BBWI - Bath & Body: Daniel Loeb Scores A Win

2023-03-16 10:36:05 ET

Summary

• Daniel Loeb, who leads Third Point, sent a strongly worded letter to Bath & Body Works last month revealing that his hedge fund plans to launch a board challenge.
• Mr. Loeb was pushing Bath & Body to appoint his close ally Munib Islam to the Board – a request that was denied by the company.
• On March 6, Bath & Body appointed Thomas Kuhn to the Board, and there is reason to believe that the company's capital allocation policy is up for a few changes.
• The company has a long runway for growth, and the activist approach of Third Point may accelerate its growth in the coming years.
• Investors, however, will have to deal with some challenges in 2023.

At Leads From Gurus, we keep a close eye on guru activities to uncover investment opportunities and also to validate our thesis for certain companies. Bath & Body Works, Inc. ( BBWI ) caught our attention with billionaire investor Daniel Loeb, who leads Third Point, sending a strongly worded letter to Bath & Body on February 22, revealing that his hedge fund plans to launch a board challenge. The letter addressed the company’s corporate governance, capital allocation, and executive pay, and claimed the company’s appointment of new directors does not address these concerns. Third Point’s initial 13D filing in December 2022 expressed concern about the company’s financial discipline, investor communication strategy, board composition, and executive compensation structure. Mr. Loeb is calling for shareholder representation on the Board to alleviate concerns about decision-making processes. This proxy fight comes after Third Point revealed in December that it owns a 6% stake in the company and criticized its high costs and lagging share price. Mr. Loeb was pushing Bath & Body to appoint his close ally Munib Islam to the Board – a request that was denied by the company for reasons highlighted in a letter to Third Point on February 27. However, on March 6, Bath & Body appointed Thomas Kuhn to the Board on the recommendation of Third Point.

In this article, we will look at the concerns highlighted by Daniel Loeb in his letter to determine whether investors should be concerned about Bath & Body's future.

Third Point's Concerns

Third Point's concerns about Bath & Body are centered around corporate governance, capital allocation, and executive pay. Mr. Loeb's criticism of Bath & Body’s Board centers around several key areas. First, he takes issue with the Board's corporate governance practices, claiming that the company's decision-making processes are flawed and that additional oversight is required. Second, Mr. Loeb is critical of the company's capital allocation strategy, arguing that it has not been effective in generating expected returns for shareholders. Finally, Mr. Loeb targets the company's executive pay strategy, arguing that it is excessive and not in line with industry standards.

Corporate governance

Third Point has criticized the way Bath & Body’s Board operates. In his letter, Mr. Loeb wrote:

As fiduciaries, we have no choice but to put forth qualified director candidates and give our fellow shareholders the opportunity to elect directors who can hold the stewards of their capital responsible for the decisions they make.

The company, anyways, has progressed well since the separation from L Brands in 2020 both from a financial performance perspective and a market performance perspective.

Capital allocation

Third Point has expressed concern about Bath & Body’s capital allocation strategy. The company's high costs and lagging share price in recent months have raised red flags. Mr. Loeb is criticizing the company's lack of financial discipline and the need for additional expertise when it comes to financial and capital allocation. Third Point has suggested that shareholder representation on the board would ensure that the company's capital is allocated wisely.

This is an area that Bath & Body has also identified as necessary. The company, in its response to Mr. Loeb, accepted the need for more financial expertise at the Board but expressed its concern that Munib Islam was not the right candidate to bring this expertise.

Executive pay

Third Point is also criticizing Bath & Body’s executive pay structure. The company's interim CEO, Sarah Nash, received an $18 million pay package on top of her $700,000 salary as Board chair. Mr. Loeb has called the pay package "outsized" and has accused the company of a massive governance failure. His claim is not unfounded. The fact that the board named its own chair as interim CEO without conducting a comprehensive search for qualified candidates and without seeking input from shareholders or an activist investor raises questions about the Board's independence and its commitment to securing shareholder interests. Sarah Nash, Chair of the Board, was named interim CEO of Bath & Body following the resignation of former CEO Andrew Meslow. The company agreed to increase Ms. Nash's annual compensation as Chair to $1 million from $700,000 and pay her an annual base salary of $1.35 million with a short-term performance incentive compensation target of 190% of her base salary for her work as interim CEO. Additionally, the Board awarded her $18 million of restricted stock, regardless of how long she served as interim CEO. Ms. Nash served as interim CEO for seven months. This significant increase in compensation that the board awarded to the interim CEO, including an $18 million restricted stock grant, appears excessive and out of step with industry norms, particularly given the short duration of her tenure. Further, Mr. Loeb has criticized the company's succession planning, saying that Ms. Nash was ill-suited for the role of interim CEO. Bath & Body Works appointed Gina Boswell as CEO late last year.

Bath & Body Works Board Slams Third Point's Proxy Challenge as ‘Misguided’

Bath & Body has said that it disagrees with the views expressed in Third Point's letter, but indicated the company will review and consider its proposed board nominations. The company's Board added Lucy Brady and Steve Voskui, who are considered to have financial and capital allocation experts, possibly to assuage Third Point's criticisms. However, this move did not appease Mr. Loeb who said that the Board's response to his request to add a shareholder representative was inadequate. With the appointment of Thomas Kuhn, however, Third Point is likely to take a back seat for now.

The board of directors at Bath & Body Works has labeled Third Point's proxy challenge as "misguided," and the retailer has expressed disappointment that a costly public proxy fight seems inevitable. The Board emphasized that it had engaged "constructively in good faith" with Third Point for several months and demonstrated openness to all its views and recommendations.

In its letter to shareholders, the company stated that it had taken all reasonable steps to avoid a costly and distracting proxy fight and highlighted the Board's recent refreshment, which involved adding two new directors, as an indication that the company was already taking steps to address any governance concerns. The company also stressed that its current slate of directors was confident in its ability to execute the company's growth strategy.

Long Runway For Growth

Bath & Body still has a long runway for growth, aided by the company's strong footing in several high-growth markets such as the beauty industry, home fragrance market, and the soap market. The company is focused on expanding its product pipeline to move into new product segments to capture new market opportunities. The company is yet to fully tap into the potential of international markets as well.

Bath & Body is one of the very few retailers that have demonstrated stellar growth in foot traffic over the last decade. With e-commerce continuing to disrupt the retail industry, this achievement is a testament to the brand loyalty associated with Bath & Body's products. This brand loyalty suggests the company is enjoying competitive advantages, which should help Bath & Body earn economic profits in the future.

Sales per average selling square foot of Bath & Body Works

Despite the promising long-term outlook, Bath & Body is likely to face short-term challenges as a result of a weak consumer and inflationary pressures, which was evident in the company's Q4 earnings as well. Margin compression is also likely as a result of cost pressures, and the company has guided for lackluster earnings this year with revenue expected to decline in Q1 while EPS for the full year is expected between $2.50 and $3, well below the EPS of $3.40 reported in 2022. This expected slowdown in business could lead to a sluggish stock market performance in 2023.

Takeaway

Daniel Loeb has scored a victory by securing a board seat at Bath & Body Works, a company that is well-positioned to grow in the long run despite facing short-term challenges. The company is likely to focus on more effective capital allocation decisions in the coming quarters with this appointment, some of which may include changes to the shareholder distribution policy and a renewed focus on accelerating growth. We will keep a close eye on the company to identify potential inflection points in the company's story.

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