Governance for Owners is a different kind of investment house, looking to create value for institutional clients by investing and driving improvement in companies.
GO started life in 2004, set up by Peter Butler and Steve Brown, and has developed three major business strands: its European Focus fund, a recently launched joint venture product investing in Japan and stewardship outsourcing.
This latter service is designed for equity owners and fund managers, providing independent voting, corporate engagement and other advisory services on environmental, social and corporate governance.
Ex-JP Morgan manager Robert Machell, who runs the European Focus offering, said the founders started the business based on their experiences running similar engagement products at Hermes.
In the simplest terms, the goal is to add long-term shareholder value by exercising owners' rights to drive through corporate change - differentiating the group from shorter-term investors in this space.
GO feels that being an active, responsible owner is a key driver of equity returns and the investment philosophy is grounded in the belief that companies with involved and informed shareholders are worth more over the long term. Machell said the firm is an activist house in so far as it is helping companies reach fair value but acknowledged the term has been hijacked by investors looking to force through change for short-term profit.
He believes this actually enhances the appeal of genuine engagement investors like GO, with its long-term strategies to add value all the more persuasive with short termists operating in the background.
Taking a position
Machell's European Focus fund invests in 12-15 core positions on the continent, aiming to become a top five shareholder, and build a long-term relationship with the management. "We want to help our holdings achieve a better rating and create sustainable value for shareholders," he explained.
"Our process looks to do this in three ways; encouraging and driving change through a company’s overall strategy, financials or governance."
On the first of these, the team asks whether a company is the best owner of its assets, analysing whether certain divisions are failing to add sufficient value.
"We want our holdings to be producing a decent return on capital and every company allocates capital differently," said Machell.
"This is not shorthand for breaking up and selling off parts of firms, and our aim is to help businesses grow by adopting the most appropriate corporate strategy. That could mean encouraging a company dominant in one European country to expand into other areas on the continent for example."
On the financial side, the GO team analyses the shape of a company's balance sheet to ensure it is appropriately capitalised.
Businesses are often constrained by a lack of capital and GO has instigated various rights issues over the years, giving companies a stronger balance sheet so they are better placed to take advantage of opportunities.
As for governance, the team investigates how a company is run at board level, ensuring the right people are doing the right jobs and pushing for replacements where this is not the case.
The value opportunity
Apart from scope for business-improving change in these areas, holdings in the European Focus fund will also offer a strong value opportunity, typically trading significantly lower than what GO deems their fair price. "There are six partners and six analysts working on the portfolio so that is effectively one for one at stock level," added Machell. "All our effort goes into identifying companies where something can be improved in order to unlock value, and we set a fair value price target that reflects this potential corporate improvement. When the stock gets to that level, which can change depending on circumstances, we will sell out and move on to the next opportunity."
According to the manager, this approach does not mean an entirely deep value focus, typical of more traditional recovery funds, and the team has also held growth stocks performing well where they felt further improvement was possible.
Machell said the group only takes a top-down view for risk control purposes, ensuring the portfolio does not end up with 15 retail stocks for example.
"Our fund is typically a blend between these deep value recovery-type stocks and those already performing well where there is scope for even higher returns," he added.
"We also look to have a spread across economic sensitivities in our holdings, so the overall fund performance will not collapse if retail sales go into sharp decline or the oil price climbs above $100 for example."
A couple of stock examples show how GO’s long-term process can add value for shareholders - although these are companies the fund no longer owns as it does not disclose current positions.
Machell highlights French company Sperian for example, a global market leader in making personal protective equipment such as hard hats and gloves used in industrial and commercial workplaces.
When GO bought into the company back in 2005, the team noted a muddled business plan that lumped high and low value-added products together.
"In gloves for example, Sperian was offering niche products for the glass working industry - able to withstand temperatures up to 22,000 degrees - alongside basic marigold equivalents," added the manager.
Gloves off
"This put together very high value-added products with something offering no barriers to entry or competitive advantage, and we felt the business would be much stronger if it allocated more capital to its most attractive and profitable areas."
Machell said Sperian made slow progress in shifting its portfolio towards the high-value added end and GO attempted to accelerate the process by boosting its 10% stake and taking a seat on the board.
"They were unwilling to allow this as the company already had two shareholders on the board and the next development in March 2010 was a bid for Sperian from private equity firm Cinven," he added. "At the time, the company's share price was e59 and the bid was pitched at e70, which we felt was substantially below fair value given what we felt it could achieve. We refused to tender our shareholding at that level and also felt the management were incentivised by equity participation to push for the deal to go through."
To counter any possible bias, GO organised a sub-committee of managers less incentivised by the bid to establish whether it was in the best interest of shareholders and also used its local expertise to add further scrutiny.
"We have 12 different European nationalities working at GO, one of whom is a French ex-lawyer, and can often bring this to bear on our holdings," added Machell.
"In French corporate law for example, one of just five independent experts is required to rule on whether bids represent fair value and as they take turns, we asked one of those not involved with Sperian to help us analyse the deal. These experts usually take 15 days to present their findings but the one analysing the Cinven bid was unable to finish in that timeframe, suggesting we had managed to put this bid under greater scrutiny than usual." Another GO partner is a former investment banker, who was able to get two industrial buyers interested in Sperian and after an auction, Honeywell finally paid e117 a share for the company.
"This example shows how our in-depth knowledge of holdings - including how much its assets are genuinely worth - can add major long-term value for shareholders," added Machell.
Keeping the heat on
Another previous position in European Focus is German firm Techem, the country's leading producer of heat cost allocators.
These allow landlords to know how much heat individuals are using in a building and charge them accordingly, which Machell said is important in a high energy price environment when people want to know they are not paying too much. GO bought into the company in 2005 and the team said this was a case of a fairly predictable business where the management had become bored and tried to diversify, with unusual purchases like a biomass plant in East Germany and a combined heat and power plant in Northern Greece.
"We did not like these acquisitions and said to Techem that it had a great business in Germany and should look to expand that into other European countries as opposed to diversifying," added Machell.
"The company also had a very strong balance sheet, throwing off a lot of cash, and we felt it could return some of this to shareholders without jeopardizing growth plans. Through these strategic changes, Techem’s core business moved onto a growth path and we also made the balance sheet more efficient."
As with Sperian, the business attracted interest from a private equity bidder - BC Partners this time - and GO again felt the initial bid was too low, especially as it had modelled potential cashflow developments as the company expanded further into Europe. "Again, we felt the management was incentivised by the bid so established a relationship with the company's supervisory board, which sits above the main board," said Machell. "This led to a unique situation where the main board was advising people to tender their shares while the supervisory board was urging them not to - and in the confusion, Macquarie came in with a second bid." GO felt this further offer was also too low and went public with its own fair value figures.
This eventually prompted the two bidders to join forces to launch a joint offer at the required level.
With no real top-down view other than for risk management, Machell said there is no sector bias in the portfolio, but there are certain areas where the group's process makes it difficult to invest.
This includes sectors such as pharmaceuticals and technology where companies are often reliant on a single product, as these are too high-risk according to the team.
Financials is another difficult area for GO as the team is often unable to understand the balance sheet sufficiently to meet its in-depth requirements.
Looking forward, Machell said several European companies are coming into 2011 with their strongest balance sheets in years, with many having cuts costs and paid down debt since the credit crunch.
With the economic background also slowly improving in core Europe he sees the coming months as a strong environment for merger and acquisition activity.
"This is a beneficial background for our style of identifying and improving business where value is being held back, as these companies are exactly those that will attract the attention of potential buyers," he added.
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