Activist Jana prepares to bring star nominees to Freshpet’s board of directors. This is how it can create value

In this article

  • FRPT

Company: Freshpet (FRPT)

Business: Freshpet manufactures and markets natural, fresh meals and treats for dogs and cats in the United States, Canada and Europe. The Company sells its products under the Freshpet brand along with the Dognation and Dog Joy brands through various retail classes including grocery, bulk, club, specialty pet and nature, and online.

market value: $2.3 billion ($50.09 per share)

Activist: Jana Partners

Percentage ownership: 9.89%

average cost: $42.76

Activist Comment: Jana is a highly experienced activist investor founded in 2001 by Barry Rosenstein. They have made a name for themselves by taking thoroughly researched activist positions with well thought out plans for long-term value. Barry Rosenstein called his activist strategy “V-Cube”. The three Vs were: (i) value: buy at the right price; (ii) votes: know if you have the votes before starting a proxy fight; and (iii) Variety of Winning Opportunities: having more than one strategy to improve on. Since 2008 they have progressively transitioned this strategy to what we characterize as “the three S’s” (i) stock price – buy at the right price, (ii) Strategic Activism – sale of business or spin-off of a company; and (iii) Star Advisor/Nominee – working with top industry executives to advise and take board seats when needed on sales of Pinnacle Foods, PetSmart, Safeway, Whole Foods and ConAgra’s spin-off of its Lamb Weston business.

What’s happening?

Jana entered into nomination agreements under which the following six nominees have agreed to serve on a potential Jana board of directors for election at Freshpet’s 2023 annual meeting: (i) Diane Dietz, an investor and consultant in the consumer and retail sectors, who Served as President and CEO of Rodan & Fields, LLC, a premium skin care brand, and CMO of Safeway, Inc., a grocery and drug retailer; (ii) James Lillie, a private investor who previously served as CEO of Jarden Corporation, a consumer products company; (iii) Timothy R. McLevish, Managing Partner of Strategic Advisory Partners LLC – he was also previously CFO of Kraft Foods Inc. and Kraft Foods Group, CFO of Carrier Global Corporation, an HVAC manufacturer, and CFO of Walgreens Boots Alliance – (iv) Dwyane Wade, CEO of Wade Enterprises, Inc., an owner of the National Basketball Association’s Utah Jazz and founder of Wade Cellars, who was previously a professional basketball player in the NBA for 16 years; (v) Carsten Charles (“CC”) Sabathia, Jr., Special Assistant to the MLB Commissioner, Executive Vice President of The Players Alliance and host of the R2C2 Podcast, who was previously a professional pitcher in MLB for 19 years; and (vi) Ginger Gorden, CEO of GD Group, Inc., a business management services company. In addition, Jana announced that she intends to hold discussions with Freshpet’s board and management team to (a) assess the company’s strategic value in a sale, given interest in the category of significantly larger companies with lower costs of capital and strong operational capabilities leveraged globally footprints and larger scale; (b) capital allocation, including Freshpet capacity expansion initiatives; (c) operations, fill rates, costs, free cash flow, brand building and margin execution; (d) investor communications; (e) administration; (f) management compensation and incentives; and (g) board composition and governance matters.

Backstage

Freshpet is a manufacturer of fresh food for dogs and cats. It has a great product in an attractive, growing market with huge distribution and exclusivity deals that are difficult to replicate. The company owns 27,000 Freshpet refrigerators in grocery and specialty stores. These are refrigerators that Freshpet buys, maintains and stocks, which is a win-win for both the company and the retailer. The company benefits from this because it gives it a great competitive advantage for its business and a competitive edge over competitors. Retailers love it because it doesn’t take up space in their existing fridge and because customers who buy fresh pet food are less likely to stock up on the product that takes up fridge space, drawing the customer back to the store sooner.

Since the end of April 2021, Freshpet’s stock has fallen from about $184 per share to about $45 per share at the end of September, while revenue has grown from $425 million to over $500 million over the past year and keeps growing. The problem isn’t the top line. The problem is that the company has grown rapidly to a point where the management team’s skills are not up to the challenge. We see this a lot in activist campaigns like Chipotle. This has led to issues such as a 70% fill rate on client orders where well managed peers generally operate at a 95% to 100% fill rate.

The first opportunity to add value here is to moderate Freshpet’s expansion plans and get the supply chain in order. Without it, the company could end up using all of its liquidity and balance sheet capacity to fund its expansion. It has already made three stock offerings to fund its growth. Those operational issues are fixable, but that would require a reshuffled board and a management team focused on efficiently growing the company. Unfortunately, management does not appear to be well positioned or focused on growing the company to maximize shareholder value. Freshpet Chairman Charles Norris has served on the board for approximately 16 years. Although the company hired a new CEO in 2016, co-founder Scott Morris still holds the title of President and COO. If you’re wondering how focused he is on the business, all you need to know is that he co-founded a new company, Hive Brands, in 2020 while presumably working full-time as Freshpet’s President and COO. Shockingly, the board had no problem with that.

The other way to create shareholder value is to sell the company. Pet and baby products are two of the most attractive categories among consumer packaged goods companies (“CPGs”), which is a consolidating area as these companies are notoriously difficult to grow organically. There is likely to be significant interest in Freshpet from larger CPGs that already have a pet food business or from CPGs looking to start a pet food business. These larger companies already have the management team and infrastructure capable of handling almost any rate of growth with order fill rates in excess of 95%. This would be the much easier option with less time investment and uncertainty and should definitely be looked into by the company. In that regard, this is very similar to Jana’s 2017 campaign at Whole Foods, which had similar issues and dynamics as Freshpet and was quickly sold to Amazon. Achieving any of these value creation opportunities depends on Jana’s ability to win seats on the board, either by consensus or by force.

As in many of his earlier activist situations, Jana has teamed up with an all-star group of Operators to help develop his thesis, consult with them and, if necessary, become potential board candidates. The six people who have agreed to become potential Jana directors at the 2023 Annual Meeting include former CEOs, CFOs and CMOs of large publicly traded companies, as well as two people we see in a plaza or field rather than a boardroom: Dwyane Wade, formerly of the Miami Heat, and CC Sabathia, formerly of the New York Yankees. While Wade and Sabathia may not have the obvious relevant experience of former public company executives, Wade has entrepreneurial experience as the founder of Wade Cellars, and both have extensive experience building their own brands. Additionally, it takes an extreme level of work ethic and focus to achieve what they have in the sport: two things the company seems to be in dire need of, along with a diversity of experience and perspective as the board is 90% off White and 70% male. Although Jana has agreements with six potential candidates, there are only four seats up for election next year, so there is likely only room for three of those six seats as Jana is historically adding one of her own executives to the board. Accordingly, the list that makes the most sense would be a Jana candidate, two former executives, and either Wade or Sabathia.

Freshpet’s 2022 AGM will be held on October 3rd, so Jana will not have the opportunity to nominate directors this year. But at next year’s October meeting, the company’s longtime chairman, Norris, and CEO, William Cyr, will both stand for election. When they are replaced, there will be a real power shift in the company, not to mention a shareholder mandate for change. Additionally, due to Freshpet’s severe underperformance, there is a high probability that this shareholder base will support Jana. Many major shareholders, including those who bought for $81 per share in the May 2022 share offering, are deep on their investment and would likely support Jana. Those same shareholders would also likely support a sale of the company at a 40% premium, though that’s well below 2021 highs of about $184 per share. Unlike many similarly positioned companies, there may not be much management resistance to a sale. The President/Co-Founder has a foot in the door with the formation of his new company. The chairman is up for election next year and would probably prefer to exit through the sale of the company rather than be voted off the board. After all, the CEO, who is also up for election next year, would have a similar motivation, in addition to a likely big payday on a sale.

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 13D activist assets. Freshpet is a holding in the fund. Squire is also the creator of the AESG™ investment category, an activist investment style focused on improving portfolio companies’ ESG practices.