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The Activist Train Rolls On

Thursday - 5/23/2013, 5:07pm  ET

Billionaire activist Nelson Peltz runs Train Partners, the hedge fund that manages some $5 billion and focuses on a select number of stocks, owning only ten stocks at the end of the first quarter. The latest big win for the hedge fund was when billionaire Warren Buffett announced the takeover of H.J. Heinz, which Train had a 5.4% stake in. Outlined below are Train's latest moves from its first quarter per its first quarter SEC filing (check out Train's portfolio). 

Pushing for a merger

Train Partners is speculated to be pushing for the merger of Mondelez  and PepsiCo , and as of the end of 1Q 2013 Train had Mondelez as its top stock holding, making up 26.3% of the fund's public equity portfolio, while Pepsi was in second and accounted for 20.3% of its portfolio. This comes after Train upped its shares owned by 107% in Mondelez and 205% in Pepsi from the end of 2012. 

Mondelez is the 2012 result of the separation of Kraft Foods, and now operates as the global snack foods portion of Kraft Foods. The possible downside surrounding Mondelez is if a deal does not materialize with Pepsi, yet Mondelez's international presence gives it an impressive advantage over other snack food companies. Mondelez also has Mason Hawkins' Southeastern Management as one of its top shareholders, owning over 34 million shares (see Hawkins' bullish bets).

Mondelez operates the brands that includes Cadbury, Oreo, and Trident. The Pepsi-Mondelez merger would make the combined company an international powerhouse. In 2012, Mondelez received some 45% from developing markets, including Latin America, parts of Asia-Pacific and Central/Eastern Europe. Meanwhile, about 70% of Pepsi's revenues are from North American beverage and food segments. Pepsi is the largest food and beverage business in North America and the second largest in the world.

The real advantages to the international and emerging market presence that Mondelez and Pepsi commands are that a burgeoning middle class and rising income levels will promote more rapid growth than in developed markets. Pepsi has its sights set on expanding into Russia, Mexico, Canada, and the United Kingdom, as well as the emerging markets of China, India, Brazil and Africa. Don Yacktman has serious conviction for Pepsi, with over 10% of his Yacktman Asset Management's fund invested in the stock (see Yacktman's top five).

Train's sells

Notable selloffs for Train included a 98% reduction in shares owned of Tiffany  and a 100% selloff of MeadWestvaco . Tiffany might be seeing valuation concerns, as it is trading at nearly 22 times earnings, compared to an industry average of 18.8 times. This P/E is also near the top of its five-year range, between 7.2 times and 25.2 times. As well, gross margins contracted by 130 basis points during 4Q 2012 to 59.1%, thanks to a rise in diamond costs. 

Tiffany management has already guided fiscal 2013 gross margin to be lower than the previous year due to a shift in product sales mix toward higher priced categories carrying lower margin. As a result, Tiffany expects to see a 15%-20% decline in earnings from operations for fiscal 1Q 2013. 

MeadWestvaco is a global producer of packaging, coated and specialty papers, consumer and office products, and specialty chemicals, operating in 30 countries. One of the possible reasons for Train's big selloff could be the firm's rich valuation.

MeadWestvaco trades at over 31 times earnings, compared to the peer group average of 18.3. This valuation is especially alarming considering that the ongoing global economic slowdown leads to uncertain and possible slowing demand. The company posted lower 1Q earnings than in the same quarter in the prior year due to a slowdown in its industrial segment, which was also impacted by higher-than-expected expenses related to Brazilian expansion.

The bottom line

The activist investment fund Train Partners got active with Pepsi and Mondelez, hoping to see the two merge. I am a fan of both Pepsi and Mondelez regardless of whether or not the merger happens; as for Tiffany and MeadWestvaco, I believe both are overvalued at current levels. 

Shares of Mondelez International fell immediately after it separated from its parent company, Kraft. Is this an indictment of the idea, or a buying opportunity today? The Motley Fool's top consumer goods analyst will give you the scoop in our premium research report on Mondelez. Just click here now for instant access.

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