In the cross hairs: Starboard targets Regis, SurModics

  • Article by: THOMAS LEE , Star Tribune
  • Updated: September 3, 2011 - 10:00 PM

The New York-based hedge fund buys stakes in companies that spend a lot of money but generate little shareholder value.


Regis Salon at the Nicollet Mall and 6th St. in Minneapolis

Photo: David Brewster, Star Tribune

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Aside from their Minnesota headquarters, Regis Corp. and SurModics Inc. would seem to have little in common. The former operates hair salons in the United States and Europe. The latter makes medical devices and drugs.

But both companies have drawn the interest of a group of New York-based hedge fund managers, who see an opportunity to boost languishing stock prices by forcing management to cut costs and jettison assets.

Starboard Value LP, which recently purchased a 4.7 percent stake in Edina-based Regis, wants the hair company to cut at least $100 million in expenses and sell off its Hair Club for Men and Women business. Starboard is a spinoff from Ramius LLC, the $7 billion alternative-investment arm of Cowen Group that successfully installed two of its preferred candidates on SurModics' board of directors in January.

Starboard executives say that more often than not, they reach a settlement with the targeted company rather than engage in a costly and divisive proxy battle. But the executives also insist that they are fully prepared to finish what they started. Regis declined to comment.

So-called activist investors are nothing new. Carl Ichan, perhaps the country's most famous corporate raider, has been doing it for years, taking aim at everyone from TWA to Blockbuster Video. But the country's recent recession and subsequent weak recovery, which has wiped out billions in market value, is creating fertile ground for such investors, experts say.

"There are an awful lot of companies that are undervalued," said Kathleen Wailes, senior vice president of Levick Strategic Communications, which advises companies on potential proxy fights. "There are a lot of companies that are sitting on piles of cash. They are attractive targets for activist investors. And [the investors] are often very successful."

Even when they're not. Although William Ackman failed to force Minneapolis-based Target Corp. to spin off the property beneath its stores into a Real Estate Investment Trust (REIT), the company nevertheless agreed to sell off its $6.7 billion credit card receivables business, one of Ackman's key demands.

Starboard, which spun off from Ramius in March, doesn't target just any undervalued company. The firm, which focuses on small-cap stocks worth between $50 million and $1 billion, targets companies that spend lots of money on increasing sales (often without good results) at the expense of strategic focus and financial discipline.

Take SurModics. Under then-CEO Bruce Barclay, who joined Eden Prairie-based SurModics in 2005, the company tried desperately to move beyond its core cardiovascular business. At the time, the company generated most of its revenue from Johnson & Johnson, which licenses SurModics' drug-delivering polymer coating technology for its Cypher stent. But Cypher sales have been dropping and with it, royalty revenue for SurModics.

Under Barclay, SurModics expanded into pharmaceuticals and diagnostics. From 2007 to 2008, the company went on a buying spree. SurModics also spent a hefty $41 million over three years to acquire and build a 280,000-square-foot pharmaceutical manufacturing facility in Birmingham, Ala.

None of these moves has paid off for SurModics. In fiscal 2010, the company reported revenue of $69.9 million, down 42.5 percent from the previous year. SurModics lost $21.1 million, compared with a profit of $2.2 million in 2009.

After purchasing a 12 percent stake in SurModics last year, Ramius managed to get two nominees onto the board. The company recently announced plans to cut its workforce by 9 percent and restructured its executive team. Even more important, SurModics is looking to sell its pharmaceutical business, a key demand of Ramius, this year.

"We received significant interest from a number of parties and the process remains on track with our expectations," new CEO Gary Maharaj told analysts last month.

Not surprisingly, Starboard executives say they are pleased with management so far.

Like SurModics, Starboard sees in Regis a company bloated with costs and "lack of operational focus," according to a letter the firm recently sent to Regis CEO Paul Finkelstein.

Though Regis dominates the seemingly straightforward industry of cutting people's hair, the company operates a dizzying array of businesses, including multiple store brands like MasterCuts, Regis and Supercuts; 400 international salons; Hair Club for Men and Women; minority stakes in Provalliance, which owns 2,760 salons in Europe, and Empire Education Group, a chain of cosmetology schools in the United States.

Again, results have been less than impressive. Fiscal 2011 revenue fell 1.4 percent to $2.33 billion from $2.36 billion in the previous year. Regis lost $8.9 million compared with a profit of $43 million in 2010.

Meanwhile, costs are rising fast. In fiscal 2011, general and administrative expenses, or corporate overhead, jumped to $340 million from $292 million the previous year.

Starboard, which nominated three people to Regis' board, wants the company to drive down costs, including cutting employees at its headquarters and distribution center, and sell off non-core assets, including Hair Club, a profitable but relatively small business that could fetch attractive buyers.

But Regis seems at odds with Starboard's prescribed strategy. The company said its top priority is to drive traffic to stores versus slashing expenses. Regis also said it would take a $20 million non-operational charge next year to install a point-of-sale software system at all of its salons. The company also seems reluctant to part with Hair Club.

"Hair Club is a great business for us," President Randy Pearce told analysts in an August conference call.

Starboard executives say they have already had two conversations with Regis but would not say if they planned any more before the company's annual meeting in the fall. (Regis has not yet scheduled the meeting.) Starboard also would not say whether they contacted Regis' other top investors, including Fidelity Management, which owns 14.6 percent of Regis stock.

Thomas Lee • 612-673-4113

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