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Hedge fund sets ultimatum for Walter

Pirate Capital wants the company to split up its three key business units. Otherwise, the fund says, it will push for its own slate of directors.

By SCOTT BARANCIK
Published May 26, 2005

A hedge fund with a growing stake in Walter Industries is warning the Tampa company to break up its three key business units - or face a possible shareholder revolt.

Pirate Capital LLC of Norwalk, Conn., said Wednesday that Walter's coal mines could fetch $50 a share on Wall Street if they weren't being dragged down by its home-building and iron-pipe units. Pirate estimated Walter's three units could be worth $65 per share if separated.

By comparison, Walter's stock closed Wednesday at $38.60, down 2 percent, or 73 cents a share.

"We strongly urge the Board to immediately retain a reputable investment bank to consider strategic alternatives to enhance shareholder value, including the spin-off" of the coal and home-building units, investment analyst Stephen Loukas said in an open letter to Walter's directors. He said Pirate, Walter's third-largest shareholder at 5.3 percent, would try to elect its own slate of directors if Walter refused.

In an interview Wednesday, senior vice president Joe Troy defended Walter's board, saying it has taken a number of steps over the years to benefit shareholders and has heard the breakup request many times. "If we decide to respond (to Pirate), which we have not decided yet, then you will know about it," he said.

The demand for a breakup comes at an awkward time for Walter.

Thanks largely to record coal prices, Walter has abandoned long-held plans to sell its volatile coal division and committed $135-million to expanding output. Its share price tripled, outperforming all other Tampa Bay area stocks in 2004 and turning several Walter executives into stock-option millionaires. Chairman and CEO Don DeFosset has become a highly regarded turnaround artist. As recently as this week, he appeared on cable news station CNBC, touting his company's record.

But DeFosset also is a lame duck, having announced in February that he will retire upon the hiring of a successor. Meanwhile, former top shareholder Kohlberg Kravis & Roberts' decision to sell its stock last year led to a churning of shares and an accumulation by so-called hedge funds, high-risk investment groups that rarely hold onto an asset for even a year and are often aggressive about wringing out a profit.

Today, more than one-third of Walter's stock is held by hedge funds, including top shareholder Appaloosa Management. Pirate has spent $79-million acquiring nearly 2.1-million shares since March 30, paying an average of $38.32 apiece, the company said Wednesday in a filing with securities regulators.

"I think at the end of the day it will require a breakup in some form or fashion," Loukas said in an interview Wednesday. "There's numerous scenarios as to how you would go about that, as well as numerous timetables to achieve it. That's what an investment bank is for."

Pirate has used similarly aggressive tactics before, at times with great success.

Last year, the company acquired just more than 5 percent of the stock of Cornell Companies, an operator of juvenile jails and treatment centers, and then battled management over the company's direction. A shareholder battle ensued, during which Pirate's stake grew to nearly 15 percent. Last week, Cornell held up a white flag; in exchange for Pirate's promise to drop the proxy fight, Cornell would increase its board size to nine seats and hand Pirate seven of them.

Yolanda Holtzee, co-manager of Seattle investment club ALCAP LLP, said she doubts Pirate will have much of a problem getting other hedge-fund managers on board for a proxy fight with Walter. If anything, she said, she's surprised shareholders such as Daniel Loeb of Third Point LLC didn't demand a breakup earlier.

"Mr. Loeb likes to raise hell," said Holtzee, whose club bought and sold Walter shares in 2004 but no longer owns a stake. "Mr. Loeb loves nothing better than a good proxy battle. That is his avocation in life."

Loeb couldn't be reached for comment Wednesday.

Pirate's warning letter was not its first contact with Walter. Loukas said officials from both companies met this month and spoke before by phone. In his letter, Loukas called CEO DeFosset's response to such overtures "disingenuous, paying lip service to the lofty goal of maximizing shareholder value, while maintaining a separation of business segments was not timely."

Loukas said Walter's stock is undervalued in part because its troubled home-building unit, which lost tens of millions of dollars last year, is masking the success of its coal division. He also said Wall Street analysts don't know quite what to do with the company, given its meld of very different business lines and that when one is doing well, another may not be.

Holtzee agreed Wednesday, saying Wall Street analysts avoid recommending the stock because they tend to be knowledgeable in one business line - coal, for example, or home-building, or industrial products - but not the others. And without analysts monitoring the stock, mutual funds and other institutional investors have little independent information to go on; they, too, shy away.

Walter had an opportunity to give its new hedge-fund investors a voice on the board this year when two of its nine directors announced plans to resign. Instead, the company temporarily shrank the board to seven positions. "The board is conducting a process to identify director candidates and, if appropriate and when qualified candidates are found, the board will exercise its powers to increase the number of directors," it said in a March filing.

Pirate is not alone in thinking Walter's stock is undervalued. Barbara Allen of Avondale Partners, one of two analysts who monitor Walter, predicts the stock price will rise to $75 within the next year, even without a breakup.

Times researcher Caryn Baird contributed to this report.

[Last modified May 26, 2005, 01:16:14]