Portfolio Watch

By Pete Gallo

Let it be said that 2011 has proven to be the best and worst of times for activist investors. There has been no shortage of stocks beaten down during the prolonged economic crunch. At the same time, macroeconomic uncertainties make turnarounds that much more challenging to engineer.

What’s an activist investor to do in raucously bearish markets? Just ask Carl Icahn. These days the famed activist seems a bit more like a traditional opportunistic buyer, grabbing hold at lows and then waiting for recovery.

Take his stake in the medical and health information provider WebMD. Since October, Icahn funds have added 2.5 million shares of WebMD, bringing holdings to 5.7 million shares, representing a 9.99 percent stake in the Nasdaq-traded company, based on its recent filings with the Securities and Exchange Commission.

There can be little doubt that weak share prices were the immediate draw for Icahn. WebMD shares, off a 52-week high of $58 set in May, had dipped to a low of $27 in October when Icahn made his move. Shares traded at $31.75 in late November, which put the overall value of Icahn’s exposure (through multiple funds) at roughly $180.7 million. Other investors were attracted by the lower-price entry point into the stock, including funds run by Soros Fund Management. Filings with the SEC show that Soros-affiliated funds own 3.4 million shares in WebMD.

Icahn may have seen a golden opportunity. For starters, WebMD isn’t the typical Internet business: It’s not a retailer, it boasts an affluent core clientele, and it possesses the largest commercial Rolodex of medical doctors on the planet. That fact is not lost on pharmaceutical, medical device and biotech companies who provide ample advertising dollars and sponsorship for WebMD conferences aimed at reaching that audience.

Whatever Icahn’s activist plans, if any, WebMD, which went public in 2005, seems to be on solid ground long-term. Regulatory filings show the company is sitting on more than $1 billion in cash and boasts low debt, suggesting WebMD is ready and able to fund growth through acquisitions. Revenues for its web portals, mainly from advertising, weighed in at $408 million for the nine months ending September 30, up from $366 million for the same period last year.

Clearly, these factors helped draw interest from funds run by the likes of Icahn and Soros. But the famous love-hate relationship between management of web companies and Wall Street seems to have surfaced as well. Apparently fearful of a hostile takeover bid or an activist-led management shake-up, WebMD rushed to shore up its defenses. Filings with the SEC show that on November 2, immediately following the buying spree by Icahn in late October, the company issued a statement to public stakeholders informing them of a change in shareholder rights. The company’s board of directors opted for a takeover defense based on issuance of a new preferred class of shares that would be matched 1-to-1 with common stock. These “rights” would become exercisable at a set price of $153 if any investor acquired in excess of 12 percent of WebMD’s common stock. The clause sunsets in one calendar year, according to the filing.

It remains to be seen whether Icahn funds will take this as a poison pill deterrence or as a sign that a hubristic management clearly overestimates WebMD’s book value. But since Icahn’s funds already own a nearly ten percent stake in the firm, management certainly got the activist’s attention. In the special November 2 letter to investors, company management said: “The Stockholder Rights Plan is designed to guard against inadequate or coercive takeovers and other tactics that might be used in an attempt to gain control of the Company without paying all stockholders a fair price for their shares.” Strong language? Lest that sound accusatory, management added: “The Stockholder Rights Plan will not prevent takeovers, but is designed to deter coercive takeover tactics and to encourage anyone attempting to acquire [WebMD] to first negotiate with the Board.”

In the meantime, Icahn has used his shareholder girth to make one suggestion. He wants WebMD management to put its arsenal of cash to immediate use. In a filing with the SEC on November 30, the activist called upon WebMD to buy back up to $1 billion in its own stock through a Dutch tender with prices capped at $36 per share. Such an auction might be a prelude to privatization. Or it may be the activist is throwing down a gauntlet so company management won’t keep WebMD’s substantial cash reserves idle. Management may have other ideas, but attracting even a prospective suitor in a bear market can never be a bad thing.

By Pete Gallo

	Pete Gallo

And if anyone doubts it has been a tough time for brick-and-mortar retailers in recent years, it’s worth noting that shares of Sears Holdings, worth $174 in early July 2007, dwindled to a recent low of $52 on September 22. That’s surely been a heavy blow to Lampert’s ESL Investments (as general partner of RBS Partners), which owns 48.1 million shares in Sears Holdings, the parent company of retailers Sears and Kmart.

Still, rumors of a Sears retailing demise may prove to be exaggerated. Since its September low, the stock has gained a stunning $20.55 per share, hitting a recent high of $72.55 on October 17. That’s big news for Lampert, whose fund’s stake in the company swelled in value to nearly $3.5 billion, a gain of some $988.5 million in a few weeks.

Lampert has been working for years to turn around the storied retailer, once known for exclusively selling proprietary brands like Kenmore, Craftsman and DieHard. But the era of the once-ubiquitous Sears, Roebuck catalogue is long gone, and the department store has found itself in an arguably losing competition with big-box stores such as Wal-Mart and Costco, where low cost rather than brand names sways shoppers most.

But is the recent bounce in stock price indicative of a turnaround for Lampert’s hedge fund via its majority stake in a troubled Sears? In August the company reported its fifth, although small, quarterly loss. That’s concerning, given that Fitch Ratings had downgraded Sears Holdings’ debt rating to B in June, citing a sustained weakening of earnings. Monthly earnings aren’t reported, yet it is worth noting that share prices jumped more than 10 percent in a single session on October 12.

That same day, filings with the Securities and Exchange Commission show that Sears Holdings requested confidentiality from regulators regarding exhibits from its most recent 10-Q filings. What does that mean? The regulatory tease of temporary omission aside, the Street floated its own interpretation of what was afoot at Sears Holdings.

Last year Sears began leveraging its proprietary brands by selling Craftsman tools for the first time through a third party, Ace Hardware Corp. And in September Sears announced plans to license the sale of its DieHard batteries to a number of independent resellers. Shares spiked in October under the assumption that Sears would soon be unlocking value to shareholders by hiring or creating an agency that would license Sears brands to third-party party resellers like Costco, rumors later bolstered by reports from Bloomberg and the Associated Press.

Such a strategy would be a bold and risky move, though not an unexpected one. From the beginning, Lampert’s hands-on investment in Sears has recognized the value of the company’s well-known brands as assets distinct from the actual retail business. Soon after ESL’s investment in Sears, the company in 2006 created a separate entity called KCD (for the brands Kenmore, Craftsman and DieHard) in order to create an investment vehicle that would be insulated from the larger company and, presumably, creditors. Today, Sears effectively pays royalty fees to use its own brand names, and it seems the company intends to aggressively expand that model so that third-party resellers could pay royalties to distribute what were once Sears-only brands.

Might Sears kill the golden goose by licensing once-proprietary brands? Probably not. Licensing agreements may harken back to the idea that once made the Sears catalogue such a mainstay — maximizing distribution.

Elsewhere, management seems to be trying to modernize the mechanics of retail operations to remain competitive. Sears in October announced that customer service reps at some 450 stores would be outfitted with Apple iPads to help shoppers check product availability and even order items not in stock. The company also recently announced the creation of a boutique store-within-a-store called Scrubology at some Kmart and Sears locations to sell uniforms and trade items to health care professionals. (The insurance company Allstate was incubated as a boutique at Sears locations.)

Lampert’s hedge fund may not be in a position to ask for more from management. Given the size of ESL’s stake and the challenging retail environment, there can be no easy solution or exit. Sears and Kmart simply must become more competitive.

Barring a wider economic recovery no one expects anytime soon, thinking outside the box and innovating are perhaps department stores’ only hope in an age of retailing now dominated by big-box stores and warehouse clubs. AR

By Pete Gallo

	Pete Gallo

Third Point began pouring into the stock following the latest round of woes at the company, including boardroom upheaval and the firing of CEO Carol Bartz, which left the stock slinking down to a recent low of approximately $11 per share on August 8. Filings with the SEC show that in the span of a single month, between August 8 and September 8, Third Point amassed a 65 million-share stake in Yahoo.

Third Point’s investment, which amounts to roughly a 5.2% stake in the Internet company (including a sizable holding of options), almost immediately reinvigorated the stock. Yahoo shares hit roughly $15 on September 16, a gain of 36% over the low set on August 8.

But it wasn’t the size of the investment alone that made a big splash. Loeb’s team entered the Yahoo fray with a letter sent to management that sternly castigated the company’s board for its “inept” management and its decision to hire Bartz in the first place.

“The Board made a serious misjudgment in approving the hiring of Carol Bartz as Yahoo’s Chief Executive Officer, given her inexperience in the consumer-oriented internet space. Although we are pleased that the Board has terminated Ms. Bartz’s employment, we fail to understand why this decision was so long in coming given her abysmal performance over the last two and a half years,” Loeb wrote in a letter dated September 8. The letter, filed with the SEC, didn’t limit its criticism to current events. Loeb also blasted the company for turning down a $31 per share buyout offer from Microsoft in 2008.

No fewer than four CEOs in four years is emblematic of the board’s lack of direction. And for that reason, according to the letter, Loeb wants directors replaced with candidates Third Point has already scouted out, who he claims would be better attuned to unlocking Yahoo’s potential.

Few market watchers would argue against Loeb’s thesis. Yahoo has suffered staggering search-engine market-share losses to Google. And management missteps have hampered the firm from capitalizing on its considerable strengths, namely, solid ad revenues and strong inroads into Asian e-commerce markets. For those reasons, Loeb likely thinks things can only get better for Yahoo, if the company can only find traction. For now, Loeb is hoping for a new slate of directors that will lead the board to leverage its relations with strategic partners Yahoo Japan, SoftBank and the Alibaba Group to grow revenues.

So, is Third Point taking too big a gamble? The downside risk for the Third Point portfolio seems minimal. After all, filings show the hedge fund’s buildup began when the stock was trading at just $11, and Loeb pegs the stock’s intrinsic value at roughly $20, according to his letter to the board. About $5 of the $20 target is based on the midterm projections of revenue growth linked to Asian e-commerce, according to the letter.

In the interim, Loeb is taking direct-approach activist investing to a new level in trying to revive the iconic Internet brand. Perhaps harking back to the much romanticized return of Steve Jobs to Apple in the late 1990s, Loeb is apparently trying to rally the help of Yahoo founder and Silicon Valley legend Jerry Yang.

A letter from Loeb to Yang, filed with the SEC, was sent on September 14. In that missive, Loeb notes that a three-way conference call between himself, Yang and current Yahoo chairman Roy Bostock on September 13 ended prematurely when Bostock abruptly ended the call. Apparently, Bostock didn’t take kindly to being scolded for poor performance with Yang on the line. And who could blame him, given Loeb’s bluntness:

“Mr. Bostock’s failure on the call to acknowledge his pivotal role in, and accept responsibility for, the decline of Yahoo! makes clear that he does not intend to voluntarily follow his recently terminated hand-picked executive, Ms. Bartz, out the door,” Loeb wrote. “It is our strongly held belief that not only has Mr. Bostock been a destroyer of value, but also so long as he serves as Chairman of the Board, the Company will not be able to attract the talent it needs and deserves, particularly at the CEO level.”

Ouch! Did you hear that, Yang? Surely, Loeb doesn’t pretend to be a Silicon Valley guru. But large shareholders have a responsibility to say enough is enough when shares perpetually slump.

It could be that Yahoo insiders and perhaps even Yang don’t want to see a big hedge-fund-led private equity buyout of their baby, as the scuttling of a deal with Microsoft and other brief M&A courtships suggest. But if the stock continues to stumble, that’s more likely to happen than not.

By Pete Gallo

Many hedge fund investors have long been bullish on health care. And it’s easy to see why, given the graying of baby boomers. At the same time, analysts are working overtime, puzzling where the best opportunities will arise next, given the realpolitik of Washington’s efforts to quash runaway Medicare costs.

While weighing risk versus reward remains tough for given portfolio picks, investment teams like Andreas Halvorsen’s at Viking Global Investors seem confident in their own track record in the arena. Viking recently extended its reach into the sector with a sizable bet on Health Management Associates, an owner and operator of hospitals and clinics in 15 states with about 29,000 employees.

How big a bet? An August 2 filing with the Securities and Exchange Commission showed Viking owns 13.2 million shares, representing a 5.2% stake in the Naples, Fla. firm. The hedge fund began building its position in NYSE-listed HMA in the first quarter and has added an additional 5.9 million shares since the end of March.

The stock had been a solid, though not stellar, performer for much of 2011. At the start of the first quarter, shares were trading at about $9.50, hitting $11.17 in the first week of June. Following that, the stock gradually slumped, eventually hitting about $8.70 on August 2, which made it seem like a buying opportunity for Viking.

The stock slipped even further during the general market declines of early August, trading at $7.50 as of August 12. Still, even at that depressed level, HMA represented roughly a $100 million position in the Viking portfolio.

Viking’s big bet may say a lot about the risks and opportunities of investing in health care right now. Sure, HMA was beaten up to a large degree simply because the sector index fell on general market weakness. Many investors on the Street are wondering what Washington’s budget trimming (and possible future trimming) of Medicare spending might mean. In HMA’s case, an analyst at the Argus Research Group on August 5 cited Medicare concerns as the stock was downgraded from a “buy” to “hold.”

But other factors make Viking’s bet on HMA a bit precarious. Only two days after SEC records showed the hedge fund had upped its stake in the firm, HMA officials announced that the company had been hit with not one but two federal subpoenas. HMA said it was cooperating fully with the inquiries.

One involved doctor referrals in a joint venture program. A separate probe focused on “emergency room management” and operations, which included scrutiny of even the medical record software being used by HMA. According to the company’s filings, the first subpoena was received on May 16. The other followed a few weeks later. Still, when news of the federal probe broke on August 4, shares tumbled more than 6% to $8.20.

Surely, Halvorsen’s team isn’t happy that its charge into HMA has been inaugurated by this stroke of bad luck. But the fund must have assessed such a risk, as it’s well known that HMA has been operating joint ventures since 2009.

In fact, much of the company’s growth has been driven by joint ventures. During the second quarter, net revenues grew 13% to $1.4 billion with same-hospital revenues jumping by more than 4%. This was likely not missed by Viking or other investors who could see that HMA has a model to fund its expansion organically. The company has been focusing on rural and semirural regions that lack the modern and large-scale hospital facilities found in metropolitan settings. And here, HMA has also been active of late in acquiring new hospitals to operate.

For instance, SEC filings show that on June 30, HMA entered an agreement to purchase assets of Mercy Health Partners, which is owned by Catholic Health Partners, a nonprofit regional health care system with facilities in Ohio, Kentucky and Tennessee.

It’s a respectable-size deal. Mercy Health Partners has annual revenues of $660 million and operates seven hospitals in Tennessee with a combined 1,300 beds, according to filings. The deal, which is expected to come in at $500 million, still must be approved by U.S. regulators as well as get a final nod from the Vatican.

Regulatory and macroeconomic risks abound. But deals like the one with Catholic Health Partners suggest that HMA’s efforts to create regional hospital networks have strong potential. And although it will likely continue to draw regulatory scrutiny, HMA doesn’t seem to be lacking in its ability to find new opportunities for joint ventures that involve operating leased facilities either.

Whether HMA’s model can continue to match or exceed its current level of revenue and business growth is not clear. But for the moment, considering its $100 million bet, Viking thinks it can.