CNBC Exclusive: Keith Meister, Tom Sandell and Jeffrey Smith Speak from CNBC Institutional Investor Delivering Alpha Conference

WHEN: WEDNESDAY, JULY 15TH

Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Keith Meister, Managing Partner and Chief Investment Officer, Corvex Management LP; Tom Sandell, Founder, Chairman and Chief Executive Officer, Sandell Asset Management; and Jeffrey Smith, Managing Member, Chief Executive Officer and Chief Investment Officer, Starboard Value LP live from the CNBC Institutional Investor Delivering Alpha conference in New York City on Wednesday, July 15th.

Mandatory credit: CNBC Institutional Investor Delivering Alpha conference.

>> Welcome, gentlemen. Come to the stage. And your conductors for this session will be seated right over here. The Wallace and Gromit of CNBC, Jim Cramer and David Faber.

Gentlemen, you're going to both introducing, calling the gentlemen to the podium, and then following up with some respondent questions. So welcome one and all.

>> Thank you.

>> Thank you, Tyler. And we'll just get right to it. Guys, you can feel free to use the podium, or if you're not comfortable doing that, feel free to stay seated.

I think, Jeff, we'll start with you. I know you have an idea that will be of interest to I think our audience. We can get started.

JEFFREY SMITH: Good morning, everyone. Thanks, David.

I'm looking for my slides. Okay. So today we're going to be talking about Macy's, an investment we have at starboard. It's not one we have previously disclosed, so this is a new idea.

So Macy's is a stock that currently trades about $66 a share. We think that it's worth in excess of $125 a share. Macy's on the surface appears to be fairly valued.

If you look at Macy's, you can see that it trades in line with its peers, you can see that its performance, its operating margins are in line with its peers, but that doesn't tell the whole story.

Macy's also owns this building at Herald Square that we think is worth $4 billion. They also own this building in Union Square in San Francisco, worth $1.5 billion. They also own State Street in Chicago, worth $1 billion. Then they own 400 mall properties, worth $13 billion.

When you put all that together, there's $29 billion of enterprise value at Macy's today, $21 billion of that enterprise value is made up of the real estate value.

We have used one of the leading real estate firms to help us value this real estate. Again, it's $21 billion of value out of the $29 billion in enterprise value for all of Macy's. That leaves $8 billion left for what would be the remaining operating business of Macy's, with -- after taking away the rent that would be associated with the real estate property, the EBITDA would go from $4 billion to $2.8 billion.

So again, if you just look at the operating business, X the real estate, you're talking about a company that's valued at $8 billion against $2.8 billion in EBITDA, less than three times EBITDA.

There's also more if you look at Macy's. They also have highly valuable credit card earnings. That's $776 million in profits. We believe these credit card earnings deserve a higher multiple than the regular business.

If you use an 11 times multiple for the credit card earnings, you would get about $8.5 billion in value for the credit card earnings.

If we do this waterfall again, starting with the $29 billion of value for all of Macy's today, less the $21 billion of real estate value, less the $8.5 billion in value for the credit card earnings, the Macy's operating business is actually free.

Again, subtracting out the remaining EBITDA that would go for rent and for the credit card business, you would then be talking about the operating business being for free. They would have $2 billion in EBITDA.

There's also an opportunity on the operating side, so $2 billion of EBITDA is not the best that they can do. If you compare Macy's on a like-to-like basis to Kohl's and Nordstroms and you rent adjust each of the businesses for their own real estate, what you would see is there's actually a 200 basis point operating opportunity at Macy's.

We believe that their operating margin can be improved by 200 basis points. This equates to over $500 million in additional potential EBITDA or another $10 a share.

When you put it all together, again, we think Macy's should be worth more than $125 a share. We believe there's an opportunity to create two leading companies, Macy's operating business, as well as the real estate company. We believe you can accomplish this goal while maintaining the dividends and actually making it safer and by maintaining the credit rating.

Thank you.

DAVID FABER: And thank you, Jeff. Well, we should point out the stock is already up about 4% after you started speaking, but you know, this is --

[LAUGHTER]

This is not a name unfamiliar to the hedge fund community. It's been bouncing around for a while. I have to admit to having had a number of conversations with some of your peers about this very idea, and so there's been an opportunity for the company and for others to at least weigh in. And I want to share some of those thoughts with you and get your responses.

Matt McGinley, an analyst at Evercore ISI, says, "By locking themself into long-term leases, they'd be stuck in B&C malls the next 20 years."

Executives of the company are quoted as having said, "They would rather spend the money on improving the underlying retail business, and there's a basic idea that it would burden them with significant lease expense that erode profitability and weaken finances."

The CFO, who's been on a call, at least talking about some of these ideas and saying, "It's far more complicated than what most people think, and some of the estimates of value in our real estate I think have been done over-simplistically."

Your response?

JEFFREY SMITH: There was a lot there, David. So as it relates to the mall quality, look, we understand that there are different properties that they have and there's not one answer for all of them. As it relates to our analysis, we are not assuming that they would lock themselves into long-term leases for B&C malls. We are actually only counting the high-end malls, the A malls, in our analysis, as well as the trophy properties.

So we would not be advocating for any company to be taking any store or any restaurant in the case of Darden that couldn't handle the rent burden and didn't have the visibility on its future operating metrics to put that into a long-term lease.

So we agree, but we still think there's enormous value and enormous opportunity to do this with the really good stores and then you can still continue to own the other stores.

>> In terms of the way you went about valuing the real estate, could you give us a bit more of a sense as to what your underlying assumptions are in terms of cap rate and the like? Because, again, given this has been out there in the investment community, there have been analysts who have weighed in this morning, I think.

There was a downgrade, but they said, well, we think the real estate's worth $32 a share, but you are willing -- above even that. Why?

JEFFREY SMITH: So we hired one of the leading real estate advisory firms, and they did a property-by-property analysis to come up with valuation. And we looked at standalone values, so highest and best use, but the numbers that we are using are actually only for an analysis where Macy's remains a 10, and even though in some -- in some instances you have higher values if you were to sell the property.

So we looked at the rent, the burden that each store could have, we looked at the cap rates for each property. Some of the trophy properties may be as low as 3% cap rates or 4% cap rates.

On average, we are looking at 6 to 6.5% cap rates to get to those numbers, which is something that, again, has been verified by the leading -- one of the leading third-party real estate groups.

>> All right. I just -- first, congratulations on what you did with Darden, which is really incredible; turned around an underperforming restaurant chain into one of the best there is.

One of the greatest investments I ever had for my personal career was I was able to sell a huge number of Macy's bonds when I was at Goldman Sachs, and take the money and put it into something better. Macy's did not have the cash flow to cover those bonds. It was one of the worst disasters in retail history.

Current Macy's, I think -- I know you can say, well, look, listen, we are using very conservative EBITDA standards, but the cash flow went down so dramatically in what was the number one retailer in the country at the time.

How can we be sure that this company, which has missed a quarter up to several times -- not unlike Darden, but has very inconsistent, I'd say, longer-term cash flow over time, to meet all the different rent payments that you would be setting up if you did the single tenant lease, which would probably have to happen.

JEFFREY SMITH: Yeah, we did a sanity check and went back and looked at the numbers for the 2007, 2008, 2009 time frame. And on our assumption, they would more than be able to meet the free cash flow goals and not have any issues that relates to that.

But we are talking about a company that has $4 billion today of EBITDA, and the rent burden we'd be talking about putting on, it would be a little over $1 billion, so there's still a lot of room there.

And then, in addition, as we talked about, there's an operating improvement plan here as well. They should be able to find another 200 basis points of margin improvement, which actually more than makes up for about -- for over half of the rent burden.

So from our standpoint, we think that they can more than handle it.

>> Okay. Logistically, obviously, they have been on record many times, including those recent quarters, that they think this is a bad idea.

Would you like to challenge them, put some people on the board, obviously Terry Lundgren does not want to do this. The CFO is quite clear he does not want to do this. So would you have to throw management out in order to be able to accomplish this?

JEFFREY SMITH: So we are, as you know, ready, willing and able to get involved and actively involved in every company in which we invest, but that's not our first choice. Our first choice is to work with the company.

In this instance, we do believe that their attitude is different from what you are saying. We believe that they are open to looking into this alternative and do recognize that there is a really good opportunity with this real estate today.

>> You think there's a -- when she says she won't do it; it's a bad idea, simplistic?

JEFFREY SMITH: Well, I'm not going to go back and forth as it relates to that, but in our conversations with them, we think they are receptive to looking into this opportunity.

>> And to be fair, she also did say on the most recent conference call, Karen Hoguet, I believe, the CFO, that they are studying closely with their key banking partners, all the various transactions that have happened lately and all the possible strategies, the pros, the cons of how you would do it, et cetera, et cetera, to see what's right for them.

JEFFREY SMITH: Well, I think the Hudson's Bay transaction being a joint venture instead of a REIT really opened their eyes to different ways that this could be accomplished.

>> There is no doubt that they created a great deal of value in accordance with the Saks transaction and others in Hudson Bay, but again, this is a perhaps more vibrant retailer than others.

I mean, do you think you are going to make traction here, Jeff? I mean, this is a fairly large company. Are you willing to undertake a proxy side if it should come to that?

JEFFREY SMITH: I don't -- you know, we're willing to do whatever is necessary to increase value for the best interest of the shareholders.

In this situation, our hope and belief is that we'll be able to work with management, but we go into every situation believing we'll be able to work with management. We have to prepare for instances where we might have a good faith disagreement.

DAVID FABER: Any of our other panelists, our esteemed panelists, both of whom I know are well-acquainted with sort of this basic idea, have a question for Jeff on this?

You don't have to. Just giving you the opportunity if you want.

TOM SANDELL: We looked at Macy's a while ago, David, and it seemed very interesting to us, and I would say that we didn't really get involved because you have a whole menu of other names to choose from that perhaps are more suitable for us. We tend to prefer investing in the middle market, mid caps, because, you know, historically have better returns in that space, and it's -- it's a quicker way for us normally to drive value than an operational turn-around that could take four years or perhaps even longer.

So, you know, I mean, Macy's is a great name and, you know, have done really well in a lot of fields, so I'm sure it's going to be worth investment.

>> So an observation, I'm not sure -- we don't have a position on Macy's unfortunately, but forgetting whether Jeff's plan is the right plan or not, if you make investing really, really simple and say is this the right lens to look at Macy's through -- and it's the right question. How you answer it, I don't know.

But, fundamentally, the value of real estate has increased dramatically over the last few decades. You can't say the same thing about the value of operating a department store. It's gotten more competitive. You have the Internet, you had, you know, fast fashion, you've had all these competitors.

So if you look at the value of Macy's today, whatever it's worth, it's worth, and the value of Macy's several decades ago, the mix has changed between how much of it comes from real estate and how much of it comes from its core retail and business.

As that mix changes, the business should think differently about how it finances its cash flows. That's sort of the question that people were talking about with McDonald's today a little bit.

And these great questions to be asking.

>> Yeah, in terms of capital allocation, everything else.

Jeff, we're going to come back to you a bit but we've got to move on. Thank you for that idea.

And our next panelist, Tom Sandell, can take the podium and present.

TOM SANDELL: So on your idea, there's a company called Ethan Allen, furniture retailer with an iconic brand name, it's American retailer. And what's very interesting here is that they have tremendously valuable real estate.

And the company was taken private in 1989 by the chief executive Farooq Kathwari. And that was sort of like in the midst of the last -- the prior financial crisis. And that was a very interesting, you know, restructuring of the business, given that, you know, interest rates were much higher. Interest rates were above 18%.

So the team that took Ethan Allen private, was, you know, financing at very significantly higher rates than what you can be today. The company is trading at $30 today, and -- but the real estate, as you can see, is sort of like brand new, you know, very attractive real estate. It's very enticing to go into an Ethan Allen store and it's high-quality furniture they make.

Now, the company, you know, is -- I would say -- I don't know if I want to call it -- management, but they haven't really done much for shareholders. The stock is down 20% over the past ten years.

If you're looking at the stock chart, you will see that they haven't created any value. Roughly, I wouldn't say -- shareholder value, but they frankly lost 20%.

So if we were back here in time, you will see that this sort of appears -- the chart appears -- and this is Ethan Allen, you know, down 20% over the past ten years. We feel that, you know, in terms of driving down the shareholders, the real estate is obviously one -- you know, very exciting opportunity here. You know, 50% for the market cap is real estate, and it -- it has a very inefficient balance sheet.

So part of the reason why the stock hasn't depreciated is that the company has no debt. There's about 0.14, you know, leverage on this company, basically fell that that's free. And there's multiple paths to realize shareholder values. Again, a very significant up-side if the management is more focused on -- dollars.

If you are looking at the stock price right now, that was $26 before they started to have takeover rumors, and this was an ideal candidate. Basically a firm could take the company private and pay down all the debt immediately, or even prepay it without taking any debt.

Now, even further, a tax efficient recap, they would do a spin-out. They are getting even more value. So at this time, the shareholders of Ethan Allen, they have not disclosed their state yet.

We had discussions with the management. We went to meet with them in the headquarters in Danbury, Connecticut a couple months ago. It's very impressive. We were taken on a two-hour tour around the entire headquarters, which was 144,000 square feet. And the meeting started out where they -- invited to sort of like a forum where everybody in the firm, like in a mobile forum like this, was listening to the morning -- the chief executive, and this was sort of dial-in from other subsidiaries around the country and they become a large -- they're surprised they got invited -- particularly how the other markets were.

But it was interesting because the CEO seemed to really care about his employees a lot, knows everybody by name, and it took us two hours to tour his headquarters. Even had a TV studio. I started to wonder why do they have a TV studio. Maybe they make some commercials. Sorry, Ethan Allen, I keep mixing them up.

Is it because it makes sense? But I would think that you could cut a lot of costs by getting rid of the TV studio.

>> Well, we love TV here, so we would not be in favor of that. I know Jim knows this company and the CEO fairly well, so I'll let him start off.

JIM CRAMER: Yes. He's worked very hard to clean up the balance sheet, including the most recent quarter. And I think one of the reasons why he's done that is because the furniture business, despite the fact the peer group, which includes something like Ralph Lauren which is not that much furniture, Tiffany, not furniture, William Sonoma, this business is a terrible business for him and he's tried many times to reinvent it.

I don't think he's that bad an operator, but the furniture is a notoriously cyclical business. And that's one of the reasons why he wanted to clean up the balance sheet.

I know a lot of people feel that activists come in and smash and grab. Would this be one where you would load up the balance sheet, we have a downturn in furniture and the company goes away?

TOM SANDELL: Well, they have so much real estate. I mean, there is, I mean, 70 stores that they own, that the company owns. They have eight manufacturing facilities.

They have a 200-room hotel. And we actually did a tour of the hotel, which is a conference center. They own acres and acres of land in Danbury, Connecticut. And the hotel was empty, almost nobody there. That's 200 rooms. And you know, if you leaseback of the -- the hotel and you recapitalize the balance sheet and buy back the stock, stock is really cheap, too.

Now, what's interesting, the company hadn't bought back any stock for years, or maybe, you know -- almost nothing for at least a decade, but you were very glad to see them came back to the -- they started buying back some stock, half a million shares last quarter. So that's kind of a good start in the right direction, but I think this is a great opportunity, because when we have fairly good confidence in Farooq, and I think he should take it private. There's a huge opportunity -- he did this before in 1989. Back then, you know, 18%. His real estate is worth a lot more today than back in the day.

>> His stock doesn't get -- he's in the second of three phases of being able to put the new furniture out. I think he'd be in favor of what you are saying. He's always complained about the undervaluation. Would you close the U.S. plant and move the rest of the manufacturing to Honduras and Mexico?

TOM SANDELL: You know, I frankly -- would I close U.S. plants? I mean, I would close any plant not operating properly, you know, and move it to anywhere with better margins; but they are not getting any credit for their brand name as Ethan Allen. It's a really strong, iconic American brand name; but the market gives them no credit at all.

And the other thing is that we had been approached by parties; called us, wanting to take on the entire company.

>> So you have been approached by private equity firms who have at least expressed some interest in it?

TOM SANDELL: Yeah.

>> And have said what? We'll be able to buy it --

TOM SANDELL: Well, we haven't got an answer in any of the discussions, because it is not appropriate; but we had been approached and we know there is -- this is an ideal candidate; can pay back all the debt immediately and --

>> Did Farooq give you any reason why he didn't want to monetize the real estate?

TOM SANDELL: We tried to reach him last week. And I was in Europe, traveling in Europe and working from our London office, an we couldn't really get a hold of him. We got a hold of the CFO instead, but we frankly had a very short conversation. We'd like to engage a little deeper in that discussion.

>> Just one last question. Do you think that when you spoke with Farooq -- he's making this major turnover with adding all these showcases. Would you stop the showcase right now and start monetizing what he has and end the rollout he is doing, which basically is a reinvention of the company that --

TOM SANDELL: Would not stop that, because we feel that's a step in the right direction.

>> Tom, thank you. Should mention shares of Ethan Allen, which is a relatively small cap company, under $1 billion market cap, I believe --

TOM SANDELL: $900.

>> Maybe $1 billion now. Tom, thank you.

Now to the stage, Mr. Meister of Corvex. I think we have a theme emerging here. I don't know where you are going. Actually, I kind of do.

KEITH MEISTER: Thank you, David. So these guys could give my presentation for me, because the company I'm going to talk about is a huge beneficiary from corporations looking to officially monetize and finance their real estate.

So our investment is in a company called American Realty Capital Partners, the largest owner of real estate, so very apropos. American Real Estate was created in the last two and a half years by a very, very aggressive management team. Not going to comment on the management team, other than to say they are all gone now. So one step backwards, for two steps forward.

The management team moved quickly and assembled the biggest, best portfolio in a very quick period of time. And as a result, there were some accounting issues, complete restatement of financials. That is now behind us and the NOI was the NOI, the real estate is the real estate. This is a very, very simple business.

What did they do? They own Walgreens, they own a very, very diversified portfolio, where scale is an asset. The bigger you are, the better opportunity you have to go to Macy's or to go to Ethan Allen and buy a portion of their portfolio and still have diversified stream of cash flows.

So this slide, Macy's, McDonald's, MGM, Dillard's's, who's next. The concept is there's a trend. Corporate America is thinking much more progressively about real estate as a tool for financing its balance sheet, and ARCP is a huge beneficiary of this over time.

At Corvex, we invest in companies with easy-to-understand fundamentals that are going through change. We want to buy good businesses at discounted valuations. Everyone wants to do that. Usually there has to be a no-brainer reason. Why is a good company cheap. And then it's during those periods when businesses are going through volatility that we believe an active investor can help. Not good guy fighting bad guy, but shareholder partnering with a new management team, saying how do we fix the business, how do we have a fresh start, how do we rename ARCP? How do we think about a new board? How do we think about a new management team? How do we help rebuild this business?

In the case of ARCP, it is simple to us why it's cheap. People buy REITs for dividends. You own a REIT, you -- particularly if you own a triple net lease REIT. It's hypothecation of corporate cash flows. We buy ARCP at a 7% unlevered cash flow yield. They have a medium amount of leverage against their leases, and you get a 10% cash-on-cash return to own an investment grade-like bond with a security interest.

Guess what? If they aren't paying a dividend, it will create a discount in valuation. As a result of the restatement and having to work through amendments with their lenders, they suspended their dividend. So for a period of time, there's a unique opportunity to invest in the largest triple net lease REIT with no dividend, with no leverage target. This is all about to change with the first-class new management and new board.

I should have said in the beginning we are the largest shareholder, other than one index fund. We own 8% of the company. The company trades at 11.5 times AFFO. That's free cash flow. So I would think of it as trading at about 9% free cash yield. That's after tax. They don't pay tax. That's after CapEx. That is not adjusted. $750 million of free cash flow is generated each year against an $8.5 million equity value.

We think the investment is really compelling, because we are owning bond-like risk and making equity-like returns because of the moment of time we're in. We think there's 25% to 50% up-side, associated with this going from being off the run to on the run.

We think the coms traded about 17 times AFFO, probably a reasonable valuation. If ARCP traded there, it would be worth about $13. If it makes half way back -- and stocks often remember where they were and don't go all the way back immediately -- there would be 25% up-side.

So opportunity to buy $23 billion of cost basis real estate. I don't know if it was worth 23 when they bought it. It is worth more today now. They generated cash flow, interest rates are low, cap rates are low, and the portfolio's grown. So you're buying $23 billion of real estate at $18 billion. It historically traded at discounts, it was bad management. Now we have a new management team that's great.

So the old logos, just pictures tell 1,000 words. The old board, there was no company you've heard of that they were involved with. The new board, the chairman is the chairman of Berkadia, a well-known Buffett-backed joint venture between Leucadia and Berkshire, was a former cofounder of Black Rock. The new CEO was the former CEO of Cushman & Wakefield, real credible. There's new directors; a woman from Providence Equity, from J.P. Morgan, from Mills Corp. This company has done all the right things to repair itself, and we think the new team will make the right decisions. What was a liability will now be an asset: The board of management.

And what they have to do is really, really simple. They have to re-establish the dividend. Will they pay out 80%, pay out 70%? I don't know, but they will make the right decision. They have to have a target leverage ratio. They need to sell some assets to optimize their portfolio. This is really, really easy blocking and tackling, and there's a clear date. August, August 7, I believe, they will hold the second quarter earnings conference call. The new CEO will say here's my target leverage ratio, here's my payout. Here's the new name for the company. And all of sudden ARCP will go from being off the run to on the run. The pitch is bond-like risk for equity-like returns.

>> Thank you. I wonder, of course -- Jim and I followed the ledger fraud that took place, and I do wonder, is there some cost associated with liabilities that may still be -- the company may be open to, as a result of that?

KEITH MEISTER: Our sense is $23 billion company that had about $5 billion worth of equity loss, that one could allege is a result of misrepresentations in the market during the period of time that financials were in question. If you look historically at where the liabilities get settled, the numbers end up between 4% and 6%, is a pretty good benchmark. If that's the case, you would be talking about $200 million. So I don't know if that's the number, but in a frame, if I'm off by $1 billion -- that's $1 a share -- they recently hired a new general counsel, who came from the U.S. Attorney's Office and previously was general counsel at Revlon; so the right kind of people to work through these issues, our sense is $300 million issue goes away in the next nine to twelve months.

>> Glad you did that one. Got too aggressive; we all know, but what was interesting, the properties were always unbelievable and the cash flow was really amazing. And what I was hoping was that when the new CEO spoke at the convention, he would say listen, we are going to pay a good dividend; but he said his first choice was to retain cash from de-leveraging.

I said oh, my God, he's going to delay it again. Aren't you worried he's going to take the wrong option?

KEITH MEISTER: I would rather he start at an 80% payout ratio. The core comps are 80%. It's a 60 cent dividend per year. If we get a 60 cent dividend, $11 stock. If he chooses 50 cents, that other 100 million isn't going away. He's obligated to pay out 95% of his net income, so the hedge fund guy, saying here, give him some time. He is going to get to the right place. Whether it's a month or six months, we are going to have 80% payout ratio and origination platform that's been reenergized.

There are some REIT guys, I argue pay out 80%, get there immediately. Other guys start at 65, 75, and be able to grow it. I think it's -- people can have legitimate difference of opinions on that. I don't think it's that big an issue.

>> How much constraint is there from the lenders? Any of the lenders breathing down his neck --

KEITH MEISTER: Sure. This is an investment-grade quality capital structure. It will take them a year to regain credibility and execute; but they have all the metrics of investment grade, their bonds trade like investment-grade bonds. This was never a distressed asset. It was just a distressed management team that got replaced.

>> I remember, of course, that period of time, and there were plenty of hedge funds -- the idea that the company was severely undervalued. Were you one of them? Are you still under water here?

KEITH MEISTER: Yeah. We bought well. We bought after the disclosure, so the stocks trading at our purchase price -- I think we own 73 million shares, and my guess is the stock is trading at or about our investment basis. And we invest in December. Part of the reason I pitched the idea today, I think any point in our investment horizon, this has been the best risk return time to own ARCP.

I mean the day we first bought it, we took a risk. Maybe the financials were all bad. That's now been done by a new audit firm. We are good there. Maybe they will keep the bad guys, put a bad board in place. The stock hasn't worked. Why? We got a little pressure from the tenure; but everyone is waiting for dividends. When that happens, I think the stock will work.

>> In this case, as an activist investor, were you particularly active in the recomposition of the board?

KEITH MEISTER: So we have had numerous private constructive conversations with -- when they were looking for a board with their financial advisors, Morgan Stanley; then when they brought in the new CEO with the new CEO, before he came in, when he came in. We met with the chairman and the independent directors. I think we can serve as a nice sounding board for them of hey, here are the issues that Wall Street cares about in this name. And ARCP is a high-emotion name, as you know. So here's why Nick really irritated investors when we talked about Muda. He was in, he was out. Here's why you have to pay more attention to that issue than you might not. We have been very much about you get very few chances to make first impressions as a company. They get a fresh start. It is a triple net lease REIT. How do you make it best in class, corporate governance and do everything like 100% perfect, and they have been very constructive.

>> All right. Either of you gentlemen, Jeff or Tom, have a question?

TOM SANDELL: Worried about the accounting fraud, but glad to hear --

KEITH MEISTER: I have -- sorted out. Filed financials.

>> And you are connected in a way -- I think it was the Red Lobster transaction that they did with ARCP.

>> We know ARCP is a good buy or investment.

>> Yes. Clearly overpaid for the Red Lobster --

>> Well, thank you, Keith. We're running out of time, but I would love to direct some general questions on activism. They will tell me if I can do that. Keith, let's go to you. You were very active, the largest right now in terms of the size of your assets, Keith; but the DuPont vote, Jim and I talked a lot about it. It was a seminal moment, where all the funds voted in favor of management, despite ISS and a number of these other firms. We could talk about whether they should have influence. Was that a seminal moment? Does it make your job more difficult, if and when you do undertake proxy -- the index funds will not be in play, if we look at what happened in DuPont?

KEITH MEISTER: I think DuPont is an interesting case, illustrative, but also unique. I think the issues -- Nelson did a great job this morning with Jim talking about DuPont. And ultimately, he will win. He's handled this right. He's either going to get rich or he's going to be right. And they're -- he'd rather be rich, but if he's right, he will win from that perspective. So I think he gives activists a good nine.

People had a difference of opinion. It was a close call. He's going to stay, and it will get judged. The big issue that will evolve over time, our capital markets have done great because shareholders functioned like owners. The mutual funds and pension funds deserve a lot of praise. They vote the shares in a way they think is the right interest for them as shareholders. That becomes a harder mandate for the index funds to do, because by definition, they own everything forever.

So as the index funds gain share, which I think they will, and the average big cap company goes from being 16% owned by index funds to 30% owned over several decades, if the index funds are successful. It will be a really interesting balancing exercise to make sure there's the same accountability in board rooms when 30% of the shareholders are passive. I think activists get all the media attention, but the real untold story of this activist-led capital market activity over the last several years, the average shareholder acting more like an active owner. That is a really good thing. The activists on stage are just the ring leader. And that's had a balanced shift, where corporations are really managing that balance to focus on equity, not just other stakeholder interests, which are sometimes hard.

What I wouldn't want to see happen is that swing back. It's a great subject for talking about later today, because it is a hard issue. Index funds shouldn't make decisions for ten minutes. We also shouldn't make decisions for 20 years, and where in the middle that lies is an important issue.

>> Jeff, would you agree some people refer to the index funds as accidental shareholders, meaning they don't seem to have any responsibility?

JEFFREY SMITH: I agree with what Keith was saying. The big winners here are the shareholders of these companies and that shareholders are now taking ownership in their voting responsibility. From our standpoint, we look at it and say that's a good thing. The index funds are going to be making active decisions as to what they think is best. We want all shareholders to make active decisions.

In this situation, it happened to be they supported a management team that started to make a better case for what their plan was. That may prove to be correct or not correct, but that is the way this is supposed to work. It is supposed to work where we, as shareholders, show up and provide the rest of the shareholder choice. Board members run unopposed most of the time, and we are providing alternative. Shareholder base should be making an informed decision, and we provide a platform.

And what happens during that context, much like a political election, the management team has a chance to talk about what their alternative platform is or how they will do a better job of running the business. If the shareholder base likes what management is saying, the stock price is usually higher when that happens, management may succeed. That's great. That's how this was all supposed to work.

>> Jeff, finally, Macy's, you brought up. All of you have waged proxy fights and had successful ends. I'm curious as to when you choose to pull the trigger, what are the motivations, and when you don't? Yahoo comes to mind, Jeff, that you and I talked about a number of times; and there you chose not to, or seemingly chose not to, despite what seemed to be leading up to that possibility. How do you decide?

JEFFREY SMITH: For us, it is about balancing the up-side and the effort, versus what you think you can get accomplished by working with management. It's a lot easier to work with management, if you can get them to make the right decisions for what is in the best interest of the company. If you start to have some confidence that they are going in the right direction, it is a lot easier to work with management. We don't fight contests just to fight contests. We measure success by making money, but having companies perform better. So in the Yahoo situation, as we were leading up to a nomination deadline, as you are referring to, we were having good conversations with the management team and the board, and they started to take few actions along the lines of the things we wanted, notably spinning off Alibaba and returning cash to shareholders and starting to take costs out of the business. So they are starting to go down the path of the things that we wanted them to do, which led us to make the decision; we don't need to do this right now. There's another choice, we can own the shares and we can make sure they continue to go down that path. And we always have the ability to do something next year, if they fall down. If they continue to go the right direction, that would be fantastic. That's what best for all the shareholders.

>> We are going to leave it there. Keep an eye on Macy's and Ethan Allen and ARCP. Thanks to Jeff Smith, Tom Sandell and Keith Meister.

[APPLAUSE]

>> Thanks also to David and Jim.

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