Activist Meister eyes another possible conglomerate breakup to unlock value

Keith Meister, Founder and Chief Investment Officer at Corvex Management LP.

Brendan McDermid | Reuters

Company: MDU Resources Group Inc. (MDU)

MDU Resources is a regulated energy delivery and building materials and services company. The Company is organized into the following four business segments: (i) Utilities: Electricity and Natural Gas Distribution, (ii) Pipeline, (iii) Building Materials and Contractors (their aggregates business) and (iv ) building services.

Market value: $6.3 billion ($31.20 per share)

Activist: Corvex Management

Percentage of ownership: 5.5%

Average cost: $26.57

Activist Comment: Corvex was founded in 2011 by Keith Meister, the former lieutenant of Carl Icahn who served as CEO and Vice President of Icahn Enterprises. Corvex is a highly focused, fundamentally driven hedge fund that uses activism as a tool, but not a primary strategy. Their preference is not to be activist, proxy contests being a last resort, and would prefer to be amicably invited to board meetings.

What is happening:

Corvex expressed support for the company’s recently announced decision to separate the building materials from Knife River through a non-taxable shareholder spinoff. Additionally, Corvex intends to enter into discussions with the Company’s Board of Directors and management to discuss: (i) other strategic alternatives to further maximize shareholder value and (ii) plans to improve the earnings potential of the company’s assets at levels in line with industry peers.

In the wings:

MDU operates in a conglomerate structure with utilities, pipelines, building materials and contracts, and construction services. Its utility business operates in eight states – North Dakota, South Dakota, Idaho, Washington, Montana, Oregon, Wyoming and Minnesota, and depending on the state, it earns a contract profit of nearly 10% on its costs.

This militant campaign is above all pure play and simplicity. One only has to look at Corvex’s 2020 activist campaign at utility company Exelon to see it. At Exelon in October 2020, Corvex said the company is trading at a discount with shares up 30% due to its diversified business structure and that pure play, regulated companies receive higher valuations. The stock was then trading at $39.32.

Six months later, Exelon announced the spin-off of Constellation Energy Corp. In February 2022, when the split was completed, the stock was trading at $42 per share. Exelon shareholders received $16.50 of value at the spin-off’s closing date and $25 of value at today’s price from their Constellation holdings and not only Exelon shares have not down, but they are trading at $46 per share today. Corvex is likely pursuing a similar game plan here.

These are all good companies that alone should be worth 20 times corporate earnings, but together they are trading at a discount due to the conglomerate structure. The company took the first step in pursuing this value-creation opportunity last week when it announced it would divest its aggregates business, Knife River Corp, which is expected to be completed in 2023.

However, it is unclear whether this was the first step in a larger plan to break up its conglomerate structure or whether it was appeasing an activist who had been buying shares for some time now. Interestingly, the company retained JP Morgan, PJT Partners, Joele Frank and Wachtell Lipton in this derivative transaction. These are all top advisers in defending against militants and indicate that the company could be preparing for a fight rather than initiating the beginning of an acceptable plan.

If the company is preparing for a fight, there’s no doubt Corvex will bring one up if it can’t settle with the company. But they have plenty of time to try to reach an amicable agreement, with the appointment window not opening until January 10, 2023. What Corvex would seek is the divestiture of the construction services segment and a form of board representation to assist management. run the business more efficiently. Sounds like Carl Icahn, Meister’s former mentor, does at Southwest Gas. The plan could result in a stock price over $45 in MDU in an investment that has significant downside and inflation protection as a rate-based utility.

There is also an Activist ESG (AESG) thesis here. The company’s energy production is currently divided into three areas: coal, natural gas and renewable energy. However, as equipment and facilities depreciate, they can no longer be included in the rate base and the company cannot be paid for them. So companies like MDU will be closing facilities, retiring equipment, building new facilities, and purchasing new equipment that can be added to the rate base. The trend in the industry is towards more environmentally friendly assets. So while MDU is currently about one-third coal, one-third natural gas and one-third renewables, in 2010 the company was only 11% renewables.

Finally, it should be noted that Corvex filed its 13D with a 4.99% stake and a cash-settled swap exposure of 0.59%. Like Icahn in Southwest Gas, there could be state restrictions that prohibit a utility shareholder from acquiring 5.0% of the common stock. To get the economic exposure they wanted, Corvex used cash settled swaps and it is commendable that they disclosed this in a 13D filing. We often see activists using cash-settled swaps as a gray area and a loophole to avoid exceeding a 5% beneficial ownership threshold that requires a 13D deposit, and as a result this is now the subject of a proposal of the SEC. It’s refreshing to see an activist like Corvex err on the side of transparency here and indicate that they’re not here to play games, but openly work with management to create long-term shareholder value.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and he is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist investments 13D. Squire is also the creator of the AESG™ investment category, an activist style of investing focused on improving the ESG practices of portfolio companies.

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