Actively Watching Activist Filings

 | Oct 27, 2016 | 12:00 PM EDT
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Stock quotes in this article:

FRGI

,

cdi

Browsing the SEC website for corporate filings is pretty much a daily activity. I sift through 13D and 13G reports every single day to see if there is any interesting buying and selling going on. Most days, I do not find anything that is all that interesting, but this week I turned up three activist situations that look like they have the potential to produce solid total returns.

My dislike of most chain restaurants is pretty well known, but there is one fast food chain that I actually like. Since the Pollo Tropical opened up in the area earlier this year, we have probably had take-out from there an average of once a week. The Caribbean take-out establishment is owned by Fiesta Group (FRGI) out of Addison, Texas. The company has about 150 Pollo Tropical locations, and also owns around 160 Taco Cabana locations in the U.S. and Central and South America.

FRGI was recently the subject of a 13D filing by a group of activist funds led by JCP Investment Management, which announced that it owned a total of 6.2% of the company. In their initial filing, the activists said they were buying the shares because they were undervalued and represented an attractive investment opportunity. They followed that filing up with another, in which the activist group revealed that they had sent a letter to the Board suggesting the company declassify the Board of Directors. The Board has responded by saying that entering into a settlement with the activists would be inappropriate at this time.

There is a lot of chatter about the company possibly putting itself up for sale, or spinning off the Taco Cabana franchise as a stand-alone company. The New York Post last week reported that the company was quietly putting itself up for sale -- and several private equity firms had expressed interest. The company produces very strong cash flows and has very little debt, so it should be an attractive target for a private equity firm. I won't be surprised to see a deal get done before the end of the year.

Any buyer should be aware that changing the recipe for the ribs or black beans and rice could lead to a sharp decline in revenue in at least one part of Florida.

CDI Corp. (CDI) first came to my attention when it showed up on one of my net current asset screens earlier this year. The stock still sells for right around net current asset value, and the price-to-book ratio is just 0.60, so the stock is cheap at this price. Apparently, I am not the only one who thinks so, as activist funds run by Brad Radoff and Josh Schechter filed a 13D announcing that they own 6% of the company. Last week, they filed a new 13D to announce  that they had purchased more shares of the staffing company -- and now own 7.2% of CDI.

In the initial filing, the activist expressed concerns about corporate governance at CDI, saying "Specifically, the Reporting Persons are concerned that a majority of the Board is over-tenured (five of eight directors have served on the Board at least since 2003), directors are significantly overcompensated relative to the Issuer's size and financial performance, and the continued relationship with Barton J. Winokur's law firm while he serves as a director creates inherent conflicts of interest in the boardroom." The activists want to see the board size reduced, director compensation decrease and all contact with Winokur and his law firm terminated.

This could be an interesting battle. Insiders won about 8.8% of the company, and a trust established for the benefit of the Chairman's children owns another 17% of the enterprise. However, institutions own about 50% of the company, and many of them may well be frustrated with the stock's long-term performance -- and may be willing to consider voting to shake up the board in hopes of a higher stock price.

CDI has a lot of exposure to the oil and gas industry and the U.K., both of which have been weak so far in 2016. Management has said that their plans to execute a successful turnaround are starting to work, but will take time to improve the bottom line -- and hopefully the stock price. The activists don't want to wait that long and will try to force the company to make changes that move the stock price higher sooner. I like the risk/reward here. I think I win as a shareholder, with only the timeframe really in question.

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