General American Investors Company, Inc. Targeted By Activist Fund
Summary General American Investors Company, Inc. currently trades at a 13.94% discount to net asset value and has been targeted by the well-known closed end fund activist Phil Goldstein. Phil Goldstein has a long track record of fighting and winning proxy battles against closed end funds, whose boards resist initiating value enhancing liquidity events to benefit shareholders. A market neutral position, long GAM vs. short the S&P 500, offers an attractive opportunity for alpha generation based on the fund’s deep discount to NAV and involvement of activists. General American Investors Company, Inc. (NYSE: GAM ) is a diversified closed end fund that invests mostly in large-cap domestic common stocks. The fund has consistently traded at a double-digit discount to its net asset value for the past five years. The current discount is 13.94%. This past October, Special Opportunities Fund (NYSE: SPE ) submitted a shareholder proposal to General American Investors Company, Inc. requesting the Board of Directors to authorize a self-tender offer for all outstanding common shares at or close to net asset value. If more than 50% of the fund’s common shares are submitted for tender, then the tender offer should be cancelled and the fund should be liquidated or converted to an ETF or open-end mutual fund. If SPE is successful in its campaign, then shareholders stand to capture a windfall gain of as much as 14%. Special Opportunities Fund is a closed end fund run by the well-known hedge fund activist investor Phil Goldstein , co-founder of Bulldog Investors. SPE and Bulldog invest primarily in undervalued assets and engage in activism to unlock the value of their investments. SPE and Bulldog mainly target closed end funds which trade at large discounts to net asset value and pressure management to engage in value enhancing liquidity events, such as share repurchases or, in some cases, liquidation. They have had numerous successes with their activist campaigns and are not easily deterred once they set their sights on a particular target. GAM filed a preliminary proxy on February 6th, which includes the shareholder proposal submitted by SPE. The proxy also states that SPE is proposing to elect three of its own nominees as directors of the company. The Board of Directors of GAM has unanimously opposed the shareholder proposal and is recommending shareholders to vote against it. The board’s statement of opposition lists the standard multitude of reasons why they believe that the proposal is not in the best interest of shareholders. Many of the reasons are valid, but it is very difficult to argue that an event resulting in an instantaneous narrowing of the fund’s discount would not be beneficial to all shareholders. Since it is not the focus of this article, I won’t attempt to address the individual bullet points presented by the board. The list is too long to summarize, so please refer to pages 12-15 of the preliminary proxy for the details. Conclusion There are many different scenarios that can play out during this activist campaign. The most likely scenario is that the Board of Directors of GAM pursues a smaller buyback in order to placate Mr. Goldstein and avoid a proxy fight. Two of Bulldog Investors’ recent proxy fights may provide some insight into the potential expected outcomes. Firsthand Technology Value Fund (NASDAQ: SVVC ) entered into an agreement with Bulldog last May. Under the terms of the settlement , Bulldog agreed to withdraw its nominees for the fund’s Board of Directors and withdraw its proposals regarding termination of the fund’s investment management agreement. They also agreed not to present any proposals at the annual meeting and to vote their shares in accordance with the Board’s recommendations. In return, SVVC approved a plan to repurchase up to $10 million of common stock in the open market, and to conduct a self-tender offer for at least $20 million worth of common stock at 95% of net asset value. The fund also agreed to liquidate its Facebook (NASDAQ: FB ) and Twitter (NYSE: TWTR ) holdings and to distribute any net realized gains from those holdings to shareholders within 60 days of completing those liquidations. Facebook and Twitter accounted for close to 30% of the fund’s holdings at the time of the announcement. The net result for SVVC shareholders who submitted shares for tender was a return of more than 45% of their capital at close to NAV. Bulldog was also recently successful in pressuring Nuveen Investments to restructure two of its closed end funds and conduct a tender offer for 25% of the outstanding common shares at 98% of net asset value. Nuveen Global Income Opportunities Fund (MUTF: XJGGX ) and Nuveen Diversified Currency Opportunities Fund (MUTF: XJGTX ) were combined into a new fund called Nuveen Global High Income Fund (NYSE: JGH ). The net result for JGH shareholders who submitted shares for tender was a return of more than 43% of their capital at 98% of NAV. It is likely that SPE would agree to a similar proposal from GAM. Unfortunately, there is not a high probability of SPE’s proposal garnering more than 50% of shareholders’ votes due to the constituency of General American’s shareholder base. Only 30% of the outstanding shares are held by institutions and mutual funds. Small investors who own the remaining 70% of the fund tend to be apathetic when it comes to voting proxies. Let’s examine a few possible scenarios with hypothetical probabilities: Hypothetical Return Scenarios For GAM Outcome Potential Return On Shares Tendered At Current NAV Discount % Of Shares Submitted For Tender Total Return Probability Of Occurrence Probability Weighted Return Fund Liquidates Or Converts To Open-End Mutual Fund 13.94% 100% 13.94% 15% 2.09% Fund Initiates Tender Offer For 25% Of Outstanding Common Shares At 98% Of NAV 13.66% 49% 6.97% 40% 2.79% Fund Initiates Tender Offer For 10% Of Outstanding Common Shares At 98% Of NAV 13.66% 49% 2.79% 25% 0.70% Management Takes No Action And NAV Discount Remains Unchanged 0% 0% 0% 5% 0% Management Takes No Action And NAV Discount Widens To Five Year Low Of 16.4% -2.46% 0% -2.46% 15% -0.37% Expected Return 5.21% Although the above scenarios are hypothetical, they provide a framework to help assess the potential returns associated with different outcomes. They also reflect my best guess as to the final result. My opinion is that the majority of scenarios offer a favorable risk-reward profile for a market neutral position, long GAM common vs. short the S&P 500 ETF (NYSEARCA: SPY ). My recommendation is to enter into a market neutral position: long GAM and short 1.1X the dollar amount of the S&P 500. The reason for suggesting a hedge ratio greater than one to one is to account for the fact that the fund often employs leverage of approximately 16%, which magnifies returns relative to the S&P 500. The fund also held 8.5% of its assets in money markets as of year end, which will offset some of the effects of leverage. A one to one hedge ratio would not be my preference due to the aforementioned factors. The obvious risks to this trade are that GAM’s correlation to the S&P 500 breaks down and leads to an underperformance in GAM’s net asset value relative to the S&P 500. Another risk is a further widening of GAM’s discount to NAV. While these risks are by no means negligible, the broad diversification of the fund’s large-cap holdings tend to make it unlikely to diverge too much from the S&P 500. The fund’s discount to NAV has averaged approximately 14.3% for the past one, three, and five years, which is close to the current discount. The discount did, however, fall below 20% during the height of the financial crisis in 2008 and 2009. It is highly likely that the discount would widen dramatically again if another market panic sets in. Lastly, the success of this strategy hinges solely on SPE’s ability to succeed in its proxy campaign. The close of business on February 17, 2015 has been fixed as the record date for the determination of the stockholders entitled to notice of, and to vote at, the shareholder meeting. Investors who want to vote in favor of SPE’s proposal must purchase shares on or before February 10, 2015. Disclosure: The author is long GAM, SPE, SVVC, JGH. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: I am currently long “GAM”, “SPE”, “SVVC”, and “JGH” and short “SPY”. I may initiate long or short positions in any or all of the aforementioned securities over the next 72 hours. I plan to vote in favor of SPE’s shareholder proposal and its nominees to the board of GAM.