Tuesday, October 28, 2008

Activist Spotlight: Wynnefield Small Cap Value Fund

This post was contributed by Ted Wallace, an analyst with the proxy solicitation firm The Altman Group. We're pleased to have Ted contribute to our blog and look forward to additional posts from him in the future.

Will the current market conditions lead to an increase in hedge fund activism? Wynnefield Partners Small Cap Value LP is one firm that has recently increased its communications with management teams as a means of protecting its investments. Below are the four situations in which Wynnefield has chosen to take a pro-active stance with management in recent months. In three of these, Wynnefield converted a 13G (5% or greater, passive investment) filing to a 13D filing (5% or greater, may seek to influence management).

Four activist situations for a single fund at one time, while not unusual, is rare. Four activist situations in three months on the part of Wynnefield Partners Small Cap Value LP is unheard of.

Nobel Learning Communities, Inc. (NLCI)
Wynnefield converted its 12.5% interest from a 13G filing to a 13D in July with the intent of persuading NLCI to enact a poison pill with a 30% trigger. Since then, Wynnefield has amended this 13D in September and October with letters to the Board, urging it to consider the acquisition offer made by Knowledge Learning Corp.

NLCI has a $130.29M market cap and is 19% institutionally held. It represents 7.4% of Wynnefield’s portfolio. Wynnefield holds 12.8% of NLCI as of its October 23rd 13D/A.
NLCI Filings

Liquidmetal Technologies, Inc. (LQMT)
Wynnefield converted its 8.34% interest from a 13G filing to a 13D in August, stating that LQMT had defaulted on its Subordinated Convertible Notes by not amortizing them ab initio. Wynnefield also stated its intent to seek a more active role in the company, “in order to protect their position and the position of other shareholders and creditors.”

Since then, Wynnefield has formally rejected LQMT’s settlement terms with respect to the Notes, and in October sent a letter to the company demanding the formation of a special committee of independent board members to evaluate the capital situation of LQMT. In the letter, Wynnefield also demanded that one of its nominees be appointed to LQMT’s board.

LQMT has a $4.92M market cap and is 2% institutionally held. It represents 0.07% of Wynnefield’s portfolio. Wynnefield holds 8.34% of LQMT as of its October 10th 13D/A (this includes the Convertible Notes and Warrants).
LQMT Filings

White Electronic Designs Corp. (WEDC)
Wynnefield converted its 5.7% interest from a 13G filing to a 13D in September, when it sent a letter to WEDC’s board in support of the request of Brian Kahn(of Kahn Capital Management LLC) to be appointed to the seat left vacant by Hamid R. Shokrgozar’s recent resignation.

Since then, Wynnefield has filed three amendments to its 13D, continuing its support of Kahn’s appointment and demanding that WEDC keep its shareholders informed of the findings of the Strategic Committee. Wynnefield has also urged the company not to waste time and money in a search for a new CEO until the Strategic Committee’s recommendations have been publicly presented.

WEDC has a $83.33M market cap and is 45% institutionally held. It represents 1.88% of Wynnefield’s portfolio. Wynnefield holds 5.8% of WEDC as of its October 20th 13D/A.
WEDC Filings

Unigene Laboratories, Inc. (UGNE)
Wynnefield amended its January 13D filing (5.4%) in September, with a letter stating its intent “to influence the Issuer’s Board and its management to take certain actions designed to enhance shareholder value.” The letter set forth a grievance list and a demand that UGNE reduce the size of the board from 9 members to 7, including 2 of Wynnefield’s nominees.

UGNE has a $55.17M market cap and is 2% institutionally held. It represents 1.49% of Wynnefield’s portfolio. Wynnefield holds 5.4% of UGNE as of its September 4th 13D/A.
UGNE Filings

Past Activism
Wynnefield and Breeze-Eastern Corp. (BZC) settled for board seats in July 2008.

Wynnefield and Crown Crafts, Inc. (CRWS) settled for board seats in June of 2008.

After pressure from Wynnefield, H. Thomas Winn resigned from the position of Chairman of the Board of Nevada Gold & Casinos, Inc. (UWN) in June of 2007 (he did not resign from the Board itself). This was also a situation in which Wynnefield converted from a 13G to a 13D; Wynnefield still holds 13% of the company.

From the Wynnefield Website:

“Wynnefield maintains a pro-active posture with respect to its portfolio names when it believes management is not taking appropriate measures to surface shareholder value, where corporate governance issues exist, or where outside assistance can be provided to a management working to implement value creating strategies. In numerous cases, we are Schedule 13-D and Form 4 filers. Wynnefield does not generally seek out Board representation. However, one of our members will, in rare circumstances where the size of the position and potential return warrants a higher level of resource commitment, accept a board of director's seat. We are not litigious and do not accept greenmail, operating only for the entire class of holders of which we are part”

In a very broad sense, activist hedge funds can be placed into two categories: corporate-raider and management-friendly. The former seeks a return on the fund investment by being the catalyst for a situation that drives stock prices up (and then getting out of the stock). The latter seeks to increase the value of its investment from the inside-out – by working with management to increase the productivity of a company or get the best price for shareholders if a sale of the company is warranted. Categorizing such situations is tricky: the categories themselves are fungible and it is possible for a fund to start out as one and become the other. At bottom, these descriptions end up being more indicative of situational strategies than of the funds themselves. They are the good cop/bad cop masks the funds wear to achieve the desired reaction from management.

Which type of investor in each of the above situations is Wynnefield Partners Small Cap Value LP?

Wynnefield’s general modus operandi has been to convert its 13G filing to a 13D – to switch from a passive investor to an active one. Wynnefield’s investments in the above four companies range from 0.7% to 7.4% of its portfolio – there are 34 companies within this range that have not received this level of communication from Wynnefield. It has a total of 61 stocks in its portfolio.

Under the current market conditions, can we expect more hedge fund activism, and if so, which type of activist strategy is more likely to succeed?

In the future, I think we can expect an increase in hedge fund activism from both categories. Many, many companies reached a 52-week low in the past couple of months, and nothing justifies pointing the finger at management as well as low stock prices. I think we will see plenty of action from the corporate raider types – demanding board representation and overhaul, calling for companies to be sold, etc. I think we will also see plenty of activism from investors who see value in a company and will roll up their sleeves and get in the trenches to help management get through these tough times.

All aggregate equity interest data from FactSet or Yahoo! Finance.

This entry was posted by Ted Wallace from The Altman Group.