How an Activist Investor Could Help Make You Money

By Markets Fool.com

Having an influential activist investor on your side could potentially help increase the value of one of your stock holdings -- if the investor is capable of enacting various types of strategic or financial changes.

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In this clip from Industry Focus: Tech, Motley Fool analyst Dylan Lewis and contributor Evan Niu, CFA, discuss a few possible scenarios that investors commonly see.

A full transcript follows the video.

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This podcast was recorded on Oct. 21, 2016.

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Dylan Lewis: We're doing a show on activist investors. Really, this started with an email fromone of our listeners. Earlier this week, I heard from Mark S. He asked, "Recently,there have been some rumors thatMentor Graphics (NASDAQ: MENT) may be looking to be acquired. Thecompany is a major supplier of CADtools that are used by integrated circuit designers, andas such are a crucial supplier for all the semiconductor companies. ShouldI as an investor or user beconcerned about their looking around?"

Prior togetting back to Mark, I did a little homeworkto see what some of the circumstances surrounding that sale were. There was aFortune articleposted a few days ago. "Mentor Graphics company, a company thatmakes software for designing semiconductors,is working withBank of Americato explore strategic alternatives,including a potential sale,according to people familiar with the matter. Mentor has beenunder pressure since activisthedge fundElliott Management Corp reported an 8% stake in the company last monthand said shares were deeply undervalued." That seemed like a good point tolaunch into a discussion about how investors should feelwhen activists get involvedin a company that they're invested in.

I think,before we get too far into this conversation,let's just take a look at what an activist investor is. Evan, what do you have?

Evan Niu:They'reusually just in it for the money. Activist investors basically pick up a bunch of shares,enough to get a pretty meaningful stake in the company,to the point where they can get board seats,they can get the ear of management,they can actually really get in there and try to have some influencebecause they have that big stake in the company. Certainly, it's easier to do thisfor a smaller company, becauseit doesn't take as much money to buy a big stake. If you want to buy 10% of a giant company versus a small cap,I think it's a little more reasonable for the small cap. In this case, I'm not too familiar with Mentorspecifically, but I know they're pretty small.

Lewis:They're a $3 billion company.

Niu:Right. So,it's not too hard for an activist investor,if they think that shares are undervalued, they can pick up a pretty sizable stakefor not too much money and try to make some change,make some money.

Lewis:Andwhat are we typically talking aboutwhen we say changes? You see the term"strategic alternatives"thrown around a lotin those types of press releases.

Niu:Usually,they just want to maximizethe value. That can take a couple of forms,like actual changes to the business,if they think there are problems with the way the company is run. If they think there's problems with management, sometimes they'll try to oust management and getbetter people in to run the company. Other times,they might have better input oncapital structure. Big investors tend to think more about -- at the Fool,we always talk about how you have to distinguishbetween investing in the company and the business of the company. There's two aspects of it. Andmanagement is mostly focused on the business,whereas investors are more focused oninvesting financials. Of course,all companies try to look at both. But some companies aren'treally good at looking at the financially deep stuff,for things like capital structure, capital allocation. So in some cases,where management isn't as good atfocusing on those things,I think activist investors canreally help in that sense.

Lewis:Yeah,add some value, bring in some of that morefinancial expertise. Some of the other things you might see activist investors push for,we talked about capital allocation, something they need, buybacks, dividends realm,maybe spinning off specific segments, trying to drive value there. But really, at its core, activist investors see a company thatisn't being properly valued, and thinkthat they have a way to boost the value throughsome sort of strategic action.

Dylan Lewis has no position in any stocks mentioned. Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.