Activist Meister eyes up another possible conglomerate break-up to unlock value

MDU Resources is a regulated energy delivery and construction materials and services business. The company is organized into the following four business segments: (i) utilities: electric and natural gas distribution, (ii) pipeline, (iii) construction materials and contracting (their aggregates business), and (iv) construction services.

Stock Market Value: $6.3 billion ($31.20 a share)

Percentage Ownership: 5.5%

Average Cost: $26.57

Activist Commentary: Corvex was founded in 2011 by Keith Meister, Carl Icahn’s former lieutenant who served as CEO and vice chairman of Icahn Enterprises. Corvex is a highly concentrated, fundamentally driven hedge fund that uses activism as a tool, but not a primary strategy. Their preference is not to be activist, with a proxy fight being a last resort, and would prefer to amicably be invited on Boards.

Corvex expressed its support for the company’s recently announced decision to separate Knife River construction materials through a tax-free spinoff to shareholders. Additionally, Corvex intends to enter into discussions with the company’s board and management to discuss: (i) additional strategic alternatives to further maximize shareholder value and (ii) plans to enhance the earnings potential of the company’s assets to levels in line with industry peers.

MDU operates in a conglomerate structure with utilities, pipeline, construction materials and contracting, and construction services. Its utilities business operates in eight states — North Dakota, South Dakota, Idaho, Washington, Montana, Oregon, Wyoming and Minnesota, and depending on the state makes somewhere near 10% contracted profit on its costs.

This activist campaign is all about pure play and simplicity. One need look no further than Corvex’s 2020 activist campaign at utilities company Exelon to see that. At Exelon, in October of 2020 Corvex stated that the company trades at a discount with a 30% stock upside because of its diversified business structure and that pure play, regulated businesses receive premium valuations. The stock was trading at $39.32 then.

Six months later, Exelon announced that it will spinoff Constellation Energy Corp. In February of 2022 when the spinoff was completed the stock was trading at $42 per share. Exelon shareholders received $16.50 of value as of the spinoff closing date and $25 worth of value as of today’s price from their Constellation holdings and not only did Exelon shares not drop, but they are trading at $46 per share today. Corvex is likely pursuing a similar game plan here. 

These are all good businesses that alone should be 20 times earnings’ businesses, but together they trade at a discount due to the conglomerate structure. The company took the first step in pursuing this value creation opportunity last week when they announced that they would be spinning off their aggregates business, Knife River Corp, which is expected to be completed in 2023.

However, it is not clear if this was the company taking the first step in a larger plan to break apart its conglomerate structure or whether they were placating an activist who has been buying stock for some time now. It is interesting to note that that the company retained JP Morgan, PJT Partners, Joele Frank and Wachtell Lipton in connection with that spinoff transaction. These are all top advisors in defending against activists and indicates that the company might be gearing up for a fight rather than initiating the beginning of an agreeable plan.

If the company is getting ready for a fight, there is no doubt that Corvex will bring one if it cannot amicably settle with the company. But they have a lot of time to try to come to an amicable agreement with the nomination window not opening until January 10, 2023. What Corvex would be looking for is the divestiture of the construction services segment and some form of board representation to help management more efficiently operate the business. This is similar to what Carl Icahn, Meister’s former mentor, is doing at Southwest Gas. This plan could result in a $45-plus stock price at MDU in an investment that has significant downside and inflation protection as a rate-based utility.

There is also an Activist ESG (AESG) thesis here. The company’s energy generation is currently divided into three areas: coal, natural gas and renewables. However, as equipment and facilities depreciate, they can no longer be included in the rate base and the company cannot get paid on them. So, companies like MDU will close facilities and retire equipment and build new facilities and buy new equipment that can be added back into the rate base.  The trend in the industry is towards more environmentally friendly assets. So, while MDU presently is approximately one-third coal, one-third natural gas and one-third renewables, in 2010 the company was only 11% renewables.

Finally, it should be noted that Corvex filed its 13D with a 4.99% ownership and 0.59% cash settled swap exposure. Like Icahn in Southwest Gas, there could be state restrictions that prohibit a shareholder of a utility from acquiring 5.0% of common stock. To get the economic exposure they wanted, Corvex used cash settled swaps and it is commendable that they disclosed this in a 13D filing. We often see activists using cash settled swaps as a gray area and loophole to avoid exceeding a 5% beneficial ownership threshold which requires a 13D filing, and as a result this is now the subject of an SEC proposal. It is refreshing to see an activist like Corvex err on the side of transparency here and indicate that they are not in this to play games but openly work with management to create long term shareholder value.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and he is the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving ESG practices of portfolio companies.