By David Marcus

"In the middle of difficulty lies opportunity" - Albert Einstein

The worst economic and market disruption since the era of the Great Depression has profoundly changed the rules for business engagement and success around the world.  But at the same time, opportunities will abound, both internally and externally, for managers to unlock the value inherent in their companies-to the benefit of discerning investors.

What's required is for management to take necessary transformative steps that position their companies to respond to new imperatives and outpace their competitors for the long term.  Not all corporate management teams will do so.  Identifying those that will-through an in-depth, personal assessment of the team itself-is a cornerstone of a highly active approach to value investing.

Active value is a methodology based on seeking out undervalued businesses undergoing significant strategic changes and taking advantage of these opportunities through investments across the capital structure. The approach demands careful evaluation of whether a company can achieve its strategic plans and projections-a process that draws its best support from practical business and operating experience as well as long relationships with managers globally.

It's not a hedge fund approach that focuses on finding and profiting from small inefficiencies via significant use of leverage, with significant risk.  Rather, active value is an "old school" approach; its goal is to find companies with real value, trading at substantial discounts, with a real margin of safety.

Active value is well suited to the emerging opportunities of a changed and demanding business environment-and worthy of the attention of advisors seeking to build a globally focused, value component into portfolios.

Global Recovery Creates Opportunities For "Transformation"

It's become clear that time will be needed to repair and rehabilitate economies globally and that the days of "business as usual" are behind us.

Global GDP, which declined by 2.2% in 2009, is expected to grow 2.7% this year and 3.2% in 2011, according to the World Bank.  But growth won't proceed at the same pace throughout the world.  For example, the Morgan Stanley Global Economic Forum estimates that U.S. output will expand by 2.8% in 2010, but that the "euro area" economies will grow by less than half that rate (1.2%). Japan, according to the forum, could fall back into recession sometime later in 2010. Real GDP growth among emerging economies is forecast to reach almost 5% in 2010, with the rebound driven by China, India and a number of other vibrant Asian nations, according to the International Monetary Fund.

Going forward, corporate value's emergence will have little to do with a smoothly humming global engine of expansion.  Rather, value will be far more contingent on what each corporate management team does to discover and maximize its own growth prospects.

Seeking Growth Via Transaction

Companies seeking turbo-charged growth have often resorted to merger or acquisition, which has been illustrated in recent months. Globally, deal volume jumped 15% in fourth quarter 2009, to $684.9 billion, from $594.7 billion a year earlier, according to Dealogic.  According to Morgan Stanley's European M&A team, the dollar value of European deals could rise as much as 30% in 2010.  Sharp improvement in the fundamental financial posture of many corporations-and hence renewed management appetite for bold growth strokes-is strongly fueling this uptick in deals. M&A appetite and capacity will increase throughout 2010, global consultant KPMG forecasts.

M&A's resurgence as a growth tool is meaningful for an active value manager, because M&A is one of several key "catalysts" of corporate transformation that can signal the likely emergence of new value.  Other catalysts well suited for response to the realities of today's slow-growth, post-recession world include strategic restructurings, changes in management, spinoffs, downsizings and recapitalizations.

For value investors, identifying corporate managers committed to this difficult work demands careful evaluation, for indeed, some evidence already suggests that many managers and organizations will not rise to the challenge.  A recent study by Boston Consulting Group strongly indicates, in fact, that too few companies are taking the long term, defensive measures necessary to survive, much less thrive, in the Great Recession's wake.

BCG surveyed more than 400 executives at $1 billion-plus companies in seven countries.  The view of these executives is appropriately sober: Most are projecting lower profit levels and more difficult growth.  In response, most are taking short term defensive actions, such as increasing focus on key customers and reducing administrative spending.

But far fewer are planning longer term, arguably more wrenching moves, such as exits from product lines, customer segments, or sales channels, or the divestiture of non-core businesses.  Fewer than a quarter have made managing cash a priority; very few say that balance sheet and debt restructuring will be important.

Such longer term moves are part of the necessary, non-glamorous, often painful but completely critical, set of responses that managers need to bring to bear to realize corporate value in a far more demanding world.  The global economy will reward companies that take these necessary transformative steps-and the markets will reward investors that make a commitment to such companies early.  That outcome is the goal of an active value investing approach.

Assessing Management's Intent

It's one thing to recognize the impact, in the abstract, of corporate growth catalysts, but quite another to spot corporate management teams that will actually realize the potential of these situations through their actions.

In an active value approach, the numbers and valuation are only part of the story.  The people managing the assets of the business are just as important to the investment case, or perhaps more so.  When it comes to the actual decision to commit capital and successfully monitor the investment decision, one must literally sit down with management, face to face, and deeply probe their intentions, plans and commitment to change.

Careful assessment of management's intentions is particularly critical in leveraging one of today's most attractive, prospective sources of investment value: family controlled holding companies.  Such companies-many of them on the lists of the biggest public companies in Europe, Latin America and Asia-are among the most under-researched and undervalued companies in the world today.

In fact, families hold the reins of many highly successful, yet not-well-known enterprises around the world.  By one estimate, families control more than two thirds of the largest listed firms in Italy, nearly half of such firms in France, and nearly four of 10 of such firms in Germany.   In France, of the top 40 companies listed on the CAC 40 stock market index, one in four is family controlled, according to Standard & Poor's.

They are often complex entities, with many different kinds of businesses, and therefore not easily researched by firms that practice industry specialization.    Moreover, because the companies are family owned, it's often assumed that the owners have no interest in shareholder value.

In fact, many of these companies, centuries old, have flourished in some of the world's most challenging business environments, from a political, regulatory and cultural standpoint.  In many cases, a "next generation" of family management recently has taken control and is intensely interested in evolutionary action, either on their own or with the assistance of outside management expertise.  They are deeply committed to the maintenance and the growth of the value that their families have carefully nurtured for hundreds of years - and that they know may now be threatened in a new world.

Such situations, though they may offer extraordinary investment opportunity, are not always easy to find, get to know or understand.  It takes more than a quick chat with an investor relations functionary. To an even greater degree than in other value situations, an investor assessing a family owned enterprise must establish a lasting relationship of mutual trust and respect with controlling interests-a process that can proceed over weeks, months and literally years-and then assess in a clear way whether management will deliver on their prospects.

The value creation success of many family controlled enterprises has been clearly documented.  Analysis by Credit Suisse found that, as of January 2007, European stocks with a significant family interest-that is, where the founding family or manager retained a stake of more than 10% of the company's capital-had outperformed their peers by 8% a year since 1996.

The lessons of good business learned in challenging times over centuries are driving the success of many family controlled situations today.  Such companies represent a significant portion of the value opportunities that exist today for investors with a genuinely discriminating, active approach.

The Principles Of 'Active Value'

For any advisor seeking to evaluate the merits of a fund following an active value orientation, these portfolio management attributes are essential:
    Rigorous analysis of company fundamentals as a key initial step in the winnowing of value situations.
    "On the ground" assessment of a situation's prospects-through personal contact and dialogue with corporate management.
    Firm differentiation of managers committed to value creation from those who will inevitably destroy it.
    The consistent discipline of closing out an investment when the potential for value has been fully realized-or has dissipated.

Tough business environments-even with all their new hurdles-inevitably show smart, visionary managers new ways to survive and grow by outperforming their competitors.  These managers generate value for diligent, perceptive investors who recognize the potential of transformative action-and who are willing to spend the requisite time to identify managers who are acting to make their chances real.

Today is arguably a special moment for such companies-a point when many, having emerged from the fire of nearly unprecedented market and economic turmoil, will move aggressively to put what they've learned about business survival and success to work, for the long term.  These situations, however, will fully reveal themselves only to the most patient investors-those with the deepest commitment to understanding a new world of investment value.

David Marcus is co-founder, CEO and CIO of Evermore Global Advisors, as well as lead portfolio manager of Evermore's Global Value and European Value portfolios. Marcus has more than 20 years of experience in the investment management business, starting his career at Mutual Series Fund, mentored by renowned value investor Michael Price.