Tanarra’s portfolio manager Vidhur Rangaswamy talks about respectful activism in the public market.
02 Mar 2022
Activism doesn’t have to be confrontational. Instead, acting as a trusted adviser to companies often achieves a more lasting re-rating of the share price, Tanarra portfolio manager Vidhur Rangaswamy says.
There has been a growing group of investors who are concerned about the tendency of companies to stay private for longer and there is data to back them up.
In the United States, the number of listed companies on the various stock exchanges hovers around 4000, half the number of companies that were listed in the 1990s.
You can also see it in the age of the companies that do list. Whereas in 1999 the average age of a company at the point of initial public offering was four years, today companies are more likely to be around a decade old before they list.
For public market investors this poses the problem that much of the rapid growth associated with young companies takes place outside of listed markets and as a result the interest in private markets has been growing, particularly in private equity strategies.
But private markets have their problems too. Gaining control over companies involves the acquisition of large stakes, often at a premium.
Besides, holding periods are often dictated by the structure of the vehicle in which they are held, rather than purely on the basis of the investment case, which translates to shorter holding periods than would be deemed ideal.
Tanarra, an investment firm founded by John Wylie of Carnegie Wylie and Lazard fame, has approached these issues by developing a hybrid approach. Instead of applying a traditional private equity approach to private markets, the company takes a private equity approach and applies it to listed markets.
There are a number of key benefits to this approach, Vidhur Rangaswamy, Portfolio Manager of the Tanarra LTV Fund, says.
“First of all, we don’t have to pay control premiums of 30 per cent; we get to keep that upside for our investors,” Rangaswamy says in an interview with [i3] Insights.
Private equity companies seek to acquire a controlling stake in the companies they invest in to facilitate change and restructure the business. But majority stakes are expensive as the previous owner has to relinquish control over the company.
In practice, this often means a private equity company has to pay up to 30 per cent of the market price to entice stakeholders to sell.
“Typically, when a private equity entity acquires a business, especially in a listed context, they pay a 20 to 30 per cent premium to the share price for control. What we find is that we’re able to buy a five or 10 per cent shareholding in the company and while we don’t have control at five to 10 per cent of the register, we do believe that we can have significant influence over the company by engaging with the board and the management team,” Rangaswamy says.
Besides, he and his team tend to invest in companies that face some difficulties and sometimes these situations can crop up suddenly. Operating in listed markets makes it easier to act on these opportunities quickly.
“We can act and deploy capital when we see company-specific or market dislocations occur. We saw this during the COVID market downturn in the first half of 2020, when private transactions didn’t occur, effectively, because the bid and ask spreads in private markets were so large. Vendors weren’t willing to sell assets at prices that buyers wanted,” Rangaswamy says.
“But in the listed market there were amazing opportunities at really incredible prices and so having that approach and that access to listed markets means you can act in a high-conviction way.”
Tanarra runs a highly concentrated strategy of around just 10 names in the portfolio, but is very active in the companies it invests in. The key reason to invest in any of these companies is the prospect of releasing value through some form of restructuring or improvement.
The team puts together a value improvement plan and presents this plan to the management and board of the companies. Wylie’s pedigree from his corporate advisory work, as well as the experience and network of Tanarra’s advisory board – which includes some high-profile names, such as former Prime Minister Paul Keating, superannuation veteran Garry Weaven, Japan specialist Melanie Brock and former Productivity Commission Chairman Peter Harris – goes a long way to ensuring the investment team has the opportunity to present its plans.
It is a form of activism without the venom seen in other markets, or as Rangaswamy calls it: ‘respectful activism’.
“We believe that you can take a lot of the principles from private equity and apply that to the public market through ‘respectful shareholder activism’. For us, that involves engaging with boards and management teams to execute on these value or growth improvement plans that can create value for all shareholders,” he says.
“Where the respectful part really comes in is in trying to distance ourselves from US-style activism. A common criticism of North American hedge funds is that they look to execute on short-term initiatives that result in equally short-term re-ratings, but often leave companies strategically diminished. We like to think that we advocate for strategies that leave companies strategically enhanced over the long term.
“Besides, we think that a constructive and positive approach is just more productive in Australia and you’re more likely to get genuine change. Engaging in proxy fights and having a sort of public discourse can often be counterproductive.”
Tanarra sometimes signs non-disclosure agreements with companies once it has built a stake in the business and this allows the team to work closely with the board and management team in the same way a trusted corporate adviser would.
The team conducts extensive research on the business and identifies where the pain points are. It often share these insights with the company to show the team is there to help rather than agitate.
“A good example is when we were talking to GrainCorp. We shared the results of interviews we’d done with over 20 stakeholders on the east coast of Australia, showing them how their potential customers were bypassing GrainCorp’s infrastructure network,” Rangaswamy says.
GrainCorp’s core business is the storage of grain and related commodities and it provides the logistics for doing so. But the pricing structure in certain parts of the market made it uneconomical for a number of farmers to make use of the company’s facilities.
“Many farmers had started to build their own on-site storage or were finding other ways to bypass Graincorp’s sometimes cumbersome network. Passing on this information and, in general, our differentiated research, shows a company that you want to be seen as a trusted adviser, rather than a confrontational activist,’” he says.
What was material was Tanarra’s advocacy for a spin-off of GrainCorp’s malt business, which resulted in a new company, United Malt Group, which listed on the Australian Securities Exchange in April 2020, creating significant value for shareholders.
Another good example of Tanarra’s approach to activism is its involvement in Boral, a manufacturer of construction and building materials. While the company ran a largely successful operation in Australia, its US businesses were struggling, something the management at the time wasn’t necessarily interested in dealing with.
“We presented a value improvement plan to the company in mid to late 2019 to advocate for the sale of Boral’s poor-returning US businesses and instead for the company to focus on an operational turnaround in its high-quality Australian operations,” Rangaswamy says.
“But we could see a lot of board-level reticence towards that plan as we started and we believed that management was a big impediment to that plan. Through constant engagement and sharing of our analysis, the company eventually appointed Zlatko Todorcevski as the new CEO and very quickly after that a strategic review was announced.
“Three years later, the company has exited all of its international businesses and is now embarking on a transformation plan in Australia. But when we go back to 2019 and we first had the conversation with the company’s Chair, that certainly wasn’t on the agenda.”
It is not all about value creation. Sometimes companies need to be stopped from destroying value through bad or uninformed decisions. In Boral’s case, this was about preventing an equity raising during the tumultuous start of the global pandemic that would have diluted the share price significantly.
“We communicated our views to the company that they didn’t need to raise equity during the COVID market dislocation. We suspected were considering raising equity, but in all of our analyses we couldn’t see the company breaching any of its debt covenants or not being able to meet its debt obligations,” Rangaswamy says.
“And so we were quite critical of raising equity at $2 per share, when our assessment of fair value was north of $7. It would have been both needlessly and permanently value destructive.
“So being able to get in front of companies quickly and providing a shareholders’ perspective on those things … in Boral’s instance it was critical.”