Investor perspectives on activism
July 2015 | COVER STORY | BOARDROOM INTELLIGENCE
Financier Worldwide Magazine
Though shareholder activism has been a feature of the corporate landscape since the 1990s, over the course of the last few years it has certainly gained traction. Shareholder activism is becoming increasingly prevalent in the current corporate climate.
According to data from Deloitte’s Q1 2015 CFO Signals survey, just less than three quarters of the nearly 100 chief financial officers of surveyed North American public companies said they have experienced some form of shareholder activism of late. The most common form of activism comes via communication with management or the board, and sometimes in the form of proposals that have gone directly to shareholders. Around half of the companies surveyed noted that they have made at least one major business change specifically because of shareholder activism, be it the form of share repurchases, leadership changes or divestures.
One of the most important aspects of recent shareholder activism has been the types of firms subject to agitation. It is not just small or medium sized firms in the crosshairs; large corporations including Apple Inc have drawn the attention of notable activists in recent years.
Much of the current prominence of activism has been built on its popularity with institutional investors, many of whom view activists positively and support the nomination of independent directors for board seats by activists. Prominent and high profile investors including Carl Icahn and Nelson Peltz regularly launch public campaigns designed to shake up, and split up, established businesses and increase shareholder value.
For supporters of activism, the process can provide a valuable and much needed catalyst for change. It can help align the interests of the board and management with their shareholders, and it can force companies and boards to sharpen their strategic focus. To be sure, activism can be a real force for change. However, critics say the process can create unwanted and unnecessary distractions, as well as cause firms to take a long term approach to decision making at the expense of a short-term value boost for shareholders.
Yet, given that shareholder activism has been one of the fastest growing and best performing investment strategies in the years since the financial crisis, it appears increasingly unlikely that we will see a rapprochement between activists and boards any time soon. To that end, then, are we set for more boardroom battles and corporate shake-ups going forward? For Marc Weingarten, a partner at Schulte Roth and Zabel LLP, it is inevitable that the level of shareholder activism will continue to increase. “The strong performance of the strategy has led to huge capital inflows to established activists as well as many new activists, and ‘occasional activists’, entering the field. And activism is a non-correlated strategy, which is very attractive to investors who fear a coming market correction. This strategy definitely has legs,” he says.
Shareholder activism has been riding the crest of a wave in recent years. Major international companies such as Burberry and financial institutions including Barclays have drawn the indignation of activists over the course of the last 12 months. Though the reasons for activism often vary, and may include contentious subjects such as executive compensation, value creation is a common cause of action. Leo Groothuis, a partner at NautaDutilh, believes that much of the activism of recent years has been spurred on by poor returns in some asset classes. “The enormous influx of capital in funds with activist profiles requires these funds to take an active role at an increasing number of listed companies. In particular in the Dutch market, the attention of big activist funds in recent years seemed to be caused by a combination of some unique features of Dutch corporate governance and the need for these funds to seek targets outside their home markets in the US and the UK,” he adds.
Activism campaigns waged by notable investors, and the impressive returns they have achieved, have attracted the attention of other investors. One of the clearest reasons for the rise of shareholder activism has been the greater success rates experienced by activists in recent years. There is a clear correlation between the success rate of activist investors and the number of activist investments made per year.
In the US in particular, traditional investors have rallied behind activists. Given that activists generally hold stakes in the 5 percent to 10 percent region, it is vital for their purposes that they engage more established and substantial stakeholders. In some respects, activists have ascended as they offer shareholders another option. Understandably, the impressive returns they have generated have also played a big part of their rise. “Activists are making money and other investors are noticing. Both activists and institutional investors will tell you privately there is more formal and informal communication between them because of this,” explains Wes Hall, chief executive officer and founder of Kingsdale Shareholder Services. “Much of the credit for this budding relationship goes to the activists who have spent a lot of time building their credibility and thoughtfully planning their approaches. 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 they’ve retained activist hedge funds to manage portions of their equity investments. One activist I work with told the story of a major pension fund who 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…’”
Underperformance of company stock is also often a key motivator behind shareholder activism, according to Mr Weingarten. “In most cases, activist campaigns are directed at companies which have destroyed shareholder value, or at least underperformed, over the long term. Those are the companies where shareholders are dissatisfied and will support the activist. Even short-term gains are preferable to continuing losses. And the activists often seeks to refocus the strategic direction of the company to facilitate achievement of more realistic long-term goals,” he says. Activists may focus on underperformance relative to industry peers, rather than absolute declines in performance, using returns over a two-year period as a measuring stick. Firms which have lagged behind the rest of their industry in the previous two years may become activist targets, along with those that have experienced insipid revenue growth. Large cash balances and recurring restructuring charges are also potential indicators of looming activism.
Clearly, institutional investors are supporting activism. A recent study from FTI Consulting – the 2015 Shareholder Activist Landscape: An Institutional Investor Perspective – notes that institutional investors globally are warming to the process. In particular, institutional investors surveyed by the firms were found to be overwhelmingly in support of an increase in ‘US style’ shareholder activism. Seventy-six percent of investors believe that companies in Europe, Asia or Latin America would benefit from an increase in shareholder activism similar to what has occurred in North America.
Though that support is likely to be limited to the furthering of dialogue and interaction between investors and shareholders, truly radical transformations are, understandably, less attractive to many investors. “Institutional investors now have higher expectations for company engagement. They are increasingly willing to reach out to companies to discuss concerns, doing so by phone calls, letters, shareholder proposals and, in more limited situations, white papers”, explains Matthew Frakes, a research analyst at the Council of Institutional Investors. “Regardless of the mode of communication, they expect companies to be responsive. When the situation warrants it, they also expect to be able to talk directly with board members rather than corporate management. The Shareholder-Director Exchange, formed in 2014 by a group of leading independent directors and representatives of some of the largest global institutional investors, provides guidelines on ways to enhance engagement between investors and corporate directors,” he adds.
Communication between institutional investors and activists has been going on for a while, particularly in the US, according to Chris Young, Head of Contested Situations in the M&A Group at Credit Suisse. However, it is important for future relationships that the exchange between activists and investors is not one sided. “Engagement has been a buzzword for quite some time,” says Mr Young. “Today, in virtually all developed markets, corporates are seeking ways to engage with their key shareholders on all sorts of issues. In the US, we are seeing much more engagement by directors – a practice that historically was more commonly seen in markets outside the US. Effective engagement is a dialogue, not a monologue. Investors also appreciate issuers which engage proactively before an issue becomes acute rather than reactively merely to garner support in a live campaign. Large investors which own shares in hundreds of companies are actively seeking to build out an intelligent infrastructure to effectively engage on a wide range of issues.”
Though alliances between activists and investors can be hugely beneficial for those individuals, the growing acceptance of activism is not entirely positive for the management of target companies. “The fact that there is more collaboration between activists and institutional investors makes things tougher for management,” notes Mr Hall. “We’re seeing more and more activist approaches taking place behind the scenes as there is an increasing willingness to discuss settlements before anything becomes public. Boards are more willing to talk because of the financial and reputational costs of a proxy fight and because activists have become more formidable and sophisticated in their techniques. Activists are doing their homework and presenting compelling analysis that can win other shareholders over before an issuer is even aware.”
With investors increasingly receptive to activist agendas, boards need to prepare their response plan. When it comes to dealing with shareholder activism, boards should avoid rushing to respond to challenges. “The primary difference between those companies that effectively respond to activism and those that do not is advanced preparation,” says Mr Young. “Rushed and reactive responses invariably lead to suboptimal outcomes. Boards should ask management to periodically conduct an ‘activist audit’ – a rigorous self-examination through the lens of an activist. The audit often reveals steps the company can take to create shareholder value for full investor credit rather than waiting to be compelled to take such action by an outsider perhaps at a suboptimal time or pace. The audit also helps prepare a company to respond quickly and effectively to misinformed outside perspectives,” he adds.
When confronted with an activist investor or group of investors, boards should apprise themselves of all facets of the approach. A response team should be formed as soon as possible. This helps the firm to avoid missteps, and ensures it does not underestimate the gravity of the situation. It is imperative that boards are proactive and move to fully understand the motives of the investors. Developing a suitable and viable response strategy – leaving no stone unturned – is key. “Boards should be made aware of all issues raised via shareholder activism – whether from a shareholder proponent or an ‘activist’ seeking changes to company strategy or capitalisation,” notes Mr Frakes. “In cases involving less significant matters, corporate management may be best positioned to evaluate and respond. Boards should take time to consider all other issues raised by shareholders and respond thoughtfully and respectfully to them.”
For Mr Groothuis, when it comes to tackling shareholder activism, failure to prepare is preparing to fail. “We advise our listed clients to never underestimate the risk of shareholder activism. Preparation includes regular communication with long term shareholders and making sure that potential issues are addressed before they are highlighted in analyst reports. Once an activist makes contact, the manual should be at hand and the lessons learned in the fire-drills will pay-off, but to some extent it is already too late: prevention is better than a cure,” he says.
Shareholder activism has increased exponentially in recent years. In 2014 alone, there were 344 activist campaigns launched, according to data from Activist Insight. While many critics of the tactic will point to its perceived short term-ism and potential to be a disruptive and destructive force, it is becoming clearer that activism is here for the long haul.
Prudent and agile investors are recognising this shift and embracing activism in its many forms. By adopting a softer and more collaborative approach, activists are encouraging institutional investors to engage, and as such are making greater inroads.
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