Cramer's tale of horror—activism ruined this stock

Sometimes, one of the few things that can get a stock roaring is when an activist investor decides to get involved with a company. But Jim Cramer says to watch out, because activism is not always a good thing.

Cramer shared the cautionary tale of Timken, which was wrecked by activists who simply didn't know what they were doing.

"It is important to remember that activism does not always lead to positive results. In fact, sometimes these activist investors turn out to be dead wrong and their meddling actually destroys value," the "Mad Money" host said.

Timken was a classic cyclic stock, a maker of high-performance and alloy steel as well as various mechanical components. In 2011, business began to slow due to the worldwide economic uncertainty of the time, and the stock started to trade sideways.

In late 2012, activists pounced on the company. Both Relational Investors and the California state teacher's retirement fund took Timken under siege. They wanted Timken to break itself up into two separate companies: one for highly engineered mechanical components and one that would be more of a commodity steel maker.

The TimkenSteel 3,300-ton in-line forge press at the Faircrest Steel Plant in Canton, Ohio.
The TimkenSteel 3,300-ton in-line forge press at the Faircrest Steel Plant in Canton, Ohio.

And while Timken's management was very much against the breakup, the activists persisted. The stock had been underperforming, and three of the 11 board seats were controlled by the Timken family. Activists at Relational Investors cried foul and implied that the family wasn't looking out for other shareholders.

The activists also claimed that Timken was undervalued versus its peers. At the time the stock was trading in the mid-$50s, and the activists suggested that it could be worth closer to $71 in the event of a breakup.

Management insisted that breaking up the company was a bad idea, positing that it would be very risky to separate the company. They said that more value could be created as a single entity, and that the combined company could hold up better in a global downturn.

Timken also argued that having a more diversified business model allowed the company's different divisions to support one another in times of weakness.

However, Timken's shareholders held a vote on Relational Investors' non-binding proposal to spin off the company's steel business, and the activists won the vote. Timken also hired Goldman Sachs to help with an evaluation to study whether the breakup would make sense, and Goldman sided with the activists.

Ultimately Timken's board of directors caved into the activists' demands and announced a spinoff of its steel business as a separate company.

What happened?

After an initial spike in both Timken and Timkensteel, both stocks were annihilated. Timkensteel suffered a horrendous 17 percent decline when the company slashed its guidance a week and a half ago.

Timken was trading at about $67 on its last day as a combined company. As of Thursday, Timken trades at $27 and Timkensteel was at $11. Cramer calculated a decline of approximately 51 percent.

"This breakup that Relational Investors insisted would create value has instead caused the value of Timken and Timkensteel to be cut in half," Cramer said.

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Basically, all of former CEO Jim Griffith's arguments for keeping the company together turned out to be true. Since the breakup, Timken's end markets have also fallen apart and the two smaller companies haven't been able to weather the storm. In particular, the steel market has fallen off of a cliff.

The worst part is that the activists from Relational Investors who pushed for the breakup didn't even stick around. They sold a large chunk of their Timken position in the second quarter of 2014, right before the breakup, and the rest in the third quarter into the spike after the spinoff.

"Just because activist investors get involved with a particular company, that does not necessarily mean they will create value," Cramer said.

Sometimes, the people running a company understand it much better than allegedly brilliant money managers.

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