Why a tsunami of activist investors threatens to overwhelm public companies
December 2014 | PROFESSIONAL INSIGHT | BOARDROOM INTELLIGENCE
No one thinks it is going to happen to them, until it happens to them. By then, it is too late. Such is the quandary more and more companies are finding themselves in as they suddenly discover they are under siege by an activist investor.
Shareholder activism is entering a renaissance and boards have been slow to adapt. Estimates suggest that activist funds have grown from $12bn in combined assets under management a decade ago to over $89bn today.
Last year, over 230 activist campaigns were launched publicly in North America and, as of August this year, US activists had a 72 percent success rate in proxy fights, up from 60 percent the year before. Not a good success rate for corporate leaders who are supposed to know that these fights are coming.
There are two reasons for this rise in activism. The first is simple: they are making money. Last year activist hedge funds returned an average of 11.82 percent – ahead of the overall hedge fund average of 7.8 percent. Data from Bloomberg shows companies targeted by activists from 2009 to 2013 gained 48 percent on average, beating the S&P 500 by 17 percentage points.
The second reason is also simple: too many companies are making it too easy for activists. For management, the warning signs should be clear: they are underperforming their peers; have no clearly defined strategy in the eyes of the market; hold large cash balances; have an entrenched board; lag governance best practices; have poor shareholder communication; and maintain poor structural defences.
The latter of these, such as governance best practices, shareholder communication and structural defences, are especially important because these are the ones directors have the most control over and are the ones which speak to the overall engagement and attentiveness of the board. For instance, not only does not having structural defences like a shareholder rights plan and advance notice provision in place mean your company is more vulnerable, it also acts as a signal that says this board is not on top of things.
Appearing prepared – let alone being prepared – can be a deterrent for activism. For an activist it is not just about assessing whether or not they can make money by intervening, it is if they can win the intervention.
When companies become aware that they meet one or more of an activist’s criteria they respond in one of two ways. They can get proactive and retain the appropriate advisers to address the deficiencies or they simply default and hope an activist doesn’t come knocking. The problem is that hope is not a strategy.
No company is off limits. As with hope, size is no longer a viable defence strategy. A McKinsey study found that US listed companies targeted by activists had an average market cap of $10bn.
The activist playbook
To their dismay, many directors and executives who underestimated the capabilities of activist investors quickly found themselves out of work. Their mistake was to see the activist as simply a lone wolf, an event driven actor with a narrow self-serving agenda. The reality, which is hard for many leaders to acknowledge, is that activists are not crazy; they are now owners of the company and have a well-researched point of view.
Before an activist decides to approach management or even buy a position in a company, they have done their homework. It is a process that can last longer than a year. They have hired their own team of advisers to drill down on your numbers and arrived ready with white papers and a slate of executive search firm recruited director nominees. They have test driven and optimised their thesis with your largest shareholders, won over key analysts and identified weak points in your leadership team.
Activists generally hold the view that they cannot fix a bad company, just a bad valuation. They will look for companies that are locked on the inside where, for a relatively low resource cost, change can unlock significant value, such as a change in management, new board appointees, share buybacks and increased dividends, a spinoff or sale of assets, joint ventures, or a merger or acquisition.
The bad news for companies is that institutional investors who used to simply ‘vote with their feet’ if they were not happy with a stock, are increasingly willing to get in on the act and support activist-led initiatives. They no longer accept the conventional wisdom that exiting a stock is the only true way to express displeasure.
Pledging votes to activists is becoming more and more common as institutional investors see the pattern of value creation following activists. In fact, a number of pension funds have disclosed that they have retained activist hedge funds to manage portions of their equity investments. One activist recently told of a major pension fund which called and said: “I like what you did with my stock over here, I have this other one over here I’m wondering if you could help with…”
For any corporate leader who still doubts the tenacity of today’s activists and doubts their board needs to take action, here’s something to ask yourself: do you think they would be betting hundreds of millions – even billions – on taking a position in your company if they were not extremely confident they had identified something you had not and were sure they could sell it to your shareholders?
Having impressive people on your board does not necessarily mean optimal performance. Most directors spend about 20 days a year focused on the company they are overseeing and rarely talk to the shareholders who do not sit next to them at the boardroom table. Activists and their support teams on the other hand spend months, even years, formulating a thesis and test driving it with the largest shareholders.
What companies can do
Even the companies that say they are prepared are taken by surprise. Their inability to articulate plans to shareholders quickly can clearly be fatal.
Here is what companies can do. Firstly, the leadership should spend as much time looking at themselves as they do their competitors. Do not wait until an activist knocks to do your SWOT analysis. You should be in a constant state of review, examining the flash points that attract activists. Specifically, boards are encouraged to pay special attention to governance issues. They should be proactive in updating by-laws and adopting governance best practices. Too many companies wait until proxy advisory firms issue their reports or regulators make a policy mandatory before they take action.
Secondly, know your shareholders and talk to them. This means going above and beyond the day-to-day function of an in-house investor relations department. Boards need to get involved in communicating with shareholders. It is no longer okay for them to sequester themselves and leave all investor dialogue to management.
Companies spend a lot of time and money on market research into those who buy their products. So why not put the same effort into knowing those who buy your stock? Many issuers insist they ‘know’ what their investors think. But too often this is based on anecdotal evidence versus empirical data gathered from their stakeholder base. Issuers can head off problems before they arise by surveying their shareholder base and employing an impartial third party to look at what is being said and who is saying it. There is a big difference between the fondness of an asset and the fondness of the management of that asset.
Lastly, be prepared. Speed can kill and companies need to be doing all they can to eliminate the element of surprise. Activists often wait until the last minute to declare their position, arrive ready to move, and do not have to play by the same rules that issuers do. Too many companies underestimate activists or are unwilling to engage with the level of aggression that is required to win. They either do not know what to do or they believe taking the ‘high road’ and being passive is the best approach. Boards need to be clear before a proxy fight starts: Who will lead the corporate response? What is the message? What are the structural defences? And what legal tactics are they able, and, more importantly, willing to employ?
While every year at the AGM shareholders get a vote, rarely do they get a choice until the activist shows up. At the end of the day, a fight with an activist runs down the fault line of competing stories about who can make your company better.
Wes Hall is CEO and founder of Kingsdale Shareholder Services. He can be contacted on + 1 (888) 683 6007 or by email: email@example.com.
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