One of the most prominent activist investors of recent years, Carson Block, CEO and founder of Muddy Waters, shares his vision of activism, including some interesting perspectives on the Old Continent.
Leaders League. More than 650 activist campaigns were identified in 2016. How do you view the rise of activist funds in the recent years?
Carson Block. The appearance in Europe of short selling (like Muddy Waters) and long buying activists has common roots. My opinion is that Europe has weaker corporate governance than the US, which I believe is largely due to a culture of significant deference toward boards and managements in Europe. In other words, European investors are far more reluctant to question or challenge companies - it is almost a taboo. Therefore there are a lot of obvious targets in Europe for activists who seek to make companies more competitive and efficient through challenging business strategies and board/management compositions.
In the United States, you can easily notice that financial engineering with leverage and share buybacks or dividends has become the favorites theme of activists. This is what happens when companies are already operating their businesses as competitively as can be done. So activists in more mature activist markets often turn to financial engineering. To me, this approach is not healthy as it is often and rightly considered a short-termist approach, in contrast to increasing a company’s competitiveness. I therefore concur with the criticism regarding financial manipulation and stranglehold of debt. Because Europe is earlier in the cycle of activism, I think European companies, markets and economies can broadly benefit from listening to activist campaigns focused on corporate competitiveness.
Your point of view seems rather positive for Europe.
Low-hanging fruit with operations that can be made more are more efficient are relatively uncommon to find in the US. The European business sector is indeed dynamic. The more challenges addressed, the more managers and boards will come up with models opened up to criticism. We will probably eventually see springing activism become more financial engineering focused, as happened in the United States, although that also depends on where Europe is in the credit cycle when activism matures there.
I think that notwithstanding the often short-term nature of present day American activism, the American economy has overall benefited from activism. Europe has not yet reached the point where its companies are as competitive as they should be.
If I were to address European politicians, I would encourage them to be more obliging with activist investors at this stage of history.
Do you think that the Anglo-Saxon funds are more aggressive than their European counterparts?
(Laughs). I believe the answer must be subdivided. I think that we, Americans, are more confrontational than the British who are more confrontational than continental European investors. I personally think that confrontation is an important part of the political and corporate spheres. I firmly believe that the American approach, however noisy and sometimes unpleasant it may seem, leads to more efficient effects on the long-run in comparison with the political correct approach.
Activist managers are sometimes perceived as vultures, but their aim remains to enhance a company's value in the interest of both employees and shareholder. Do you see yourself more as an entrepreneur or as an investor?
I have a quite different approach from long-buyer activist investors since I come from the activist short-selling approach. I see my approach more as an entrepreneur. I have in the past been an entrepreneur in the real (non-financial) world, even though I did not always succeed. However, this experience taught me to respect what I consider "the rules of business," i.e. the laws of value creation. Observing that some people take shortcuts without respecting the principles of entrepreneurship has stirred up my desire to do what I do. Thus I criticize those companies whose management I feel violates these principles. I was shocked at times by some business practices I saw.
Can you tell us more about the expression "muddy waters makes it easy to catch fish."
This is a Chinese proverb I learned before starting this business. I was with local officials in Shanghai and I was complaining about what I call value subtraction layers that are seemingly present in every transaction in China. In many transactions in China, there are people interfering without adding any value, who I call parasites and economists call rent-seekers. And when I was alluding to these parasites, I thought that the government could set up gates to restrict this phenomenon but without finding the reason why it was not doing it. My guide answered that there was an old saying about muddy waters making it easy to catch fish. I at first did not really understand what it meant but he told me about how he grew up in during the Cultural Revolution and how he was sent to the countryside. Once he was there, he was hungry and went to a pond to fish. He tried to catch fishes by hand but they went away. Remembering the saying, he kicked up silt from the bottom of the pond to make the waters muddy, and then the fishes came up and he succeeded in catching them. What I took away from this story is that there is this belief in China that opacity leads to opportunity. It explains a lot of things in China. Many people indeed believe that keeping things hidden or complex provides different ways to earn money. This belief applies to many companies we follow outside China! Companies committing fraud with mere lies or through a distortion of reality with the use of financial engineering. It is commonly a legal fraud based on financial engineering. There are people wishing to do so with the aim of controlling a company’s shareholders for their own profit. The goal is to put the proverb into practice, and thus proving that people can actually earn money thanks to the market by creating blurry situations.
What do you think of the Mifid 2 regulation which is currently disrupting Europe?
I think the intention is a good one because this is the acknowledgement that broker research is a merely a highly priced dating service to introduce management to institutional investors, and otherwise doesn’t add any research value. Nevertheless, it could have unintended consequences. I do not know which ones, but I think there is a problem inherent to regulation, which is that although many agree on the issues, too many rules are implemented to solve them. This can eventually lead to much worse issue. I am closely looking at it.
What advice would you give to a young entrepreneur wishing to become an activist?
Being an entrepreneur is a really good experience if you want to become an investor. In fact, most of the people who make decisions and allocate capital have no experience in non-financial companies, which is almost insane. I often recommend to students who I speak with that if they want to be an investor, starting a real world business is great training.
Original article by Yacine Kadri