Ryan Morris spent a week steeling himself for the showdown. Then 27 years old, he was in his first campaign as an activist investor, trying to wrest control of a small company named InfuSystem (INFU), which provides and services pumps used in chemotherapy. In the meeting, Morris would confront InfuSystem’s chairman and vice chairman, two men in their 40s, and tell them that as a shareholder, he thought the company was heading in the wrong direction.
Morris is competitive—his high school rowing teammates nicknamed him “Cyborg,” and he took a semester off college to race as a semi-pro cyclist—but face-to-face confrontation wasn’t something he relished. “I like the thrill of the hunt, but not the kill,” he says. To prepare, Morris outlined questions, guessed potential responses, and tried to anticipate what tense “pregnant moments” could arrive. He built his clout by lining up support from InfuSystem’s largest shareholder as well as a veteran activist investor. Morris knew his own looks—he resembles a sandy-haired Mitt Romney—could help mask his youth, and decided he’d wear a tie, much as he hates to.
The company, with just $ 47 million in revenue, was spending too much money, and in the wrong places. In the previous year, InfuSystem’s board and CEO earned more than $ 11 million combined. This was for a company whose stock had lost 40 percent of its value over the previous three years. Morris figured that as a shareholder voice on the board, he could help cut expenses—including the high pay—and, once it was clean enough to sell, reap a return for his own small hedge fund.
On Dec. 13, 2011, he finally sat at a conference table across from the two directors. After 45 minutes of discussion, he still didn’t think his concerns were being acknowledged. So he got to the point: He wanted three board seats.
When an activist investor like Carl Icahn tries to take over a household brand, it plays out on CNBC. Most shareholder struggles occur when little-known investment funds try to take over little-known companies like InfuSystem. Of the more than two dozen activist battles in 2012, most involved companies with a market value under $ 50 million. In the smallest face-off this year, Georgetown Law student Daniel Rudewicz, 29, tried and failed to gain control of a $ 2.2 million company that makes microwave filters.
Many of the fights are being waged by a younger generation of activists, according to Ron Berenblat, Morris’s attorney at Olshan Frome Wolosky. Among the firm’s clients is a 24-year-old about to start his first activist campaign, trying to take over a technology company. Morris’s experience, says Berenblat, puts him “on the new forefront of 30-and-younger activist investors who are intelligent, patient, and highly methodical.” After the financial crisis exhausted even the most seasoned investors, young activists like Morris are bringing new energy to the hunt, shining light into dark corners of the market that are often overlooked.
Growing up in Toronto, Morris dreamed of becoming a nuclear physicist, obsessed with the idea that nuclear fusion could create infinite, clean energy—that was, until his father let him in on some bad news. “Even if you become the best scientist in the world, you will not make fusion happen,” Ryan recalls him warning. “If you want to make something happen, you need to be in charge of capital. It’s the resource allocation that gets things done.”
Morris started reading Warren Buffett’s Berkshire Hathaway (BRK/A) shareholder letters. To the 12-year-old Morris, it seemed so easy: With hard work and a clear mind, an independent thinker could spot an undervalued company, buy it cheap, and hold on until other investors recognize the company’s true worth. “Something where you can do well while being a loner was kind of appealing,” he says.
Using money from a summer job laying lawn sprinklers, Morris soon bought his first stock, a company that made fuel cells. He kept investing when he moved to upstate New York to study operations research at Cornell University and later as he extended his undergraduate degree into a master’s in engineering. Alongside classes and cycling, Morris worked with fellow student Paul George to found a profitable company called VideoNote that made it easy for Cornell to stream lectures online. As graduation loomed, Morris decided he didn’t want to take a job on Wall Street, where he could earn millions in the algorithm-driven world of quantitative finance. The financial models that drive the market’s split-second trades were “dumb” in Morris’s eyes, George says. “His whole position is take long-term positions on companies and don’t try to trade on noise. You can’t predict anything.”
He still wanted to be an investor, though. In the fall of 2008, with the stock market in freefall, and lots of companies at historic lows, Morris saw an opportunity. By early 2009 he was talking with George about managing his money, with a compelling pitch: “He said, ‘Cast aside your emotions. … People are overreacting, so I can come in and be rational,’ ” George recalls. George handed over some of their payout from VideoNote and a small inheritance, becoming Morris’s first investor. With their combined $ 50,000, Morris opened his fund on Feb. 24, 2009, naming it Meson Capital Partners after a subatomic particle. His timing was perfect: The stock market bottomed in March and has more than doubled since.
Over the coming months, Morris sent some close friends and professors a 10-page letter detailing his value approach, which embodied Buffett’s idea of investing in companies that have strong business prospects and are not simply hot stocks. A few gave him money, and a single question Morris asked of Berkshire Hathaway Vice Chairman Charlie Munger at Wesco Financial’s annual meeting helped him pull in more. He asked whether it’s harder to pursue a “buy and hold” strategy when businesses seem to evolve faster and faster. Ben Claremon, a blogger who circulated a transcript of the meeting, noted next to Morris’s name: “Watch out for this guy: Some very smart people think he is going to be a star fund manager.”
Morris didn’t start out as an activist. At first he looked for sound companies that had been swept up in the market panic and noticed that some small aircraft leasing companies had taken a beating. “If you think of a headline for an investment that involves ‘airlines’ and ‘finance’ you can imagine there was not much competition in buying these stocks,” Morris would write to investors. He invested about 40 percent of his fund in three companies and the stocks soared. By the end of the year, Morris’s fund had gained 753 percent before fees—17 times the return of the Standard & Poor’s 500-stock index. In his first annual letter, he told his investors this was “embarrassingly far off our target” of beating the S&P by 10 percent annually over three to five years. “This was not a sustainable performance.”
The returns attracted great interest, some of which Morris calls “the wrong kind of attention.” One potential investor asked, “OK, I will get 50 percent a year, right?” Morris says he turned away several of these hot money types. His letters, which laid out his strategies, started making the rounds among well-known value investors and eventually landed in the hands of Whitney Tilson, founder of hedge fund T2 Partners. “There’s this young guy who looks off the beaten path for interesting, misplaced situations,” Tilson says. And those returns? “That catches anyone’s eye.” In 2010, Tilson and Zeke Ashton, founder of Centaur Capital Partners, became seed investors in Morris’s partnership, providing a bit of capital and a regular source of advice.
Morris’s second year didn’t match his first. In the words of his next annual letter, it was “marked by frustration and underperformance.” There were some bright spots when he “coat tailed” the work of other activist investors. One forced a bloated pharmaceutical company to sell itself, and another managed to wring some money for shareholders out of an industrial laser business reorganizing in bankruptcy. Reflecting on the year, Morris told his investors that the success of those activists made him optimistic about his own future, writing, “Hopefully, as we grow in the future, we can be the ones to save the day.”
“Why did he become an activist investor? Because he got screwed,” George says. In early 2011, Morris invested in a hearing aid provider called HearUSA, which he thought was undervalued after it signed a long-delayed deal with AARP. Then HearUSA’s largest supplier, Siemens (SI), forced the company to file for bankruptcy protection over a contract dispute. Morris says he was caught totally off guard—he’d seen no warning signs in the hundreds of pages of filings he’d read—and sold 80 percent of his shares at a loss.
After reading more documents from the case, Morris decided that HearUSA’s business was sound and that Siemens acted because it was at odds with the company’s management. As HearUSA’s stock fell in the wake of the bankruptcy filing, Morris began buying shares, paying on average a third of what he paid for his original stake. He then joined other investors in persuading the bankruptcy trustee to establish an equity committee to represent shareholders. Morris and the rest of the committee helped negotiate a deal for Siemens to buy HearUSA, avoiding liquidation and doubling Meson’s total investment.
As that foray ended, a HearUSA shareholder tipped Morris off to InfuSystem. The company had a steady, recurring revenue stream. After all, “cancer treatment services are totally economically insensitive,” says Morris. “If Europe crashes, you still need this service.” But that cash flow was obscured by what Morris politely calls “nonessential costs.” In 2010 the board awarded $ 7.2 million in salary, stock, and other compensation to Chairman and Chief Executive Officer Sean McDevitt, gave $ 1.3 million to Vice Chairman Pat LaVecchia, and awarded at least $ 400,000 to almost every other member of the board, according to Securities and Exchange Commission filings. It let the stock awards vest immediately and had InfuSystem pay the personal income taxes they triggered. That meant InfuSystem’s board earned six times the median compensation for other micro-cap companies, according to data from the National Association of Corporate Directors. Reading the filings, Morris questioned how the board, which included pharmaceutical executives and an astronaut, could approve the largess. “These don’t seem like bad people,” he thought. (Members of the board did not respond to requests for comment for this article.)
Fresh off his experience with HearUSA, Morris thought if he could get a voice on the board, he could help investors. He says he called the largest shareholders and learned they were irked too. That’s when Morris began laying the groundwork for battle. He bought 2 percent of InfuSystem’s shares and persuaded Kleinheinz Capital Partners, the company’s largest shareholder, and veteran small-cap activist Chuck Gillman to join him in an official group of concerned shareholders. On Dec. 6, 2011, Morris filed a form called a Schedule 13D with the SEC, declaring the group controlled 11.4 percent of InfuSystem’s shares and intended to influence the board.
In the face-to-face meeting a week later, Morris says McDevitt and LaVecchia defended the stock awards, explaining that the board wanted to boost the company’s market capitalization so it could move from trading on over-the-counter exchanges to the NYSE Amex. Morris says that when he raised the prospect of joining the board, McDevitt’s face reddened as he sarcastically retorted, “Oh, we’d love to spend more time with you.”
Five days later, Morris learned the board rejected the shareholders’ request for three seats. He scoured InfuSystem’s bylaws and decided to demand a “special meeting,” which management must call within 75 days after a majority of all shareholders demand one. Morris was confident he could get the support he needed, and on Jan. 18, 2012, filed a preliminary proxy statement calling for the special meeting to replace the board.
This is about the time when many shareholder activists would start firing off nasty press releases attacking current management as corrupt or incompetent in an effort to rally shareholder support. Such battles can escalate quickly and end up in court. Morris says, “as much as I love lawyers, I don’t really love paying them.” Instead, he issued what he calls “gentlemanly” press releases that announced his SEC filings.
When Morris called shareholders, some said, “Thank God you’re here.” Others were skeptical. How did they know that Morris wouldn’t raid the company for himself? “I was like, ‘I’m 27. I would be ending my career right now if I was going to do that,’ ” he recalls. By March 5, Morris’s group had more than the 50 percent support needed. The InfuSystem board now had until May 7 to call the special meeting.
McDevitt and the board began negotiating. In the final deal, McDevitt, LaVecchia, and all but two of the board members were out. “I fired an astronaut,” Morris says now with a slight smile. McDevitt waived the 2 million shares he was entitled to under his employment contract and instead took a $ 1 million payout. “If we had had nasty press releases, there’s no way we would have settled that severance thing,” Morris says. InfuSystem would get a new CEO and seven new board members, with Morris as the chairman, one of the youngest on the NYSE. “I am two months younger than Zuckerberg,” he says. “But he’s about a zillion dollars richer.”
On a November afternoon in Manhattan, Morris sat at a desk stacked with moving boxes and explained that he was closing InfuSystem’s New York office. InfuSystem had leased the office for McDevitt and a team of financial analysts to use as they looked for other biotech firms to buy. “They had these investment bankers to make acquisitions, but we don’t have capital to do acquisitions,” Morris says.
After the takeover, Morris and the board laid off the New York staff and sublet the midtown office space, saving InfuSystem about $ 1 million a year, Morris estimates. When he visits New York, Morris crashes on George’s couch rather than charge the company for a hotel. These cost-cutting moves helped InfuSystem post its first quarterly profit since 2010 in November. Yet Morris has more work to do—shares are still down since he bought them.
Morris now spends about a third of his time on InfuSystem and the rest on other investments. Knowing he’s not likely to see another market like 2009, he views activism as a way to get a persistent advantage in normal times. “I think now he is struggling to say, How do I apply this? What will allow me to be my own catalyst and allow me to find another edge?” says Ashton. “Not in terms of size of return, but where I have an edge that is somewhat durable.” Chris Cernich, executive director for proxy contest research at Institutional Shareholder Services, has found that companies with an activist investor on the board typically outperform their peer groups by 16.6 percentage points. But activism, with its patience and strategizing and expense, isn’t for most people, and the battles don’t always end well.
In August, Morris saw a different activism project fall apart. He’d tried to take over Pinnacle Airlines, a regional carrier, which later fell into bankruptcy. After a judge denied Morris’s requests for more shareholder input, Morris decided it wasn’t worth appealing the ruling. “Investing isn’t a crusade, it’s about making money,” he says. Pinnacle became the 28-year-old’s biggest loss to date.
Around the same time, a friend who runs another small hedge fund tipped Morris off to Lucas Energy (LEI), a small energy producer with rights to drill on oil-rich properties but not enough capital to get the crude out of the ground. It also had a CEO and co-founder who was “not a great communicator,” Morris says. “I’m being polite here.” After acquiring 11 percent of the company’s shares, Morris flew to Texas to meet the CEO and chairman. He headed back the next day with an invitation to have two seats on the board, with no strings attached. Within three weeks, he and the rest of the board brought on a new CFO, and in December they replaced the CEO.
Morris says he’s getting used to the ups and downs that are part of long-term investing. He works out of a two-bedroom apartment in San Francisco he shares with his “really supportive fiancé,” a blonde Belarussian he met at a coffee shop in Santa Monica. “So that keeps me sane,” he says. Plus: “My investors are very patient with me. I’m very grateful.” Morris now has 33 investors and about $ 15 million under management.
His long-term plan is to “cut my teeth with these small ones that I fix up and sell, and then you can start doing more interesting strategic stuff once you get bigger.” Eventually, he wants to merge companies, change operations, and make the big plays. But to get there, Morris needs more money, and more experience sitting across the table from executives and demanding a seat on a board. It may require a new tie.
Businessweek.com — Top News
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