Here is yet another reminder why small, individual investors
should not be spending their time and savings on buying
individual stocks. The savvy pros always manage to find some
sort of advantage.
Case in point: California-based activist investor Relational
Investors, co-founded by Ralph Whitworth and David Batchelder,
has identified its newest target Dallas-based Flowserve
The activist investment firm earlier this week filed a 13D
disclosing it owned more than 3 million shares, or 5.65
percent, of Flowserves total shares outstanding. It also
simultaneously filed a delayed 13F disclosing it owned more
than 238,000 shares at the end of the first quarter. Flowserve,
which has a $6 billion market capitalization, makes industrial
pumps, valves and other equipment for the chemical, oil and gas
and power industries.
Keep in mind that the deadline for the March 2012 13F was
around May 15. So, it took about a 40-day extension. Investors
can obtain an extension for the filing if they feel it could be
hurt by the disclosure. Under SEC rules, investors can seek
"confidential treatment" in certain limited circumstances for
an ongoing investment strategy, including an ongoing program of
acquisition or disposition. It is not unusual for us to
request confidential treatment while in an accumulation
program, Whitworth said in a phone interview.
So, thanks to this provision, the $6 billion Relational
wound up accumulating most of its Flowserve position since the
end of the first quarter, but chose not to disclose its
earlier, much smaller position until it passed the magic 5
percent threshold required to file the 13D. This presumably
gave the company more time to pick up a lot of stock without
tipping off other investors.
And lo and behold, between May 15 when the stock topped $108
and earlier this week when the disclosures were made by
Relational, Flowserves stock hit interim lows of $101 and
$100. Even so, according to the SEC filing, Relational seemed
to buy most of its shares between $104 and $108. The stock
closed Thursday at $111.18.
Whitworth and Batchelder are two savvy activist operators.
Whitworth has served on the boards of 11 public companies,
including Hewlett-Packard, where he currently remains a
director, Genzyme, Mattel, Sirius Satellite Radio, Sovereign
Bancorp and Sprint Nextel. He also has served as chairman of
Apria and Waste Management. Batchelder has served as chairman
of one public company and as a director of 10 others. Few
individual stock pickers can match that level of
On the surface, Flowserve is an attractive, undervalued
stock with big fans on Wall Street.
Most sell-side analysts who follow the company have assigned
it their highest rating and have set target prices of between
$142 and $146.
Research outfit S&P Capital IQ has a "strong buy" on the
stock. In its analysis in a recent report released before
Relationals filing, S&P figured Flowserves
discounted cash flow model indicates intrinsic value of $136.
Its relative metrics, which includes the companys ratio
between its enterprise value to ebitda and P/E to EPS growth,
suggest a value of $154, the investment firm states.
Blending these valuations, we arrive at our 12-month
target price of $145, it adds in the report.
S&P told clients in its report it projects close to 7
percent sales growth in 2012 based on the companys
expanding product offerings and global reach and on the
presumption that bookings will pick up in oil and gas, chemical
and general industrial markets. It also expects earnings to
strengthen later in the year after the company works down what
S&P reckons is low-margin past-due backlog. We see
strength in the Middle East, Asia-Pacific and Latin America and
believe increased oil and gas activity will lead to an improved
long-cycle business, it adds.
On Wednesday UBS raised its price target from $140 to $146,
but analyst Robert Barry says this move was made before
Relational disclosed its stake. The timing is
unrelated, he stresses in a telephone interview with
Institutional Investor. I was working on
updating my estimates. He believes strong bookings and an
improving margin outlook will benefit the shares.
Barry questions what exactly an activist could accomplish
making a move on Flowserve. What can they agitate
for? he asks. Things are going well; it is
shareholder friendly; it is doing a buyback.
Ah, but Barry may be missing the whole point here.
It seems that between the deadline that most investors met
for filing their 13F and this week when Relational finally
filed its 13D and 13F, Flowserve took the kinds of steps that
activists usually push management to implement.
For example, on May 31 Flowserve announced what it called an
updated capital structure strategy designed to make the
companys financial structure more efficient.
Key to the strategy: A whopping $1 billion stock repurchase
program, including roughly $233 million remaining under the
companys most recent share repurchase authorization. It
increased its long-term gross leverage ratio.
This new capital structure strategy involves prudently
increasing our leverage to drive cash utilization efficiency
and return increased capital to shareholders, while still
maintaining a strong balance sheet to fund future growth,
said Mike Taff, senior vice president and chief financial
officer, in a statement. And those shareholders, of course,
include Relational, which at the time was building its big
position. Except the rest of us didnt know this at the
time. We believe this new capital structure strategy will
provide us ample flexibility to allocate cash in ways that
drive attractive returns for our shareholders, which include
stock repurchases, dividends, disciplined capital investments
and value-creating, bolt-on acquisitions that represent a
compelling strategic fit, Taff added. We believe
this $1 billion repurchase program will be a very attractive
investment for the company that will create increased
In its announcement at the time, the company said the new
share repurchase program was in addition to its previously
announced policy of annually returning 40 percent to 50 percent
of running two-year average net earnings to shareholders, which
the company intends to maintain after attaining the announced
target leverage ratio.
Then, on June 14, Flowserve announced it entered into an
accelerated share repurchase (ASR) agreement with J.P. Morgan
to buy back $300 million of the companys common stock.
The agreement is part of both the $1 billion share repurchase
program and its new capital structure strategy, the company
added. Flowserve said the ASR was funded through a combination
of cash on hand, existing revolver capacity and proceeds from a
new $250 million term loan.
Did Relational have anything to do with these
shareholder-friendly decisions? The company did not
In its filing earlier this week, Relational said it began
investing in Flowserve in February, about the same time it
began speaking with management and presenting its views and
concerns regarding strategic positioning, operational
improvements, capital structure and capital allocation,
according to the recent SEC filing. It also stressed that the
firm recently intensified their communications around
certain of these topics and believes the company
has taken, and will continue to take, actions to improve
its performance in these areas.
So, basically the company took several of the kinds of steps
an activist would typically push for, all before Relational
told the world it was an investor in the stock and was speaking
Relational, however, is apparently not very satisfied with
all of the moves the company has taken so far. In this
weeks filing, it said Flowserves share price does
not adequately reflect the potential for significant earnings
and cash flow growth and that it has discussed a number of
areas of concern, including the companys strategic
positioning, operational improvements, capital structure and
Relational also said strategic investments made by the
company over the last three years to improve its high-margin
aftermarket product and service offerings which account
for 40 percent of revenues are underappreciated despite
exhibiting lower volatility and significantly higher margins
than its original equipment revenues. Relational stressed in
the filing the companys plan to expand its aftermarket
presence will reinforce earnings growth stability and margin
Even so, Relational also stressed it is confident management
is intently focused on achieving the stated
long-term profit margin improvement target of 250 basis
Relational is also somewhat grateful for the bones the
company has already thrown to investors. In its filing this
week, it also credited the companys May 31 announcement
to increase its target gross leverage ratio to fund an expanded
stock repurchase program of $1 billion.
Relational also stressed the company has substantially
completed the investments necessary for its strategic
positioning, thus freeing up excess cash flows in future
periods for distribution to shareholders through dividends and
share repurchases. It believes share repurchases represent a
low-risk, high-return hurdle against which all
alternative uses of capital must be benchmarked. In the
phone interview Whitworth added: We would like them to
execute their strategic plan and follow best practices in the
capital allocation, and the actions they have taken indicated
they have the discipline.