PNC May Have A Hedge Fund On Its Tail

Highfields Capital could soon be pushing the Pittsburgh bank to shake out some value

Activists don't Usually target companies like PNC Financial Services Group Inc. (PNC ) The stock is up more than 20% in 12 months. Net income nearly doubled in 2006. And the bank is at the tail end of a three-year cost-cutting plan that reduced annual expenses by $300 million.

Yet in February the $10 billion hedge fund Highfields Capital Management revealed that it has bought 525,000 shares of PNC in the fourth quarter. Led by Jonathon S. Jacobson, a former star at the Harvard University endowment, and Richard L. Grubman, best known as one of the first investors to question Enron's accounting, Highfields has a history of scooping up stakes in undervalued companies and pushing for change. Lately the two have opposed the management-led buyout of Clear Channel Communications Inc. (CCU ) So why is Highfields eyeing PNC?

Certainly, much of the low-hanging fruit that activists salivate over has been picked at PNC. Chairman and Chief Executive James E. Rohr upped the dividend by 15% on Apr. 5. He has also been a smart acquirer, buying a bank a year since 2004--a strategy that's helped propel PNC to the No.50 spot on BusinessWeek's 2007 list of top corporate performers. Last year investment bank Merrill Lynch & Co. (MER ) picked up a stake in money manager BlackRock Inc. (BLK ), which PNC partially owns, freeing up money for the Pittsburgh-based bank to buy Mercantile Bankshares. "You're starting to see PNC play ball with shareholders a little more than they used to," says Thomas M. Finucane, a fund manager at Loomis, Sayles & Co.

Still, PNC may have some untapped potential. One move: selling part of the bank's growing data processing group, PFPC Worldwide Inc., to the public markets. Based in Wilmington, Del., the unit handles the back-office work for some $2.2 trillion of mutual funds and hedge funds. Similar businesses, such as State Street Corp (STT )., trade at 16 times future earnings, compared with 11 for PNC. Analysts figure investors aren't giving PNC credit for the servicing business, a disconnect that a partial spin-off would change. Rohr says a sale "is a possibility, but it's not something we're considering right now." Highfields would not comment.

Such a deal would be reminiscent of Highfields' recent successes. In 2002 it pushed then-beleaguered mutual fund manager Janus Capital Group Inc. (JNS ) to divest its fund servicing unit, DST Systems Inc. (DST ), which Janus did the next year. Three years later, Highfields pressured management at Mellon Financial Corp. (MEL ) to sell a similar business that the investor thought didn't complement the bank's money-management group. Mellon publicly rejected Highfields' demands but sold the entire company to back-office servicing giant Bank of New York Co. (BK ) less than a year later.

Others contend Highfields may want PNC, which had $8 billion in cash in 2006, to pick up the pace of its stock buybacks. PNC retired 5 million shares last year and has the board's approval to take an additional 14.5 million off the market. Rohr already plans to speed up the process.

Meanwhile, PNC still owns 34% of BlackRock. It's worth about $7 billion, but PNC only carries BlackRock on its books for half that. When PNC can increase the value of BlackRock on its balance sheet, it would free up capital elsewhere on the books--money it could use for more acquisitions or buybacks.

Of course, there's always the possibility Highfields will take a more passive approach. That's what Rohr thinks. So far, he says, Highfields hasn't come calling: "There's this concept that they are by nature activists in all their investments, but they manage so much money they can't be."

By Aaron Pressman

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