[Jin's Note: I occasionally conduct interviews with fund managers and other investors to document their unique approach to investing. The following is an interview I conducted with Joel Freudman, manager of Resurgent Capital.]
Jin: Could you please introduce yourself?
Joel: My name is Joel Freudman. I am born and raised in Toronto, and studied Commerce at the University of Toronto and Law at Western University. I practiced law for about six years before deciding to establish Resurgent Capital Corp. In addition, I have been managing my personal investment portfolio for over a decade.
Jin: Could you explain what activist investing entails? How is it different from "normal" investing?
Joel: Most investors – which likely includes many of your readers (and myself personally) – buy securities such as stocks or mutual funds as “passive” investors. Essentially, they find a company they like that has good prospects, and then invest in the hope that the company and its management team will deliver results that increase the value of their investment.
By contrast, activist investing involves acquiring a stake in a company for the purpose of influencing or controlling the company’s performance. This requires a combination of significant financial resources, complex legal manoeuvering, and operational expertise in the target company’s industry or business. Typically, an activist investor will have major structural changes in mind to improve the target’s operating performance or share price, such as replacing board members, distributing cash to shareholders, or undertaking M&A (mergers & acquisitions) transactions.
Also, since activists are typically seeking active involvement with their target companies, they are likely to make fewer, but more heavily concentrated, investments. For example, Resurgent only invests in up to 3 targets at a time, which is much less diversified than a normal stock portfolio or mutual fund.
Jin: You have extensive experience as a securities lawyer. How does that affect the way you implement your strategies?
Joel: The capital markets are heavily regulated, so a thorough understanding of securities laws is crucial to success as an activist investor. When researching a potential target and planning my approach, I have to consider securities legislation, regulations and guidance from securities regulators, and stock exchange policies. All of these govern how Resurgent can accumulate a stock position, when Resurgent has to disclose its ownership, and so on.
Because of my legal background, Resurgent’s strategy typically includes a thorough review of a target’s public disclosure record to identify legal vulnerabilities, such as poor corporate governance or non-compliance with securities laws. My experience is also helpful in understanding the securities and corporate law procedures Resurgent has at its disposal, as well as the M&A transaction structures available in a given situation.
Jin: Why did you decide to focus on microcaps?
Joel: Large publicly-traded companies are typically followed by many research analysts and institutional investors, each trying to determine the company’s fair value and share price. Plus, hundreds or even thousands of individual investors are watching those companies. As a result, large-caps are well-researched and thus more likely to be valued ‘correctly’ by the market.
However, there are hundreds of publicly-traded micro-caps in Canada that have limited market exposure and only a small retail (individual) investor base. The main downside to this is that these stocks are typically illiquid (i.e. traded infrequently), making it difficult to acquire or dispose of a large position. On the other hand, these factors result in information asymmetry and persistent mispricing, so someone combing through enough of these companies may be able to earn excess returns by uncovering a few hidden gems.
Jin: How do you select companies to get involved in?
Joel: I start by running proprietary screens based on financial metrics in order to identify undervalued companies. Then, I review those companies’ financial statements and continuous disclosure records to get a better understanding of their business and possible structural reasons for the undervaluation. Typically, I also speak with the CEO to get their take on the company’s plans. Ultimately, Resurgent only invests in a few targets at a time, so as to focus on the most promising opportunities.
Jin: Do management of these companies generally welcome you with open arms, or do they usually try to keep you away?
Joel: This is a great question, and one I get asked frequently. Many micro-cap companies have high insider ownership or a few major shareholders supportive of existing management, and are unused to being approached by an activist.
One of the differentiators for Resurgent is that in most cases I try to put forward collaborative, win-win proposals that I believe would benefit the company and its shareholders, as well as the incumbent board of directors and management team. In a sense, Resurgent aims to be a ‘value-added’ partner rather than an overhaul of the status quo. In my experience so far, management is more receptive to this approach than traditional activist tactics, which are highly confrontational.
Jin: Once you accumulate a stake in a company, how would you go about influencing the decisions of the company? What are your leverages that you can pull?
Joel: As a general principle, the larger the ownership stake, the more influence Resurgent has. I typically ask for one or more seats on the target’s board of directors in order to meaningfully impact strategic direction. However, I also call and meet with members of the board and management on an ongoing, informal basis to put forth proposals and discuss possible changes.
There are numerous legal mechanisms available to influence the board and the company’s direction. These include tactics like shareholder meeting requisitions or ‘proxy contests’. However, these procedures can be expensive (for both sides) and risky, which is why a collaborative approach is often preferable.
[Joel's Note: A proxy contest involves one or more dissatisfied shareholders soliciting proxies (i.e. votes) from the rest of the target company’s shareholder base in favour of changes being proposed by the dissatisfied shareholders, such as replacement of the incumbent board.]
Jin: Could you talk about an example in which activist investing would have helped shareholders?
Joel: Resurgent is still identifying and working with its first set of investees to effect positive change. However, a number of successful (and unsuccessful) activist investments in the large-cap space have made headlines in recent years. A great example is Pershing Square’s 2012 proxy contest for control of Canadian Pacific Railway (TSX:CP). After electing its nominees to CP’s board of directors, Pershing installed an industry veteran as CEO to improve CP’s performance. CP’s share price rose from the $50 range when Pershing first got involved to as high as $240 before Pershing exited its position in mid-2016.
Jin: Who can invest in your fund, and how?
Joel: As a private company, Resurgent can only accept investments from accredited investors (i.e. high-net-worth individuals and institutions), as well as family and friends. Resurgent relies on securities law exemptions to raise capital from these investors.
Having successfully closed two rounds of financing earlier this year, Resurgent is now adequately capitalized to execute its business plan, and is not currently looking to raise additional funds.
[Jin's Note: I would like to thank Joel for taking the time to conduct this interview. If you're a fund manager and would like to get interviewed, please drop me a line at firstname.lastname@example.org.]