A battle heats up between a deep-research investor with a private equity mindset and an underperforming small cap software stock. This is a textbook case of good activism — a company with poor operating history, horrible corporate governance, underperforming stock, overpaid CEO and a large, long-term shareholder with a very friendly and reasonable request with impressive director nominees.
Company: Virtusa Corp. (VRTU)
- Business: Virtusa’s technology services include information technology (IT) and business consulting, digital enablement services, user experience (UX) design, development of IT applications, maintenance and support services, systems integration, infrastructure and managed services. Its services enable its clients to accelerate business outcomes by consolidating, rationalizing and modernizing the clients’ core customer-facing processes into one or more core systems.
- Stock Market Value: $924 million ($30.67 per share)
Activist: New Mountain Vantage
- Beneficial Ownership: 8.98%
- Economic Exposure: In addition to the 2,706,161 (8.98%) shares of common stock owned by New Mountain, they have economic exposure, but not voting control, to 540,654 shares underlying cash-settled swaps for a total economic exposure of 3,246,815 shares (10.78%).
- Average Cost: $37.79 per share
- Activist Commentary: New Mountain manages private equity, public equity and credit capital with aggregate assets under management totaling more than $20 billion. It started as a private equity fund but has had a public equities fund for over fourteen years, and manages $1.8 billion. The firm is fundamental, bottoms up, deep-research investors with a private equity mindset and a long-term view. Their style is active shareholders who are very engaged with management, but most of the time privately. This is New Mountain’s first 13D filing in seven years.
On June 17, 2020, New Mountain Vantage nominated the following three director nominees for election to Virtusa’s Board at the 2020 Annual Meeting: (i) Michael Baresich, founder and CEO of New York Tech Advisors, L.L.C., which provides specialized advisory services to technology-focused companies; (ii) Ramakrishna Prasad Chintamaneni, managing director at New Mountain Capital, L.L.C., where he leads the firm’s investment initiatives in digital transformation; and (iii) Patricia “Patty” Morrison, former executive vice president and chief information officer at Cardinal Health, Inc., Motorola, Inc. and Office Depot, Inc.
Behind the Scenes
New Mountain began investing in Virtusa in the fall of 2019. On April 29, 2020, New Mountain delivered a presentation to the company including a specific path forward and made a formal request for Board representation for Chintamaneni and Chad Fauser, two New Mountain employees. On June 12th, the company announced that it would appoint an additional independent board candidate with IT services experience, ignoring New Mountain’s request for a board seat, causing New Mountain to escalate its activism publicly with a June 17th letter to the Board.
In the letter, New Mountain points out, among other things:
- The company’s horrible operating margins (declining from 14.3% in 2015 to 8.7% in 2020, 50% below peers)
- Poor annual EPS growth of only 3% despite annual revenue growth of 22%
- Poor capital allocation decisions, specifically the company’s acquisition of Polaris.
- Corporate governance practices that include a staggered board, co-Chairman/CEO, lack of board diversity and the inability for shareholders to call a special meeting or act by written consent.
But more importantly, all of this has led to a stock price that has declined by nearly 40% over the last five years while its relevant Russell 3000 peer group has delivered a nearly 70% return all while Virtusa’s CEO’s compensation has grown by 122%.
Accordingly, on June 22nd, New Mountain announced its nomination of three director candidates for election to the board at the 2020 Annual Meeting, but is willing to compromise for: (i) Board representation for either Chad Fauser or Prasad Chintamaneni at Virtusa’s choice; (ii) the addition of two mutually agreed upon independent directors, one of which can be sourced by Virtusa and one by New Mountain, (iii) formation of a business optimization committee or task force of the board or the expansion of the scope of the existing finance committee to include developing a detailed margin improvement and revenue diversification plan; and (iv) a commitment to articulate to the market a concrete margin improvement plan and revenue diversification strategy, together with improved communication to investors, analysts and other market participants.
New Mountain has nominated two directors with industry experience and a New Mountain executive who also has deep industry experience as an operator at Cognizant. When boards and founders see this, they often think someone is coming for their jobs, but that is not New Mountain’s style. This is a case of a company that needs better board oversight that holds management more accountable. With fresh industry executives on the board, they can work with management to improve margins by diversifying revenue stream, walking away from low-margin revenue and better optimizing and managing the employee base. Moreover, an increase in digital revenue could lead to a multiple expansion from approximately 10 times where Virtusa trades today to over 15 times where its closest peers trade.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.