Motley Fool Hidden Gems Investing - Activist Investors Shake the Tree

Episode Date: October 18, 2022

If you'd like to see tech stocks turn around, some activist investors feel the same way. They just have some more fire power. (0:21) Deidre Woollard and Asit Sharma discuss: - Starboard Value's recent stakes in Splunk and Salesforce. - Dan Loeb's push for a spinoff at Colgate-Palmolive. - Layoffs at Microsoft. Plus, Robert Brokamp and Matt Frankel (14:06) discuss how your home fits into a financial plan. Companies discussed: CRM, MSFT,  CL, SPLK, GIS, INTC Host: Deidre Woollard Guest: Asit Sharma, Robert Brokamp, Matt Frankel Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. Welcome to Motley Fool Money. Today, we're looking at the impact of activist investors amid a tech slowdown. I'm Deidre Willard, sitting in for Chris Hill, and I'm joined by Motley Fool Senior Analyst, Asit Sharma. Hi, Asit. Hey, Deidre. How's it going? Going great. We're in the midst of this busy earnings week, sort of kicked off last week, and so far so good. Tentatively optimistic here. It's been a decent week in the stock market. But amid all of that, we've got this activist investor who's kind of stealing the spotlight

today, Jeff Smith. He's the founder of a company called Starboard Value. He announced the company has taken stakes in both Salesforce and Splunk. Starboard Value manages billions in assets. Why is it news when an activist like this steps in? When an activist of this capability and track record steps in, it's news because you know that they are serious and they are probably going to drive for either a board seat or really push for change in an organization. The quality of activist investors, I think varies depending on how much firepower they have, how much shares they're actually able to snap up. And this is a significant one. So people take notice and they really re-examine the business models of the companies that the activist investors announced

they've taken hold in. Well, I think it's particularly interesting with Salesforce because Jeff Smith, he's been very complimentary about Salesforce, talking about what a great company it is, how it's so important to so many businesses. But he also zeroed in on this idea that it has the subpar mix of growth and profitability. And it seems like there's a lot of concern about Salesforce's spending. So if you're a Salesforce investor, should you be thinking about that ability to cut costs here? I think you should. Deidre, Salesforce has grown to such a size where it's no longer feasible for it to forever grow serially through acquisitions, which has been its mainstay, even though it has an amazing core product in its namesake product.

It's picked up great businesses like Slack along the way. In recent years, what's happened with Salesforce is that it's become a big generator of cash flow in terms of dollar magnitude. But when you look at the percentages across its income statement, when you compare cash flow as a function of revenue or net profit as a function of revenue, it starts to look weaker. People have questions about the company's return on its invested capital. Here's a company that's quadrupled its revenue over the last five years, mainly through acquisitions. It's also more than doubled its net income, but its operating margin has decreased by 93% over the same period. What that clearly shows is, this company is still really good at acquiring

more revenue, more cash flows, but organically, its ability to generate profits is going in the other direction. Now, management has said that they're going to focus on that operating margin. They're no longer going to be a company that strives to make it spread solely through acquisitions. But you have this period where you're shifting gears. It may take a few quarters. These are the types of vulnerable periods where you are ripe for an activist investor to come in and say, what's wrong with this picture? Well, management's already said what's wrong with the picture. They just need some time to start working on those costs. And I think they can be more efficient with their cost structure. And I think they can

start to show some operating leverage, but they may not have any time left at their disposal at this point. Yeah, I think that's really interesting. It is sort of a slower turnaround. definitely, yes, they need to stop acquiring so many companies, even though they've been really good at it. I know that they've put some of their lease in Salesforce Tower up for lease. So they're trying to make better use of that space. They're looking at some layoffs. It's really, really interesting to see how fast they can turn it around. Wanted to also talk about Splunk. So Starboard Value, they took a 5% stake in Splunk. That company is a little bit lesser known. It's data and analytics company. It was a takeover target earlier this year. Cisco was interested

and nearly bought it. Is that what's going to be happening with this one? I know that Jeff Smith is also interested in the idea of buying up companies that are takeover targets. Yeah, I think a takeover would be the main impetus to take a position in Splunk. Splunk made quite a splash when it came public several years ago. It's a company that has a very interesting business in that it generates information off of machine data. And when they first came onto the scene, they showed multiple, multiple use cases for the software. The problem with Splunk is that it's never really been able to generate consistent profits over the years as it's piled up losses upon losses. It's also leveraged its balance sheet.

They've got something like $3.8 billion of convertible senior note debt on their books. It's not the kind of company that you could easily go into and say, I'm going to turn this around. You could try that. But what this more obviously points to is maybe a sale to another big buyer like Cisco, a company that has billions and billions of dollars of cash in stock to snap up Splunk. But this would be a really, really hard case for even an activist investor to just come in and say, okay, I'm going to do away with some payroll, I'm going to cut some variable expenses, really sharpen this picture up, and then try to increase share price as earnings start to come in. They're sort of far in the distance for Splunk still.

You've got this activist investor. He's got two different companies he's interested in. He's really got two different paths because with Salesforce, he's trying to incentivize them to do things they're already doing a little bit, which is cutting costs and being smarter about their operations. But with Splunk, it sounds like turning that around isn't going to bring him the kind of payday he wants, so the end choice is then to sell it off. Yeah. I think the best activist investors are tree shakers. They look at one tree and say, okay, this is a really thin willow. I can just grab this with one hand and shake it in this way, and the fruit will fall down. Other trees are bigger, they're harder to deal with,

and so you have to take a different approach. The good activist investor has many routes to persuade his or her fellow investors that he or she is going to create that kind of value in the marketplace. The ones that don't stick around for long periods of times are the ones who only come in and agitate in one style. After a while, it's just counterproductive. Yeah, really good point. I think this speaks to a larger issue that we're seeing cost-cutting all around tech. Tech has had a great run and now this year has been a little bit of a a little bit of a wake-up call. We've seen so many tech layoffs. Microsoft is the latest to confirm it might cut as many as 1,000 jobs. Meta has been doing that. Alphabet has been doing

that. Obviously, these are the big companies, but it's happening all the way down the line for smaller companies. What are the longer-range implications of these widespread tech layoffs? Deidre, I think the longer-term implications really get case-specific where you're talking about medium-sized or big tech. For some companies, you can look at it as an optimization exercise. In other words, Microsoft, I think they're hearing that investors are a little more focused on earnings. They understand that investors understand that their growth is slowing, so they got to show some other impetus to push dollars to the bottom line. You can think of that as just getting a little bit more into fighting trim.

them. Microsoft is a net investor in their technology, in their people, in their solutions. They're going to, at some point, turn the faucet back on and start hiring again. Now, there are other companies where the business case looks wobbly. Meta is a great example. They've got that huge investment in the metaverse. We saw reports over the last week or so that hardly anyone wants to hang out there. You and I are both really interested in the metaverse. I have not been on their space yet. I don't know if you have, but the descriptions I've heard up until now haven't really seemed persuasive, like, why would I even want to go try out that space? There you have a company whose advertising model is slowing down. They've

got investments that might look misplaced in a year if they can't generate some momentum out of them. For them, that could signal something longer-term. The fact that Meta says we're to be a significantly smaller company by next year, you wonder, where is the catalyst to rebound? How will this company start growing again? It placed its big bet already in the metaverse and now it's scaling back. With each of these companies, like sight unseen, I'll say it's an optimization exercise, but there are some specific cases where you wonder if it's not the portent of something more serious down the road. I think that's a really good point, because one of the things that I'm always looking for when I hear about these layoffs is I want to

know which departments. With Intel, they were looking at cutting some marketing and some sales. Okay, that makes sense. They're obviously not going to be cutting back in manufacturing. You're absolutely right. It's a case-by-case basis and also within the company, what are they cutting, why are they cutting it, and how does that position them for the future? Yeah, I think that's a great perspective to take whenever you hear about these. If you can dig one layer deeper, sometimes you get a clue as to what it means for the company longer-term exactly when you see which departments they're cutting in. Well, speaking of clues, we've got some interesting clues of another activist investor,

Dan Loeb of Third Point. He's a pretty famous hedge fund guy and an activist investor. He's He's built up a big stake in Colgate-Palmolive, and he's done that because he's interested in Hills Pet Nutrition, the pet food side of the business. And I found this interesting because a couple of months ago, he took a stake in Disney. He's got this aim of pushing it towards a spinoff of ESPN. And I'm really thinking about what is he trying to accomplish and what does he see in the value of spinning off something? Is it to protect the core business or is it because he sees the spinoff as being the more interesting part? For most of these activist investors, there's one part of a spinoff that's really attractive,

and that's that usually you get a tax-free distribution. So I'm too small of an investor to worry about this stuff, and lots of my investment anyway is in my retirement savings accounts. But the bigger you are, the more you're going to look for opportunities where you can get a quick rise in some type of value and have that come to you tax-free. Why that can be good for shareholders is that often the progress or potential of a smaller division just gets obscured because it's part of a bigger, slower growth corporate ball of wax. If you look at what General Mills did with Blue Buffalo four or five years ago now, they purchased that small premium pet food company in 2018. They've grown it into a billion-dollar

business. We see how strong this pet humanization trend is. He's looking over at that and saying, hey, I could take this part of Colgate-Palmolive, carve it up, offer that to the public. People who own Colgate-Palmolive will get shares in the new company. That value is perceived by the public when they can see it as a separate company and see the growth rate, those shares will rise. The total value will be greater than if Colgate-Palmol just kept plodding along and no one can see how great the potential of this small pet division is. I think that's what he's after. That would be my guess. This strategy of the tools that we've been talking about, the ways to shake the tree, this one has proved one of the ones that I seem to think

makes a good case for the activist investor. I mean, so many of the times you look at these deals and you're like, gosh, these people are like buccaneers. They don't care. They'll take a position in a company and sometimes just bail after six months after destroying a lot of confidence in management. I've seen that movie so many times. But this can be a pretty fun tool. So we'll see what happens as he keeps probing Colgate Palmolives and various business units within it. I love what you said there. That's sort of a perfect way to end this, is this idea of when we see an activist investor, we have to look at the motivation and we have to look at what their end goal is. Are they just trying to unseat the leadership? Are they going to work with the

leadership? There's so many questions to ask. Definitely going to keep an eye on all of these. It is fascinating to watch. Thank you so much for your time today, Asit. Deidre, thanks so much for having me. It was a lot of fun. You're listening to Motley Fool Money. There's a good chance your home is your largest asset, so how does your house fit into your financial plan? Robert Brokamp caught up with Matt Frankel to discuss. For many Americans, their home is their biggest asset, and the price of that asset skyrocketed during the pandemic. The Case-Shiller National Home Price Index has grown 44% since February of 2020. According to data from the Federal Reserve, homeowners collectively had

$29 trillion in home equity as of the end of June, which is roughly the value of all the companies in the S&P 500. That said, it's an interesting time for the housing market. Combine those higher prices with a 30-year mortgage rate that has spiked to 7% this year, and the monthly payment on a new median-priced home is 50% higher than it was a year ago. Consequently, affordability has plummeted, probably spelling the end of the housing boom, at least for now. In fact, Bill McBride of the Calculated Risk blog expects prices to drop a nominal 10% and an inflation adjusted 25% over the next five to seven years. Here to help us discuss how to factor home equity into your financial plan during these potentially challenging

Times is Motley Fool contributor Matt Frankel, who is also a certified financial planner and an experienced real estate investor. Matt, welcome to the show. Thanks, Bro. Thanks for having me. Always great to be here talking personal finance with you. It's great to have you on the show because you have your experience as both a landlord and a real estate investor. You're going to help us look at probably the four most prominent ways that Americans use their home equity to pay for their retirements or other goals. Also, though, we'll talk a little bit about how that might be different given the current conditions of the housing market. Let's start with the first one. Strategy number one is basically to relocate.

You basically move to a cheaper part of the country or maybe a cheaper part of your city or just to a smaller house. You can use websites like bestplaces.net or numbeo.com as a resource. They'll show you the cost of living in your area compared to where you might move to maybe get a cheaper place. You sell the more expensive home, you buy a lower-priced home, and you realize a lump sum that you can invest, but it could also lower your annual expenses. According to the Center for Retirement Research at Boston College, homes cost 3.25% of their value to maintain each year when you look at things like taxes, insurance, utilities, upkeep, not including the mortgage. Theoretically, by moving from a $600,000 home to a $400,000 home,

you could lower your annual expenses by $6,500. All that said, given the slowdown in the market, the price you get for your home may not be as high as you hope, and it could stay on the market longer than you'd like. And if you need to take out a mortgage to buy a replacement home, today's higher rates could result in a monthly payment that is higher than what you're currently paying. So, the decision to move for financial reasons requires basically some time with a spreadsheet to analyze your trade-offs. Matt, what thoughts do you have about relocating or downsizing nowadays? Another thing with relocating, it could also make your life easier. A lot of people relocate from a three-story house to a

one-story house because they don't want to deal with stairs as they get older. It could have a lot of other benefits besides just financially as well to make your life a little easier. Yep. If you were in a situation where you still like your house, you would like to move to a lower-priced place, but you don't want to sell your house, another thing you could do then is rent your house, which brings us to strategy No. 2, either renting your house or a portion of it. Matt, you have experience with this. I do. I guess technically, you don't even need home equity to do this to some degree. As Bro said, the market for renting out some or all of your home has never been easier to break into, thanks to tools like Airbnb,

if you want to rent out a room in your house. Those things didn't exist not that long ago. This could take several forms. You can rent out a room in your house, which, to be fair, a lot of people aren't too thrilled with the idea of random people staying in their house over and over again, especially the older generations from my experience. I could just imagine how my grandparents would react if I suggested that. Another way that can play out is renting out your entire home while you relocate. Instead of selling your home to relocate, if you could afford to do so, maybe buy a condo where you want to live and keep your larger home as a rental property in retirement to generate cash flow, especially if you have a lot of equity

and you don't have a lot of overhead like a mortgage to cover. That could be a great way to generate some cash flow. Number three, one way that people don't often think of this, you can relocate from your current house into a multi-unit property and rent out one or more of the other units while you're living in one side. If you have a 3,000-square-foot house right Now, you could sell it and buy a 3,000-square-foot triplex, live in 1,000 square feet and rent out two-thirds of the property to generate some capital. You're essentially getting a wash when it comes to home equity, but it also generates a lot of income. If you don't need that much space for yourself, it's an interesting way to potentially create some extra cash flow

in retirement. When we were talking about this previously, Matt, we found out we had a couple things in common. First of all, we were both teachers earlier in our careers. We both married teachers. And all four of us, at some point, were renting someone else's place. So, when I met my wife, she was renting a basement in a retiree's home. I was renting an attic in a colleague's home. So, I can understand how people are uncomfortable maybe doing that initially. But once you get over the hump of being comfortable with that and setting things up, it actually could be a great way to add some extra money to your cash flow. Yeah. I used to live in a guest house, which is very common in Florida. Houses are built with

little small guest units. It could be easy enough to create a separate entrance to a part of your property. That's something else to consider, to put an exterior door on a bedroom or something to that effect. There are a lot of ways that could take shape. Given your experience as a landlord, um, what are some of the unexpected hassles of renting out your properties? Cause I'm sure that some people come across things that they didn't expect. Well, one, I would say if you want a truly passive investment, hire a property manager. That's number one. I have no desire to deal with tenants and stuff like that. That's a headache that I would recommend avoiding. I've done it before. Um, number two, plan for the unexpected. Don't think your property is just going to cash

flow because it's making more rent than your mortgage costs you. Set aside money for vacancies, set aside money for maintenance, set aside money for repairs. I set aside 20% of rent for those three things. That's the biggest shock that a lot of people have, especially if you're buying an older property, is that it will need things. One of my rental properties, the roof, the water heater, and the air conditioner all went within the first year because the property It was built in the 30s. So, I'd say plan for expenses like that. Start with a nice emergency fund, if you will, for your properties and keep it there. All right, let's move on to strategy number three as a way to turn your home equity into

a bit of cash flow, and that is to borrow against your home. What's your take on that, Matt? Well, the last data I saw said that refinancing is down 88% year over year. And that certainly makes sense because interest rates have risen. There are fewer homeowners that could benefit from just a traditional refinance of your house. But this can take other forms as well. A second mortgage, as you would call it, a home equity loan. You can get a home equity line of credit, which in those cases could make sense for a lot of people. Let's say you retire and you have a big chunk of credit card debt at 20% interest. By borrowing against your house at, say, a 7% or 8% interest rate, it doesn't make sense to refinance your entire property, but can certainly

make sense for refinancing your credit card debt. That's something to think about. You could save that difference in interest. That's essentially cash flow by taking 20% interest debt and making 7% interest debt out of it. There's also the opposite type of borrowing called a reverse mortgage, where you use your home equity to create cash flow. Instead of making monthly mortgage payments to a bank, a reverse mortgage, the bank makes monthly payments to you, and they're buying a piece of your home equity each time. Over time, there are ups and downs to reverse mortgages, so definitely do your homework before you get one. But it can be a great way, especially if you're not concerned about passing your house on to your heirs,

it can be a great way to create an extra stream of cash flow in retirement. Yeah. I mean, borrowing against your home has its risks, right? Because you're basically making your house as the collateral. And with the first few options, whether it's a cash-out refinance, a home equity loan, or HELOC, you have to be prepared to pay that back. Because if you don't, the bank can foreclose. They don't like to do it. They'll often work with you to come up with a better arrangement, but it can happen. Reverse mortgage is sort of different, right? You don't have to pay it back until you move or you sell the house. If the loan grew to be worth more than the house, you don't owe more than that. But you still have to pay taxes, pay insurance,

maintain the house. And that's happened to a lot of older folks. They're unable to do that. So then the company comes in and reclaims it. So what would you say to people who are like, I don't know if I want to do this. I don't know if I want my house as collateral for a loan. Well, I would say that you have to consider the pros and cons of the situation. your house is going to be collateral for a mortgage. There are alternatives to a mortgage, which in the current rising rate environment could be worth considering. It could be worth considering a personal loan because personal loan companies generally have 7% to 8% interest rates. Right now, that's what you're going to get on your mortgage. So, it's not like a year ago when

you could borrow against your house for 3% while the personal loan companies were offering 7% or 8%. Now, the playing field is a little more even. So, you can look at taking on a type of unsecured debt. You might want to take a look at something like that if you need to borrow money and aren't comfortable putting your house up for collateral. You probably won't be able to borrow as much, but there are other types of loans you might want to look into. Yeah, that's a great point. Let's get into our fourth strategy. That is basically, think of your home as one big fat emergency fund. Basically, you don't do anything about your home equity now. Basically, you leave it alone so that it can grow over the years. But then, you downsize or borrow in the future,

regular mortgage, reverse mortgage, if absolutely necessary. Often, this might be because your portfolio has plummeted so much that you just need some bridge until your portfolio recovers, or through some unexpected large expense like long-term care. Many people make reverse mortgages part of their long-term care plan. So, leave it alone, build it up. If you need it, it's there. If you don't, you can leave it to your heirs, and that leaves a bigger legacy to them, because often what will happen when someone passes away, the kids think they're going to get the house outright, but then they found out there was some kind of loan or reverse mortgage that they didn't get what they expected. Matt, what are your thoughts on just leaving your home equity alone?

Well, that's kind of my thought right now. I have no desire to tap into my home equity right now. I can't tell you what my financial situation or interest rates or anything are going to be when I retire, because that's a little ways away. But I mean, that's kind of how I view my rental property investments as kind of my big emergency fund. Because with rental properties, you're generally required to put down 20% or more. So you start out with a lot of equity. Then over the past few years, it's just gone up a little bit more. I have substantial equity in my rental properties. And I definitely view it as a big emergency fund. All right, let's close out here, Matt, with us just talking a little bit on how we plan to factor our home equity into our personal

plans. And you touched on yours a little bit already. And I'm definitely going that strategy number four, the big fat emergency fund. My wife and I love our home. I could certainly see us spending the rest of our lives here. And in terms of long-term care, that's sort of in the back of my mind, that if one of us needs it, it's there to be used. If I use a retirement calculator, for example, as I often do, I don't include my home equity. I just think that it is this big emergency fund sitting there, but I don't factor it into a way that's going to pay my retirement expenses by the time I retire. What are you going to do? I mentioned that I treat my rental properties as my big emergency fund. With my primary home,

I definitely think we're going to go the relocate route eventually. Right now, I'm talking to you from a third-floor loft. I don't picture myself doing that when I'm 70, coming up to the third floor to use my computer. We have a relatively large house. Like I said, we have three floors. We have kids. We have relatives nearby. We always have people staying with us. We have a pretty large house right now, and I don't think we're going to need that when it's just my wife and I in the house. So I definitely could see us going the downsize route as part of how we use our home equity in retirement. And do you actually factor it into like a retirement analysis or you just think it's too far off in the future? I'm not going to even worry about it. But at that point,

it probably will become some sort of a resource for retirement. Yeah, it's kind of like you said with treating your house as an emergency fund where you pretend it doesn't even exist as part of your net worth. And when we need it, hopefully it'll be there. Got it. Well, Matt, thanks for joining us and sharing both your knowledge and your experience. Thanks for having me. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell based solely on what you hear. I'm Deidre Willard. Thanks for listening! We'll see you tomorrow.

Thank you.