What’s in the box
Outside the corporate offices, a frustrated, rebel shareholder shouts into a megaphone "WHAT DO WE WANT?!"
Other shareholders respond "CAPITAL ALLOCATION"
Again, into the megaphone: "WHEN DO WE WANT IT?"
"NOW!"
Capital allocation is a euphemism often invoked by investors to prod management to allocate more capital to them, the shareholders. They're not wrong. They own the company. They have rights to the profit it generates.
Unboxing
Here's a company prodded by shareholders: it's a retailer, a traditional one. It sells all kinds of things, mostly from giant boxes surrounded by acres of parking. It sells stuff like towels, bedding, other everyday stuff. You might remember something like this nostalgically if you grew up in the burbs in the late 1900s.
Since the shop's heyday, also in the late 1900s, its struggled to find ways to grow in a world less interested in giant boxes surrounded by a sea of parking.
You can imagine the company's share price languishing. It did. You can imagine shareholders and the board bristling while other companies' stock prices soar.
Tension boils over. Shareholders rebel. Capital gets allocated.
In our story the shop specifically allocated capital to repurchase stock then retire it. Shareholders usually love this. The company makes its number of shares smaller, so each remaining share owns a bigger slice of the company.
Share Split
Our nostalgic story fits the fates of two companies. Each had a very different ending.
In one story, the company heard shareholders -- in this case an activist shareholder. It hired a well-respected exec from a competitor with an idea to revamp the stores, increase profits and plow those profits back to shareholders. It spent a bunch of money repurchasing shares. Share count went down.
It also spent a bunch of money trying to revamp the company. It chased the exact strategy of the company the exec came from — Target. But customers just decided to shop at Target instead. Money ran out. The company went under. Shareholders now owned a bigger slice of a worthless company. This was Bed Bath and Beyond.
In contrast, the second company also faced a fading market. Instead of pivoting to a shiny new Hail Mary strategy, it focused on what customers were sticking with it and listening to its employees. The employees and the owners here also happened to be the largest shareholder group. It's been closing stores for years but stayed open where the customer base favored its type of shop. It's managed decline in a way that has maximized the amount of cash it generates rather than burns through it. This is the cash it's put back towards buying shares. This story is of the department store, Dillard's. Its stock price increased more than 500% since before the pandemic.
The lesson is pretty straightforward — if your shareholders demand "capital allocation," make sure to allocate capital that you have. Allocating capital to share repurchases can earn soaring performance for a stock but can't come at the expense of the business that, you know, actually earns the money behind that stock.
High Wire
Lamplighter's holdings include several companies touting their capital allocation chops and operating in, let’s say, "difficult" markets.
One of these is Liberty Global, a broadband connectivity company in several European markets. It's jumping through a series of hoops to meet shareholder calls for "capital allocation." It bought back 20% of its shares last year. It recently changed its legal residence from the UK to Bermuda which will make it easier to do things like sell or spin-off some of its national brands to free-up more capital for shareholders.
So, is Liberty Global destined to be Bed Bath and Beyond or Dillard's?
Liberty has been a leader in fixed/mobile convergence, where customers can get both mobile and broadband service in a bundle. This has been a hit with customers. It recently reached a milestone of serving 500k customers with its market-leading fiber network in the UK. It's on its way to reach 1.5 million by the end of 2024. This has boosted its customer additions there and its profits. Its pursuing the same strategy in similar markets like Belgium and Ireland.
It took over a flailing Italian operation where it had only owned a part. Now that it owns the whole, it's begun the task of turning around the business, then managing it for cash.
While rearranging itself to allocate capital to shareholders it still tends to the business side of the equation. The overall tone of its strategy is deliver value to customers then deliver cash to shareholders. Like Dillards, it’s adjusting its business to meet the customer. That balance puts Liberty in the camp to hopefully follow Dillard's stock price too.
Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.