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Barry Rosenstein launched Jana Partners in 2001 with $17 million, an analyst, and a secretary. He has built it into a $10 billion asset manager with a reputation for prodding companies to make changes, whether it's selling off underperforming divisions or making more share repurchases. Jana's value-oriented style is usually based on free-cash-flow multiples, but it will take an activist approach if it decides that's the best catalyst to get the stock moving. (Its activist holdings range from 15% to 30% of the portfolios.) Barron's recently met with Rosenstein, 55, and a partner and co-portfolio manager, David DiDomenico, 43, who previously ran an event-driven hedge fund at New Mountain Capital, and now runs three funds with Rosenstein. Even though equity markets have had a huge run, the two say they are finding plenty of interesting companies that look undervalued and have some kind of a catalyst to boost the stock price. Here's what the Jana partners had to say in an interview at their offices in the General Motors Building in New York.

Barron's:What comes to mind, Barry, when you look back on the world of corporate raiding in the 1980s?

Rosenstein: I was 27 years old when I started, and it was very exciting. We were right in the middle of what was the hottest thing happening on Wall Street. I was actually too young and naive to even realize how unusual that time period was. Capital was free and easy. You would go down to talk to an investment bank -- maybe Merrill, Drexel, or Lehman Brothers -- and you would come back with a $1 billion subordinated debt commitment, and $1 billion really was a lot in the world of deal financing in those days. So you would go from one deal to the next, and focus on some really big companies at the time, including Burlington Industries, Telex, and Payless Cashways.

So what's different today?

Rosenstein: Today, companies and their advisors are much more sophisticated. Often times, when we show up, we will advocate certain things that they've already been thinking about. But in the 1980s, nobody thought about things that way. In fact, even from the activist's perspective, the idea of publicly shining a light on a company and advocating change for the greater good just wasn't done. It was really all about tendering for the company. Now, however, you really can't tender for a company, because you can't get that kind of financing, among other reasons. But the evolution of activism is not just an accident. The mainstreaming of activism is a function of its becoming much more institutional, and more inclusive. Everybody benefits, not just one guy. The shareholders benefit, and the employees ultimately benefit. Employees are never happy about working for companies that are underperforming. So activism has become a tool for greater efficiency and productivity.

Despite the rally, Barry Rosenstein, left, and David DiDomenico say they see lots of opportunities. Photo: Peter Murphy for Barron's

Based on your dealings with companies, are there any particular governance areas that still need improvement?

Rosenstein: You often have well-meaning directors who are smart. But they are often running their own businesses, so they are not fully focused on their board memberships. They come in every quarter. But unless something is radically wrong, they are OK with how things are going, and they move on and go back to their own businesses. And they come back the next quarter, but they are not owner-operators. They are not large owners of the company, so they don't have the financial skin in the game that would cause them to focus. So when someone like us shows up, all of a sudden it jars people's attention, and they start looking at the issues we identify. I'm not sure how that can change, but it is just a function of the board process.

How would you sum up your investing approach?

Rosenstein: It is value plus catalyst, which means we look for companies that are undervalued by the market and that have one or more catalysts to unlock that value, and in some cases, we will be that catalyst through our activism. Our short strategy is the inverse -- i.e., overvalued companies with some catalyst for correction.

How is the environment for finding the kinds of stocks you look for?

Rosenstein: Cash on corporate balance sheets and financing rates lend themselves to making acquisitions or some sort of return-of-capital, such as share repurchases. With rates where they are, every acquisition is pretty much accretive today. Private equity is getting more active, and the mergers-and-acquisitions market, which has picked up, is really strong. The economy seems to be on the road to recovery, albeit slowly. So it is proving safe now for CEOs to look at acquisitions. And considering that internal growth is still difficult to achieve, companies are more open to these types of solutions to create value.

DiDomenico: The market isn't necessarily cheap right now, but it is not overpriced, either. We are looking for 15 or 20 situations that have value and some kind of a catalyst -- a company undergoing some kind of change, for instance. And there is always ample opportunity to find a select group of situations that meet our criteria.

Let's hear about a few of your holdings, and what kind of opportunities you see.

Rosenstein: Our biggest position is Walgreen [WAG]. It is an iconic company and brand, but it has underperformed. In the 10 years prior to the announcement in mid-2012 that Walgreen would take a 45% stake in Alliance Boots, the stock was down around 7%, versus about a 65% gain for the Standard & Poor's 500. CVS Caremark [CVS] was up more than 200%, so there is a disconnect. CVS has Ebit [earnings before interest and taxes] margins that are about 50% higher than Walgreen's are. Boots has margins that are about double, and they are in the same businesses. So something is not right. But I give Greg Wasson, the CEO of Walgreen, a lot of credit for pursuing this deal with Alliance Boots, because he recognized that something needed to be done. And he's teaming up with Stefano Pessina, the executive chairman of Alliance Boots, who is the largest shareholder. He is a world-class value creator. At the close of the Walgreen-Alliance Boots transaction, Pessina will be the largest shareholder, owning roughly 17% of the combined company, with a stake worth well over $10 billion personally. So when we talk about skin in the game, this is a guy who really does have it.

Why does this combination make sense?

Rosenstein: Alliance can apply a lot of its playbook to Walgreen. Alliance has been very successful at innovating and investing in the front of its stores and developing products, including their private-label products, which have higher margins. People place a lot of value on those products. And there is a $70 billion cost base at the combined companies that they can attack. And then, postmerger and pro-forma, debt to Ebitda [earnings before interest, taxes, depreciation, and amortization] will be something like one times, which is overly conservative. Pessina has made a career out of maximizing returns on equity by utilizing more-prudent levels of leverage. He has operated with anywhere from four to nine times Ebitda. So they could double their leverage today and still be investment-grade. And then, finally, there is the possibility of doing a tax inversion, in which the company would be domiciled outside of the U.S. and benefit from a more favorable tax rate. That wasn't the primary driver for the deal. But we read with interest the recent comments of Ian Read, the CEO of Pfizer [PFE], where he said that he viewed minimizing taxes as a fiduciary obligation to his shareholders, and we don't think it is any different in the case of Walgreen.

Are you planning to take an activist approach?

Rosenstein: We just think that by shining the spotlight on the company and staying on top of management and the board -- and making sure they pursue the things they articulated -- it will bring the value.

Jana Partners' Picks Company TickerRecent Price Walgreen / WAG $68.61 Oil States International / OIS 96.49 Equinix / EQIX 195.45Source: Bloomberg Walgreen / WAG $68.61 Oil States International / OIS 96.49 Equinix / EQIX 195.45Source: Bloomberg

Let's try another sector.

DiDomenico: Oil States Internationa l [OIS] has two diverse businesses, and you can unlock value by separating them. We got involved in Oil States a little over a year ago. They are in oil-field services, providing well-site construction and other services related to onshore drilling. They also have some technology for offshore drilling. Both onshore and offshore drilling are quite healthy and attractive businesses.

Their other business provides remote employee housing, mainly for oil-field service and mining workers, primarily in the Canadian oil sands, and they also have assets in the U.S. and Australia. That business is characterized by two-to-three-year contracts for large multinational companies, and it has very attractive returns on capital. It's not driven by the next tick in crude-oil prices.

What got you interested in this company?

DiDomenico: Oil States was trading at a very low multiple when we acquired our stake at around 5.5 times Ebitda, versus 7.5 times recently. But both businesses are worth more than that. We had a great dialogue with the company's CEO, Cynthia Taylor, who has a great reputation for driving shareholder value. Shortly after we presented her with some ideas, she announced her intention to separate the company's two business. And that is set to happen at the end of the month when the accommodations business, to be called Civeo, will be spun out to common stockholders tax-free. Given the stability of that business and its underlying characteristics, it should trade more in line with, say, real estate investment trusts. You could even compare it to a nontraditional REIT like a prison REIT, and those businesses are trading at 13 to 14 times Ebitda. Corrections Corp. of America [CXW] trades at nearly 13 times forward Ebitda.

It's also interesting that some of the most sophisticated real estate investors in the U.S. are getting interested in the employee housing space as an asset class, particularly in areas like the Bakken Range in North Dakota. These properties are being sold and financed at 12 to 14 times Ebitda.

Where else are you finding value?

DiDomenico: Equinix [EQIX] is a large position of ours and what we describe as a value-plus-catalyst situation. We've held it for nearly a year. It operates about 100 data centers globally and [provides] customers with immediate access to the Internet's backbone, or interconnections with other customers in the data center. About 25% of their customers are networks, including companies like AT&T, and 25% are cloud companies like Amazon Web Services and Salesforce.com. We like businesses that have very predictable earnings and cash-flow characteristics. For Equinix, about 95% of revenues are recurring. Its churn rate is very low, about 10% annually.

The business has grown and hasn't had a down quarter on a year-over-year basis -- in terms of revenues or operating income before depreciation and amortization -- for the past seven years. It grew through the Great Recession. It has Ebitda margins of around 45% and attractive financial returns. And it has a pretty important catalyst coming up, notably that it is converting to a REIT, probably on Jan. 1 of next year. It is, in fact, the only U.S.-based publicly traded data-center company that has not yet converted to a REIT, and it is trading at a discount to all of the REIT data-center companies such as Digital Realty Trust [DLR], which trades at 15 times forward Ebitda.

What is keeping its multiple lower?

DiDomenico: The market is concerned about whether Equinix will actually be able to convert to a REIT. There has also been a concern about the slowdown in the growth rate of its business. So the growth expectations last year came down a little bit. And there was a cycle of growth investors who left the stock, and value investors who entered the stock. But if you look at the stability of the business and its inherent growth rate, it trades at a discount relative to the group.

Thanks, gentlemen.

E-mail: penta@barrons.com