Starboard Value’s Round Trip at Emulex Corporation

Jeffrey Smith's hedge fund, Starboard Value, slashed its stake in Emulex Corporation (NYSE:ELX) -a network connectivity, monitoring and management products provider- by about 26% last week. It now holds 5.34 million shares, down from 7.25 million. The stake represents 5.8% of the company's common stock and is valued at approximately $41.7 million.

Jeff Smith


What's interesting about this move is that, two months ago, Starboard had increased its position in the company, adding more than 2 million shares to its holdings. However, along with the filing at the U.S. Securities and Exchange Commission, the fund sent a letter to Emulex’s board, expressing its concern regarding the fact that the company was “extremely undervalued”, and plenty of shareholder value could be unlocked. "It is time for a significant change at Emulex. Specific changes must be made to address years of dismal operating and share price performance as well as sub-optimal corporate governance,” the fund said, basically calling for a reconstitution of the board, for it to include shareholder advocates.

A couple of days after this event, the company announced the departure of its CFO, Michael Rockenbach, effective on December 31st. Later, its Q1 2014 results came in, ahead of its guidance, but still weak. In order to enhance shareholders´ value and somehow boost profitability, Emulex announced last Monday, 12 days after the earnings release, a $200 million share repurchase plan (about 30% of its outstanding shares), expanded cost savings ($30 million in annual cost savings over fiscal 2013) and board changes (executive chairman of the board, Jim McCluney, will leave the company on Feb. 6th, 2014).

Starboard Value is a fundamental oriented activist hedge fund with a portfolio, worth about $1.4 billion, focused on small cap stocks like Emulex (its market cap barely surpasses $700 million), Office Depot Inc (NYSE:ODP), or Integrated Device Technology Inc (NASDAQ:IDTI). So, this kind of activity is quite usual for the fund, and can be interpreted in several ways.

Actually, the fund was quite active over the last month. To provide a few examples: it sent a letter to Compuware Corporation (NASDAQ:CPWR), asking them to either proceed with the restructuring of the company or sell it; and another one to Calgon Carbon Corporation (NYSE:CCC), asking for a "large" stock buyback and the conversion of its U.S. carbon assets into an MLP structure.

In Emulex’s case, the most logical explanation for Starboard’s move, I believe, is the following: the fund raised its stake in the company to 7.9% so that its demands would be heard and considered. Once this happened, Starboard sold the recently purchased stock and returned to its previous position, without big economic losses, while having achieved some of its goals. Nevertheless, this cannot be known for sure. Is Mr. Smith’s fund bullish on Emulex or is it that selling all of its shares at current prices would not be so convenient?

Certainly, Emulex’s fundamentals (especially its margins and returns) are not looking good, and its growth projections for the years to come, mediocre. Notwithstanding, Zacks rates the company as an outperform case for the long-term, and at least 24 of the hedge funds that we track are also bullish on the company. Amongst the largest hedge fund shareholders are Paul Singer's Elliott Management, and Chuck Royce's Royce & Associates.

So, even if Starboard Value slashed a considerable amount of its holdings at the company, it is still the third largest “hedgie” bull, owning more than $40 million in stock. If these funds seem to feel quite bullish about Emulex, despite it sailing troubled waters, should you too?

Disclosure: none

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