When an Activist Investor Limits Your Upside

By Markets Fool.com

In some cases, an activist investor could be looking for a short-term exit, while you're hoping for long-term gains. As a result, you could be stuck with a higher cost basis than the activist investor.

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In this clip fromIndustry Focus: Tech, Motley Fool analyst Dylan Lewis and contributor Evan Niu, CFA, discuss how these scenarios could present themselves.

A full transcript follows the video.

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This podcast was recorded on Oct. 21, 2016.

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Dylan Lewis: Mentor (NASDAQ: MENT) is not a company that either of us cover all that much. In some ways, it's kind of a niche within a niche, as asemiconductor supplier. So,as we talked about this company, we're going to be looking more broad stroke at theirsituation, and less specific to their financials. Standard caveats here that this is notpersonalized financial advice for Mark. But,because they're shopping around,and it's really at the behest of activist investors,I don't see that as a huge problem. It's not the same way thatTwitterisshopping itself around,kind of desperate for dancing partner. This is something that we see,and it's fairly commonwith activist investors.

Looking atwhat's been going on with Mentorover the past couple years, theirvaluation right now is a $3 billion company. That puts thempretty much at the height of where they've beenover the last five years. Youthink about these newshareholders with a huge stake in the company,and people who may have owned shares for quite some time, theirinterests are going to be fairly alignedwhen it comes to avaluation if there is a sale.I think the worry with these types of situations is, maybe you bought at highs a year and a half ago, and due to whatever, poor guidance -- which did happen in Mentor Graphics' case -- there was a big sell-off in late 2015, but they have since recovered. But, theseactivists getting in ata much lower valuationand then being willing to take, say, a30% premium that undercuts your costbasis and doesn't let yourthesis play out on the stock.

Evan Niu:Younever get to break even.

Lewis:Yeah,you never hit that point where, maybe you have something that's more of a three- to five-year horizon onwhatever you're looking to see from the business, andactivist investors, on the flip side, might say --

Niu:"We want to cash out."

Lewis:"Wewant to cash out in six months, or a year." And then,you might not get to see that come to fruition. So that's something to be mindful of. I do think, because that's the case here with Mentor, as an investor, and my advice to Mark assomething to watch would be, beless mindful ofwhat's going on on the sale side, and paycloser attention to anything managementmight push in terms of capital allocation,or what to do with specific business units. If they'relooking to hold this, that's the thing that'sgoing to be most disruptive to the thesis and the business that you originally had when you bought shares.

Niu:Yeah.I think, certainly,if an activist investor is pushing for sale of a company,it's really hard to say, "That'snot in line with my interests,"because obviously, the stock will go up. But it depends onwhat the activist investor wants. There's lots of different things they could want, their goal could be a wide range of things. But, in this case, if it's justpushing for an outright sale, given that the stock is at five-year highs,I don't think many investors are going to be upset about it,having someone on their sidethat can get more value out of it.

Lewis:Yeah. The gains might be less thanwhat they would have been had you letthe company play out over that five-yearhorizon, but I don't thinkthere are going to be a lot of people who wind up getting kneecapped on their position because of that.

Dylan Lewis has no position in any stocks mentioned. Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Twitter. 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.