How activism unlocked a 44% return for investors in this little-known stock

Last year, L1 Capital invested in a little-known fuel retailer out of New Zealand. At the time, the team thought the company was undervalued and boasted high-quality assets that the market didn't fully appreciate... yet. 

It owned 9% of Z Energy across two of L1's three equity funds, and after a constructive meeting with the stock's management team and board, this fuel retailer decided to hold an investor day which would, hopefully, boost the stock's share price. 

Shortly thereafter, Ampol (ASX: ALD) bid for the company. And within nine months of holding the stock, L1 and its investors were rewarded with a 44% return on their holding. 

But not all of the L1 Catalyst Fund's portfolio companies have reacted so positively to portfolio manager James Hawkins' recommendations. So in this Expert Insights video, Hawkins shares the good, bad and ugly of his first year running one of only a small number of activist funds in Australia.  

Plus, he also looks forward, explaining why M&A has slowed but not stopped, as well as why investors should expect plenty of take privates ahead – despite the difficult macro environment which we all face.

Note: This interview took place Monday 1st August 2022. You can watch the video or read an edited transcript below.

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Edited Transcript

The fund has been in operation for 13 months now. What have the key learnings been so far? 

James Hawkins: The first learning is the fact that we are often very warmly received with respect to our ideas because effectively a company's management and board are getting corporate finance advice for free. We've got alignment because we are long only; we do not short any of the stocks in our fund. So that alignment and the fact that we can actually bring ideas and a perspective of how investors look and think about stocks and importantly, how we as L1 Capital will react if the company does particular initiatives, has been a real differentiator. 

Secondly, that alignment is something that I think can create generous idea sharing, which I think will benefit both a company's management and board, our own fund, and other shareholders. 

Can you take us through some examples of your activism within the portfolio companies? 

We will sit down with management and explain our thesis to them and what we are trying to do in order to unlock value. When we sit down with management, we've typically done three months of work, not three days or three weeks of work. 

For example, we had a constructive dialogue with Ramsay Health Care (ASX: RHC) management to explain to them how we thought there was a significant value unlock opportunity through a sale and leaseback transaction, or a synthetic type of transaction, that's unlocking circa $10 billion of Australian property assets at a point in time when the risk-free rate was at all time low levels. 

So when we sit down with management and articulate our views we've done the work. They know that - they know we are coming with an independent mindset, and they know the fact that we are long-only investors and have alignment. We are only seeking to achieve growth in the share price, and that will be for the betterment of all shareholders.

What happens when a company disagrees with your recommendations? 

Not every company management team or board is going to listen and agree with our approach. I won't mention a company by name, but there has been a company that's been looking at doing M&A that we recommended they not do. 

We think they ultimately will consider doing that M&A, and we don't think that's the right thing to be doing at this point in the cycle strategically. And given the actual likely price that they'll need to pay for that acquisition, we don't think that's the right thing that they should do. 

Ultimately, as shareholders, we have chosen to exit that stock, because we have articulated our view, and the management and board are probably going to go down a different path. And that's within their rights to do so. So it's therefore been our investment decision to exit that stock and rotate into another opportunity. 

What's an example of a company that has made positive changes on the back of your recommendations, where that has flowed through to strong share price performance? 

So a company that I'll refer to as an example is Z Energy. Z Energy is a New Zealand fuel retailer. They're a company of scale, but not great size, circa a market cap of $1.6 billion. We invested in them mid-last year on the basis that we thought they were undervalued. We thought they had a high-quality irreplaceable set of assets. And we thought there were a number of catalysts that the market didn't fully appreciate that could be utilised to enact and accelerate value unlock for Z Energy shareholders.

We were a shareholder of scale. We owned 9% of the company across the L1 family of funds. We had a very constructive engagement with both Z Energy's management and board, whereby we articulated to them some of the attributes, which we didn't think the market was fully appreciating. We thought if they did so, through an investor day, the market would better appreciate and value their stock more highly. Things like they weren't going to have the same earnings volatility going forward that they had had historically, because they would no longer have exposure to an oil refinery.

We also thought the market wasn't fully appreciating their suite of property assets and that their infrastructure could be de-merged through a REIT. We actually thought Z Energy could gear up a little bit more than their current leverage on their balance sheet and utilise that higher leverage to buy back shares at undervalued prices. We had a very constructive engagement with both management and the board and articulated it to them, how we thought they could share these attributes with the market.

Subsequent to the discussion, they did a really good job in holding an investor day late last year, where they actually articulated to the market the overall investment proposition in Z Energy. The market listened to that presentation and then the shares started to trade up following that investor day. And then shortly thereafter, Ampol (ASX: ALD) bid for the company. When we invested in Z Energy, our average entry price was $2.62 and Ampol's purchase price was $3.78. 

When you last spoke with Livewire in October 2021, you said we were entering the first real M&A cycle since before the GFC. Is this still the case?

Calendar 2021 was a record year for M&A, so we’re coming off a very high base, but the increase in interest rates, and the geopolitical concerns because of the Russia/Ukraine conflict are creating uncertainty in boardrooms. Boardrooms do not like uncertainty. They need confidence, both in respect of what the macroeconomic outlook going forward may look like, as well as they need confidence as to how to value companies, through to what is an appropriate risk-free rate, for example, going forward. So there's a much higher degree of uncertainty now than there was in the latter half of calendar 2021.

However, there's one thing that the M&A market's got on its side, and that is the significant quantum of private capital.

So in my view, the M&A cycle will slow down and has slowed down significantly. However, the quantum of private capital from private equity funds, infrastructure funds, superannuation funds, and pension funds in combination, will provide some nice support to M&A going forward.

What should investors expect?

So I think some take privates are likely. Australia's industry super funds are of significant scale. Ramsay Health Care as a $28 billion enterprise value transaction would not have been deemed possible two or three years ago because of its scale. Whereas now that's possible because the industry's super funds are of such scale.

It wasn't that long ago that Australian Super was a $150 billion fund. It's now a $250 billion fund. So I think, yes, particularly when valuations are more compressed than they were 12 months ago, there's more likelihood of more public to private transactions.

L1 Capital: Investment Excellence