By late 2011 once-mighty Internet giant AOL had shrunk to less than $1 billion in market capitalization. Its stock had plummeted to about $13 a share, down from $23.50 when it was spun out of Time Warner in December 2009. That’s when a then-little-known hedge fund firm called Starboard Value jumped in.
Starboard founder Jeffrey Smith and his team quickly concluded that AOL’s dial-up and search businesses had generated a combined $800 million or so in earnings before interest, taxes, depreciation and amortization for the preceding 12-month period, but its display business was losing $500 million a year. Meanwhile, they saw that AOL was sitting on a gold mine of patents for some of the most commonly used things on the Internet, such as cookies, radio and virtual shopping carts.
Smith and his team put pressure on AOL to slash losses, particularly by dumping its troubled Patch network of local news sites, and find a way to profit from its patents. AOL responded, selling its patent portfolio to Microsoft Corp. for $1 billion, but the company refused to part with Patch and called Starboard’s proxy campaign misleading.
Although Starboard lost the proxy fight in June 2012 and sold its 5.1 percent stake in AOL shortly afterward, it profited handsomely from the deal, posting a gross return of 242 percent on its investment. The proxy fight put pressure on AOL to act; it eventually sold Patch to technology holding company Hale Global.
The AOL investment exemplifies Starboard’s philosophy of investing only in companies where the firm can make changes that would clearly translate into a more profitable business. “We’re investing in companies pro forma, for the changes we can make, as opposed to investing in companies based on how they’re being operated today,” Smith says.
The proxy fight thrust Starboard — at the time, only recently spun out of New York–based investment bank Cowen Group — into the public eye. Since then Starboard has grown to $3 billion in assets, including unfunded commitments. Smith and his team, including managing members Peter Feld and Mark Mitchell, have made a name for themselves partly by specializing in companies with small market caps. But they also have distinguished themselves with a winning track record: Starboard generated an annualized return of 15.5 percent from its 2002 inception through May 2014 and has made money in 84 percent of its activist campaigns. The Starboard crew has a knack for spotting hidden value on corporate balance sheets — a collection of patents, a portfolio of real estate investments, even an overfunded pension plan — and unlocking that value. They also have a gift for persuading other shareholders to put pressure on entrenched management teams.
Smith, 42, grew up in Great Neck, on New York’s Long Island, and earned a BS in economics from the Wharton School of the University of Pennsylvania. He joined New York–based asset management firm Ramius in 1998, doing direct investing in small publicly traded companies that needed financing. Mitchell, now 52, came to Ramius in 1999 from BT Alex. Brown, where he had been responsible for proprietary equity arbitrage trading, to head its event-driven business. Smith and Mitchell discovered that their skill sets meshed well, and the two began to invest in undervalued companies, using corporate governance tools such as proxy contests to boost share prices. In 2002 they set up a fund within Ramius while continuing to run the direct lending and event-driven efforts. Feld, 35, signed on in 2005 from Banc of America Securities, where he had been an analyst in the technology investment banking group.
After the 2008 financial crisis, Ramius merged with Cowen, and Smith and his team realized that running an activist business within an investment bank could create conflicts. With Cowen’s blessing they spun off Starboard Value in 2011.
One of the firm’s recent successful campaigns was its investment in Office Depot. Starboard presented the company with a stand-alone plan for running its business better but also pushed for a merger with rival OfficeMax. Starboard initiated a proxy contest that would have replaced most of Office Depot’s board; the two sides ultimately settled before Office Depot’s annual meeting, with Starboard winning three board seats. Office Depot and OfficeMax merged in 2013. All of Starboard’s directors are now serving on the board of the combined company. Smith praises the company’s new management team and board and says the deal resulted in “hundreds of millions” of dollars in cost savings and a reinvigorated corporate culture.
Smith says that in his experience, once Starboard goes in, the team finds that the target company’s board members are just as interested in improving the company’s stock price. In that case, there may be hope yet for Starboard’s largest investment to date, a 6.2 percent stake in Darden Restaurants. Darden, an operator of casual-dining chains including Olive Garden, LongHorn Steakhouse and, until recently, Red Lobster, has dug in its heels and is refusing to meet the hedge fund firm’s demands.
Starboard says Darden is being run inefficiently, is drastically underperforming its peers and needs new leadership. The firm is also pushing Darden to explore a separation of its remaining businesses and generate profits from its underlying real estate assets by spinning them off into a real estate investment trust. But Darden has thus far ignored Starboard’s suggestions. It recently sold Red Lobster to a private equity firm over Starboard’s objections, at what Feld describes as a fire-sale price. Smith calls Darden’s management team “among the most entrenched we’ve ever seen.” But if the activist investor’s track record is any guide, chances are the Darden management team will come around to Smith’s view — one way or another.
