Former T. Boone Pickens protégés David H. Batchelder and Ralph V. Whitworth co-founded San Diego-based Relational Investors in 1996, and their privately owned asset management firm now serves some of the largest pension funds in the world. Whitworth, a lawyer who was president of the Washington D.C.-based United Shareholders Association before joining Batchelder in San Diego, is also viewed as a prominent authority on corporate governance. He has combined that expertise with Relational’s clout as a major investor to improve the operations of poorly performing and undervalued companies—and to encourage boardroom reforms.
As an example, Whitworth was sharply critical of Robert Nardelli’s compensation package as CEO of Home Depot, and in 2006 Relational launched a campaign questioning Nardelli’s leadership. After Nardelli orchestrated an imperious shareholder meeting, Relational called for Nardelli’s ouster—and the CEO was dismissed in January 2007 (with an estimated $210 million severance package).
Whitworth and Relational instigated similar changes at Sprint Nextel, Mattel, and J.C. Penney. In late 2008, he and his firm (which currently manages a total of $6.5 billion) set their collective sights on turning around Genzyme, eventually acquiring a 4 percent stake in the ailing Cambridge, MA-based biotech. Earlier this month, Relational demonstrated its willingness to work with Genzyme’s management by calling a cease-fire in the form of a “mutual cooperation agreement.”
Whitworth agreed to answer some Genzyme-related questions when I caught up with him this week.
Xconomy: Why Genzyme? Can you describe the criteria or the general process that Relational uses when it decides to take a stake in a company?
Ralph Whitworth: We look for companies that are trading at discounts to their intrinsic value—despite the fact that they have low financial leverage, strong defensible core businesses, and growing cash flows. Invariably this discount exists because investors do not expect management to effectively reinvest the projected profits. This negative expectation is typically caused by a poor history of investment outside of the core franchise and/or from chasing growth within the core franchise in the face of maturing industry conditions.
X: Does Relational prepare a playbook for change before it begins to acquire shares? As Relational accumulates shares, is there a threshold for contacting the company to recommend operational or management changes?
RW: Yes, we map out an engagement program prior to making our initial investment. We try to gauge the likelihood of change and potential upside. Typically before we meet with management, we’ll buy some sort of toe-hold in the company. Before presenting recommendations for change we typically invest from 15 to 25 percent of our targeted long-term investment level. For example, if we had planned to invest $400 million over a number of years, we’d initially invest $60 million to $100 million before continuing forward. That’s just an example. We step into an investment over time as a risk-management tool.
X: Are there any other technology or life sciences technology companies that you believe are trading at a discount to their intrinsic value?
RW: I’m sure there are others. But we’re not invested in them.
X: What are your goals for Genzyme? And does Genzyme management share your goals?
RW: We want Genzyme to:
1. Improve their strategic direction to focus more on growing their portfolio of genetic disease cures through internal R&D and selected acquisitions, while rationalizing their existing non-genetic disease portfolio—they have yet to articulate a clear strategic direction consistent with this recommendation. To be fair, however, they are preoccupied with addressing their manufacturing problems and that’s where we want them to stay focused for the time being.
2. Improve their risk management and operational controls to make their manufacturing processes more robust, safe and durable. They are implementing significant operational and managerial changes in these areas.
3. Improve their capital allocation disciplines and processes to ensure that discretionary spending is focused on the highest and best use. The company appears to have made marginal progress in this area, though further monitoring is required to make an fair assessment.
4. Improve executive compensation to put a higher percentage of pay at risk and to incorporate return metrics into their incentive formulas. We believe they are working on these improvements and will announce them with this year’s annual compensation committee report to shareholders, which will be included in their proxy statement for their annual shareholder’s meeting.
5. Improve their board composition to add more members with financial expertise. They have begun to do this with last month’s addition of Bob Bertolini (who was chief financial officer at Schering-Plough before it was acquired by Merck last fall).
6. Improve communications with investors. This involves sharpening the entire spectrum of communications from their quarterly investor calls, press releases, regulatory filings and other forms of communications. We have seen improvement in this area over the past few months, though significant further improvement is warranted.
Related to this, last year we asked them to improve their financial disclosure to incorporate return metrics and reform their computation of key financial measures to industry best practices. They announced major reforms in these areas in May of 2009, to our satisfaction.
X: Is Genzyme CEO Henri Termeer the right guy at this moment? Or do you think the company needs someone new to lead Genzyme?
RW: We think the current management team is perfectly capable of taking the company into the future. They’ve made some poor decisions in the past. Looking forward, though, we think they’re focused today on the right things. Time will tell whether they can take it to the next level.
X: Was Relational’s mutual cooperation agreement with Genzyme a way to thwart a proxy battle with Carl Icahn, who has acquired a roughly 1 percent stake in Genzyme?
RW: That certainly wasn’t the intent of it from our perspective. It really was focused on improving the company’s performance. Our intent was to keep an appropriate amount of pressure on the management team, and it gives us the flexibility to step into more of an activist role if necessary.
X: Do you think Icahn could help Genzyme improve its business?
RW: We wouldn’t begrudge any shareholder their right to speak out on a company’s performance. [Icahn’s investment firms] certainly have their share of smart people with a great investment track record.
X: How did your interest and expertise in corporate governance evolve?
RW: As with any pursuit, our interest in corporate governance has become more nuanced and refined over the years. My interest began in 1982 when I took a class at Georgetown in corporate governance. [Whitworth holds a Juris Doctor degree from Georgetown University Law Center.] Since then I have been involved with the subject as a public policy advocate, a practitioner (as a member of nine public company boards and chairman of two), and as an investor seeking to reform governance at our portfolio companies.
X: How does your corporate governance background factor into your investment decisions at Relational?
RW: Corporate governance is a major factor in our investment decisions for two overarching reasons. First, we are convinced that corporate governance practices and policies, as well as those of executive compensation, materially impact the performance and, therefore, the value of corporations. Second, since each of our investments involve an engagement plan to influence change, we must understand how the particular governance features of our portfolio companies will impact our efforts. For example, our job is more challenging if a board and management are heavily insulated from influence and resistant to change.
X: Is there much difference in pushing for such changes at a biotechnology (or technology) oriented company like Genzyme, compared to a company like Home Depot or Sprint?
W: Not really. We are still addressing the same underlying human nature in terms of our persuasive efforts, and, broadly speaking, we are addressing the same issues and phenomena. Also, we understand our limitations. We are not there to do the science. We stick to the matters for which we have expertise: Strategic planning, executive incentives, corporate governance, communications, and capital allocation.
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