Activist Investor Takes Issue With Dillard's; Signs Indicate Upcoming Proxy Battle

by Mark Friedman  on Monday, Mar. 3, 2008 12:00 am  

At first, James Mitarotonda asked nicely for Dillard's Inc. to change its management.

In a June 28 letter, Mitarotonda asked Dillard's CEO William Dillard for a meeting to discuss several ways to improve the company, including better merchandising and unlocking the value of Dillard's real estate portfolio.

But Dillard didn't even return a call to Mitarotonda, the CEO of Barington Capital Group LP of New York, which represents a group of investors who own more than 5.3 percent of the outstanding Class A common stock of the Little Rock retailer.

After the June letter was ignored, Mitarotonda fired off a letter directly to Dillard's board in August. It was a scathing missive that called Dillard's corporate governance "nothing short of atrocious." The board, too, refused to respond.

On Jan. 29, Mitarotonda wrote the board yet another letter. This one said Dillard's needed to improve its management to increase its shareholder value.

Between June 30 and Jan. 25, Dillard's stock price dropped 52 percent, wiping out more than $1.5 billion in shareholder value, Mitarotonda wrote. During the same period, the S&P Retail Index fell by 23 percent, he also noted.

And this time, the letter ended with a veiled threat.

"As significant stockholders of the company, we are committed to taking all actions necessary to enhance shareholder value," Mitarotonda wrote.

The letter didn't say what action would be taken, and Mitarotonda declined to comment last week. 

But Barington's history suggests a proxy fight is coming, said Patrick McGurn, special counsel for RiskMetrics Group of New York, which provides corporate governance research and proxy voting advice to large institutional investors.

"Barington Capital is an experienced player in this field," McGurn said. "They've been doing this for a while now, and I think they know the drill. First you sort of agitate and then you ... threaten a proxy fight."

If a proxy fight occurs, most likely Barington would urge shareholders to use their proxy votes to install Barington's candidates on the board of directors.

Dillard's has a shareholders' meeting scheduled for May. And issues that will be brought up at the shareholders' meeting have to be disclosed this month. As of last week, Barington hadn't filed a preliminary proxy statement.

Barington Capital's activism is part of a growing trend, McGurn said. Hedge fund operators have become increasingly involved in corporate management and have succeeded at getting the changes they want, McGurn said.

"Many large funds and a subset of them have adopted corporate governance activisms as their investment strategy," McGurn said. "And so we've seen a literal explosion in the number of threatened proxy fights or other forms of activism by hedge funds in recent years."

Some think Mitarotonda can make changes at Dillard's even though the company's bylaws allow the holders of the Class B shares - that is, the Dillard family - to pick eight of the 12 board members.

If Barington can land one or two people on the board, that will be a victory, said Ron Orol, author of the book "Extreme Value Hedging: How Hedge Fund Managers Are Taking on the World."

"Management doesn't want even one of [the hedge fund managers'] candidates on the board," Orol said, "because they're part of the debate, and they can pressure the company into doing some of the things that the activist wants."

McGurn also said that if a dissident can land one or two board seats, though they won't control the boardroom, at least there would be minority representation on the board.

Dillard's spokeswoman Julie Bull declined to comment on Barington Capital.

Retail Appeal


Right out of business school, Mita-rotonda took a job at Bloomingdale's in New York in 1979 and stayed there until 1981, according to Orol's book "Extreme Value Hedging."

He left Bloomingdale's and started working for Citibank until 1984, Orol wrote. That experience appears to have paid off.

In 1991, Mita-rotonda co-founded the investment firm Barington Capital.

"I utilize my skills and various contacts in a particular industry to improve the value of businesses I invest in," Mitarotonda was quoted in Orol's book. "Certainly, the more you know about one industry, the better you should do in it."

Barington turned its attention to the small, cash-rich dot-com companies, including and Fairmarket Inc., according to a 2004 report by the New York law firm Wachtell Lipton Rosen & Katz.

"Barington had enjoyed a string of successes," the report said. "Its disruptive proxy campaigns had ended either in outright victory or with settlements that gave it board representation and forced corporate action to distribute cash such as liquidation or substantial buybacks."

Then Barington took on Payless ShoeSource Inc.

In 2004, Barington tried to get Mitarotonda and two others on the Payless board.

Mitarotonda urged Payless shareholders in a May 19, 2004, letter to vote for him and the others to improve the company.

He said the management had "a poorly executed merchandising strategy" and "diminishing returns on equity and net assts, and a declining stock price!" Payless responded by suing Barington in U.S. District Court in Topeka, Kan., to prevent Mitarotonda and his people from getting on the board. Payless dismissed the case after Mitarotonda and his two associates failed to be elected in May 2004.

But Barington continued its activist ways. One of Barington's recent successes has been with the auto parts firm The Pep Boys - Manny, Moe & Jack of Philadelphia.

In 2006, Barington led a group of investors who owned 9.9 percent of publicly traded Pep Boys to reconstitute the board and put Mitarotonda aboard. 

"I look forward to working with my fellow directors toward improving the operations and performance of the Company for the benefit of all the Company's shareholders," Mitarotonda said in an Aug. 3, 2006, news release.

The company was in need of a turnaround. Its stock had hit $19.38 in July 2004 and then fallen to $10.48 in July 2006.

After Mitarotonda took a seat on the board, the company's stock rose. It reached nearly $21 in May 2007.

For the 26-week period ended July 29, 2006, Pep Boys had $1.14 billion in revenue and a net income of $649,000. For the same period in 2007, Pep Boys had $1.1 billion in revenue and $7.4 million in income.

But in the third quarter of 2007, which ended Nov. 3, Pep Boys took a hit and reported a loss of $28 million on revenue of $535.4 million. For the same quarter in 2006, Pep Boys had a loss of $10.9 million on revenue of $551 million.

The stock price last week was trading around $12.25.

Still, Pep Boys management is happy to have Mitarotonda.

"He's been very helpful here at Pep Boys," CFO Harry Yanowitz said last week.

Yanowitz, who joined Pep Boys in 2003 and has announced that he will leave as soon as the 2007 books are closed, said Mitarotonda helped management when he brought himself and three others to the board. Mitarotonda "was instrumental in building out the full management team here, including the appointment of the new chief executive," Yanowitz said.

Yanowitz also said Mitarotonda has helped Pep Boys focus on the core stores and business.

"He's been a very constructive member of the team here," Yanowitz said.

Mitarotonda himself is something of a mystery. In a brief interview with Arkansas Business, Mitarotonda, while cordial, declined to go on the record about his plans for Dillard's and even refused to give his age. The Pep Boys proxy filing on May 2, 2007, though, revealed Mitarotonda's age as 52.

Dillard's Watch


The first public sign that Mita-rotonda was furious with the way Dillard's was being operated came in June, when he wrote the letter asking to talk with Dillard's CEO and chairman, William Dillard II.

But he didn't hear back from Dillard.

Mitarotonda watched the stock price fall. Since reaching $40.56 on May 21, the stock price has slid to around $16.50 as of last week.

Mitarotonda accused Dillard of ruining the business after taking over from his father, William Dillard, who started the company in 1938.

Since William Dillard II received the keys to the company in 1998 from his father, Dillard's market capitalization has fallen from $3.8 billion to $1.9 billion in August 2007, Mitarotonda wrote in the Aug. 30 letter to the board.

Mitarotonda, however, still couldn't get any reaction.

"We believe that the vast value potential of the Company is not being realized," Mitarotonda wrote in his Jan. 29 letter to the board. "In our opinion, if the Company were more effectively managed it would be worth substantially more than its current stock price."

Mitarotonda noted a November 2007 Deutsche Bank report that estimates Dillard's net asset value before taxes to be $59 per share because of its real estate portfolio. Dillard's owns about 75 percent of its 331 stores.

Mitarotonda said Dillard's could improve the value of the real estate by closing unprofitable stores or selling some of its property. Mitarotonda also was unhappy with Dillard's latest two quarters, in which it posted losses of $24.5 million and $6.5 million.


"The disappointing financial performance of Dillard's must be addressed," Mitarotonda wrote. "Unfortunately, the past few quarters are but a continuation of Dillard's history of chronic underperformance."

'Value Investors on Steroids' 

While it's not known exactly what move Mitarotonda will make next, whatever he does might be successful. In the last couple of years, hedge funds managers have been successful between 50 and 75 percent of the time in getting what they were seeking, said McGurn of RiskMetrics.

He said hedge funds are looking for board representation to argue for changes in the company.

"I like to describe these activist hedge funds as sort of value investors on steroids," McGurn said. "They're trying to find companies that they think are underperforming but have a good underlying business."

As soon as these activist investors invest in a company, the stock price usually rises, he said. "And so it's one of those strategies that have proven to be a winner," McGurn said, "not only for the investors that invest with these particular hedge funds, but obviously for the people who run these hedge funds and receive their fees as a percentage of the gains that they make."

The shareholder activist who lands on a company's board generally is a positive force in the company, said Amy Borrus, deputy director of the Council of Institutional Investors of Washington, D.C. She said having an activist on the board shows that the investor is trying to improve the company.

"You don't get a seat on the board unless you plan to be with the company for a while," Borrus said. The board members "are making a long-term commitment to the company. Andy they're not just doing it to make a quick buck."                               n



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