D.E. Shaw, the $50 billion hedge fund that in recent years has engaged in shareholder activism along with its many other disciplines, released a voluminous report on Tuesday outlining all the ways it says Emerson Electric has failed shareholders over the last decade.
The report, obtained by CNBC ahead of its release, starts a campaign to bring significant change to the industrial giant, including asking it to split its industrial automation business from its climate technology business. D.E. Shaw also calls for a significant effort to cut costs.
The report, which also confirms that D.E. Shaw has a more than 1% position in Emerson Electric, is the funds first public utterance since the reports of its potential activism first surfaced.
Emerson's stock price, which has already responded to stories of D.E. Shaw's potential activism, was up slightly Tuesday.
The report offers a searing indictment of Emerson's long time chief executive officer David Farr and of its board of directors, who have presided over a significant shortfall in total shareholder return over the last three, five and 10 years when measured against Emerson's peers in the automation or HVAC industries not to mention a 10-year lag of 120% vs. the S&P 500.
D.E. Shaw focuses on what it says is a history of poor capital allocation by the company since Farr took over as CEO. Since 2000, Emerson has spent nearly $14 billion of capital when accounting for mergers and acquisitions and capital expenditures but has only increased its earnings by $400 million over that period when accounting for its capex. The resulting 3% pretax return on incremental capital severely lags almost every one of its peers, which post an average return of 11.4% during the same period. One culprit for those poor returns on capital, D.E. Shaw maintains, is a cost structure that includes the highest level of selling, general and administrative expenses relative to sales among its peers and the lowest revenue per employee versus those competitors and a broader universe of industrial companies.
The report cites Emerson's 18 different facilities in the city of Houston as one example of areas that could be used to reduce costs. Another is the company's aviation department, which includes eight airplanes, one helicopter and a staff of 40 people complete with its own internship program.
CEO Farr has long been lauded as a consummate industrialist, and his retail shareholder base has stood by him given a dividend that has increased every year of his term. D.E. Shaw claims he has been overcompensated for that track record with pay of $150 million over the last 10 years, 50% more than the S&P 500 average despite shareholder returns that have lagged the index significantly.
They also note that Farr has been compensated over $300,000 annually in perks related to his personal use of the company's jets which is five times more than the average for Emerson's peers.
Emerson shares added 1% on Tuesday.
"We will carefully evaluate D.E. Shaw's proposals as we continue to assess value-creation opportunities," Emerson's lead independent board director said in a statement in response to the D.E. Shaw report.
The fund wants Emerson to change its metrics for long-term incentive compensation, which are solely focused on earnings per share and free cash flow growth to include indicators such as return on invested capital and total shareholder return. Such metrics are used widely by its peers. The fund also asks that Emerson unstagger its board so that all directors come up for a vote every year. It also notes that the board, apart from Farr, owns only 0.04% of the company's stock with only three open-market purchases by board members over the last 10 years. Four board members are currently up for election, including Farr. The window for filing a proxy closes Nov. 6.
None of these arguments means D.E. Shaw will get what it wants. It is a relative newcomer to activism, owns an only 1% stake and while it may say it's ready to endure a proxy fight for board seats, it remains unclear it will do so. Also, the track record for creating value from company splits is far from clear. Consider Dupont, where after years of activism Trian Fund Management and Third Point Capital, it got a split that has yet to create value. On Oct. 1, soon after reports of D.E. Shaw's interest were reported in Emerson, the company said it began a review of the company's operational, capital allocation and portfolio issues.