or with an activist shareholder trying to intervene, it\u2019s better to say something than nothing.<\/span>\u00a0But you are right \u2013 in a sense the market today is characterized by these huge passive institutions being the arbiters in activist disputes. They have a symbiotic relationship with the hedge funds \u2013 often they even recruit the hedge funds into intervening \u2013 it kind of leaves out the little guy. And there\u2019s not much of a chance for smaller individual investors to have a say.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">The fate of DuPont is pretty telling. It was a close vote, and the individual investors, many of whom lived in Delaware, where DuPont was based, and owned the stock for generations, they played a big role in turning the vote in management\u2019s favor. But it turned out to be an empty victory. Over time, even though it lost that particular proxy fight, Trian basically got everything it wanted, both leading up to the proxy fight, and after the proxy fight. DuPont spun off its chemicals business, replaced its CEO, and the new CEO immediately promoted and then achieved a merger with its rival, Dow. So, the individual investors, many of whom were voting their shares in the interest of maintaining the normalcy and a status quo for DuPont in Delaware, they won the proxy battle, but they ultimately lost the war, the big guys\u2019 war.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">13. As per Brunswick Group research, retail investors think the business environment in corporate America is ripe f<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">or activism, with 77% of retail investors indicating that US companies are holding more cash than ever on their balance sheets and should be returning profits through dividend payments. Do you agree with this?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: That\u2019s a complicated issue. As we discussed earlier,\u00a0<span style=\"font-weight: bold; font-style: inherit;\">a lot of activism is focused on poor capital allocation<\/span>\u00a0at public companies, and\u00a0<span style=\"font-weight: bold; font-style: inherit;\">many of the battles in my book, including the first one with Benjamin Graham, are about returning excess cash to shareholders<\/span>, as opposed to allowing it to sit around. That said, I don\u2019t necessarily think that most companies should pay more dividends. Companies face hard choices with capital allocation, they do have lot of options \u2013 they can pay dividends, they can pursue M&amp;A opportunities, they can repurchase shares, and, of course, they can deploy capital into their business. Well,\u00a0<span style=\"font-weight: bold; font-style: inherit;\">I love it when my companies reinvest their cash into their business, if they can achieve good rates of return.<\/span>\u00a0If they can\u2019t, I love seeing opportunistic repurchases if the stock is cheap. And\u00a0<span style=\"font-weight: bold; font-style: inherit;\">where there are businesses I own that can profitably grow their business through M&amp;A, I\u2019d prefer they build cash to pursue acquisitions rather than return it.<\/span>\u00a0One of my largest investments, Star Gas Partners, is a heating oil distributor in the North East, that can really add value for shareholders by acquiring other dealers. I would rather see them do that, than pay lot of dividend; it\u2019s a bit complicated.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><span style=\"font-weight: bold; font-style: inherit;\">We also must remember that lots of this cash that you read about in the papers, or the media talks about is held overseas.<\/span>\u00a0I\u2019m involved in one company where a lot of our cash is in Canada, and we\u2019d have to pay taxes on it to repatriate the money. So, I guess this is all a long-winded way of saying, I often see dividends as a last resort, and often it\u2019s less easy to distribute cash than it might look like from the 10-K and balance sheet.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">14. Do you think legislation as regards protection of rights of minority shareholders, or monitoring related-party transactions could be made even more stringent, partly obviating the need for activism?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: No, I can\u2019t think of any obvious regulatory fixes that would be a win-win for shareholders. If a public company management team and board has extremely bad intentions, there are plenty ways for it to enrich itself that would be essentially impossible to regulate away. The business world is a messy place with a lot of conflicts of interest, but I tend to favor freer markets. I think the business judgment rule, which gives managers a lot of leeway in their decision-making, is a good thing. I think over-regulating public company governance will just result in fewer companies going public, and fewer public companies taking the kind of risks they need to take to compete in the market.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">One of the interesting themes in my book, that comes across over and over again, is that there really are no best practices in corporate governance. There\u2019s no list of rules that will make a board of directors bad or good.\u00a0\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Just last year, Jamie Dimon, Warren Buffett and a bunch of other big-shots in the financial world tried to create a list of best practices and they called it common-sense principles for good governance.<\/span>\u00a0The document is interesting, and very much worth reading, but I think\u00a0<span style=\"font-weight: bold; font-style: inherit;\">it speaks volumes about how hard it is to conjure up truly \u201cbest practices\u201d for corporate governance in the traditional sense.<\/span>\u00a0Ultimately,\u00a0<span style=\"font-weight: bold; font-style: inherit;\">a director is good is he\u2019s engaged, informed and checked-in.<\/span>\u00a0Putting energy and effort into the job is the best practice I can think of.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Any form of checklist-style assessment of directors tends to fall short<\/span>, and many of the standards we focus on, like director independence, for example, are not perfect solutions.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">I obviously think corporations need to be carefully regulated, but I think a lot of legislation focused on protecting shareholders could end up with unintended negative consequences.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">15. The advent of activist investors has also led to the rise of investment bankers who are setting up special activism-focused units, and advisors, who seek a pie of the growing business. Do you think such advisors could also add fuel to the fire, simply to further their own interests?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: That\u2019s a great question, and the answer, in my opinion, is that history has already shown this to be true.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Some of the biggest figures in the evolution of shareholder activism have been the advisors<\/span>, from Michael Milken to Joe Flom to Marty Lipton.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">Nobody added more fuel to the fire than Michael Milken.<\/span>\u00a0It was in his interest in the 1980s to promote corporate raiding, which he could fund with his junk bond sales to his vast network of customers. He had more demand for bonds than supply, and this created a huge liquidity boom for corporate raiders like Nelson Peltz, Ron Perelman and Carl Icahn. All those guys made their name because of Michael Milken. Marty Lipton, was another advisor who shaped the industry. But he did it for the other side, as a corporate defense specialist. He invented the poison pill and various other mechanisms for slowing down activist investors and hostile raids. So, advisors have played a huge role in how the market for corporate control has evolved over time.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">16. Have you been involved in any activism in your own hedge fund, or have joined hands with other hedge funds for activism? If yes, what kind of results were you able to achieve?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: Yeah, we\u2019ve done a fair bit of activism.\u00a0<span style=\"font-weight: bold; font-style: inherit;\">When we engage in activism, it is usually a defensive measure involving a company that we already have a big position in. It\u2019s pretty rare that we\u2019ll activize from the start.<\/span>\u00a0Right now, we are on two boards \u2013 I serve on the Tandy Leather ($TLF) board, and my partner Greg is a director at a company called Pico Holdings ($PICO). I\u2019m very happy with our performance and our results as directors, though it\u2019s important to note that sometimes the stock performance isn\u2019t necessarily correlated to our job performance as directors.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">I\u2019ve finished three directorships \u2013 Peerless ($PRLS), Morgan\u2019s Foods ($MRFD), and Ambassadors Group ($EPAX). Peerless and Morgan\u2019s Foods saw excellent gains for shareholders. Peerless returned a huge amount of capital to shareholders through a self-tender. Morgan\u2019s Foods was acquired at a wonderful price by a strategic buyer. Ambassadors Group was a total disaster where we ended up liquidating the company and taking a huge loss. But I\u2019m actually prouder of my service as a director at Ambassador than I am at either Peerless or Morgan\u2019s. Pulling the plug on Ambassadors Group\u2019s operating business was a brutal, difficult decision, we had to lay off hundreds of employees and it was a hard thing to do. But I think we saved a lot of shareholder capital by doing it, and I think a lot of boards would not have gone through with that.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">17. Coming to my last question today, Jeff, activism is in a nascent stage in India, and has only taken root over the last decade or so. Remarkably, minority investors are increasingly taking an interest in activism, opposing decisions of the management which they believe are against the former\u2019s interests. With most Indian companies being controlled primarily by founders, who typically hold significant stakes of 30%-60%, what would be your take on the rise in activism in India, going ahead?<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: That\u2019s a real challenge \u2013 it\u2019s very hard to go active on a controlled entity. In some sense, it\u2019s an opportunity for\u00a0<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">activism there, because you see lots of extremely bad performance at controlled entities and so the stocks will be extremely cheap and you know if you can improve the management, you\u2019ll get a great return on the stock. But it\u2019s a very hard road. You can try to persuade the founders with your brilliant strategic ideas, but this is often very, very difficult. Founders rarely want to hear from minority shareholders. Outside of that, you can resort to trying to publicly shame them, find ways to get them out of office, if they\u2019ve done bad deeds. But that\u2019s a tough game too, and it makes you a lot of enemies!<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">It reminds me of hedge fund activism in the 90s and early 2000s when they really played the shame game. There\u2019s a chapter in my book that\u2019s about these hedge fund activists predominantly going after controlled entities. There\u2019s a guy in the book named Bob Chapman who I talk about a lot, who would often target companies where control was locked up and he, just through force of will, and being a nuisance for them and trying to embarrass them, actually achieved pretty great results.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">It\u2019s been interesting to watch activism in other countries. You would think the biggest factors in activism would be legal and regulatory ones \u2013 like how shareholder-friendly securities laws are. But really it often boils down to the culture. Some cultures seem conducive to activism, like Australia, I think China will emerge as a market that\u2019s like that. And there are others like Korea, for example, that aren\u2019t. Korea has historically been extremely harsh on foreign capital trying to meddle.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Britain is interesting because the laws are very shareholder friendly, but it just isn\u2019t a very activism-friendly place. I was involved in an activist situation there, where all the dissidents were foreign overseas funds, and all of the local institutional funds supported the management. I think the dissidents were right in that case. It\u2019s interesting how the culture has a bigger impact than the regulatory environment.<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">Well, great insights, Jeff!<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: Thank you so much for having me. This has been a blast!<\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\"><em style=\"font-weight: inherit;\">All your views and insights into activism, and the numerous activism case studies you shared, are a superb value-add for my audience. Thanks so much, and it was nice to have you here today. Have a nice day!<\/em><\/span><\/p>\n<p><span style=\"font-weight: inherit; font-style: inherit;\">Jeff: Thanks, it was great to be here.<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Editor\u2019s Note:\u00a0This is an interview originally conducted by Nitiin A. Khandkar of\u00a0Beyond Quant InvestTraining\u00a0and published\u00a0here. This author has also\u00a0published\u00a0several financial models on Flevy, including the\u00a0World&#8217;s First Research Report-cum-Financial Model\u00a0and a\u00a0BSE Ltd. (Bombay Stock Exchange) Financial Model. * * * * Our guest today, is\u00a0Jeff Gramm, who runs Bandera Partners, a long-oriented, value-driven hedge fund based&hellip;&nbsp;<a href=\"https:\/\/flevy.com\/blog\/interview-with-author-and-hedge-fund-manager-jeff-gramm\/\" rel=\"bookmark\"><span class=\"screen-reader-text\">Interview with Author and Hedge Fund Manager Jeff Gramm<\/span><\/a><\/p>\n","protected":false},"author":91,"featured_media":2957,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"neve_meta_sidebar":"","neve_meta_container":"","neve_meta_enable_content_width":"","neve_meta_content_width":0,"neve_meta_title_alignment":"","neve_meta_author_avatar":"","neve_post_elements_order":"","neve_meta_disable_header":"","neve_meta_disable_footer":"","neve_meta_disable_title":"","footnotes":""},"categories":[83],"tags":[1213],"class_list":["post-2955","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-corporate-finance","tag-hedge-fund"],"_links":{"self":[{"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/posts\/2955","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/users\/91"}],"replies":[{"embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/comments?post=2955"}],"version-history":[{"count":3,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/posts\/2955\/revisions"}],"predecessor-version":[{"id":2959,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/posts\/2955\/revisions\/2959"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/media\/2957"}],"wp:attachment":[{"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/media?parent=2955"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/categories?post=2955"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/flevy.com\/blog\/wp-json\/wp\/v2\/tags?post=2955"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}