Mac-Gray Corporation (NYSE:TUC) executives may have to fight for their jobs after an activist hedge fund expressed their concerns about the company in a letter to the board of directors. Fairview Capital Investment Management voiced its apprehension over the laundry company’s growth and capital allocation strategies and suggested that it either pursue a high-dividend payout model or a sale in order to unlock shareholder value.

“Ever since its ill-fated attempts to enter other lines of business through the MicroFridge and Copico acquisitions in the late 1990s, Mac-Gray has focused on its core laundry facilities management business,” said Clark & Mathieson of Fairview Capital. “Despite achieving the revenue and EBITDA growth targets needed to earn large bonuses for Management, these investments have not led to improvements in ROIC, ROE, or EPS.”

Fairview Capital encouraged the company to remedy this problem by instituting a high-dividend payout model or pursuing a sale. The first option would entail the company restricting its annual acquisition and capital spending to $25 million and returning excess annual free cash flow of $19 million (or $1.45 per share) to shareholders through a dividend. This would result in an implied valuation of approximately $20 per share. Meanwhile, the second option would generate more immediate value for shareholders that may exceed $20 per share.

“Mac-Gray's current share price of $11.79 is only 7% higher than its 1997 IPO price of $11.00,” said Fairview in its letter to the board. “How much longer must Mac-Gray shareholders endure low returns on their capital and a depressed share price?”

Clearly, Mac-Gray is facing several issues that it cannot solve without a serious change of strategy. A high-dividend payout model would increase its valuation by distributing some of its free cash flow to shareholders while a sale of the company would provide more immediate returns. Whether or not the company decides to take either action remains to be seen, but this is definitely a stock worth watching in the meantime!

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