The activist perspective

July 2016

Two fund managers share their thoughts on how they target companies.

If you take a quick look through recent business headlines, it becomes strikingly clear that shareholder activism is achieving greater levels of influence across a broader range of companies than ever before. Once considered a tool used almost exclusively by niche funds focusing on smaller companies and event-driven themes, shareholder activism has evolved into a strategy employed by a more diverse group of investment managers who are casting a wider net across the investment universe. Even high-performing, blue-chip mega-caps have come under pressure from activists.

We spoke to two activists to get their perspectives on investor activism as an investment strategy and on recent trends in the industry.

Daniel Plants is founder and chief investment officer of Voce Capital Management LLC, an investment adviser based in San Francisco, California.

Glenn W. Welling is founder and chief investment officer of Engaged Capital, based in Newport Beach, California.

The article covered a few key areas:

Growth in Shareholder Activism

In the past few years, there has been considerable growth in shareholder activism as an asset class. Research by HFR reported that assets managed by activist hedge funds have increased to more than $129 billion, more than double what they managed three years ago, and significantly more than the $29 billion activists managed 10 years ago. As more capital flows into activism as an asset class, many high-profile activists are amassing hefty war chests, allowing them to pursue larger, high profile campaigns. For example, there were multiple cases in 2015 in which an activist made billion-dollar bets with larger well-known companies, including Yum Brands, American Express and General Electric, to name a few.

Activists Working With Mainstream Investors

A number of industry trends have supported the rise of investor activism. Institutional investors -- from actively managed to index funds -- have become more willing to support activist campaigns and, in some cases, have provided suggestions to activists. Some traditional funds are putting out RFAs, or requests for activism, if they believe that their feedback is not well-received by management teams. Activists are also capitalizing on this rising trend to engage and often get support from mainstream institutional investors.

In February 2016, BlackRock’s CEO, Larry Fink, sent a letter to 1,300 company CEOs across the globe, saying, “Those activists who focus on long-term value creation sometimes do offer better strategies than management. In those cases, BlackRock’s corporate governance team will support activist plans. During the 2015 proxy season, in the 18 largest U.S. proxy contests (as measured by market cap), BlackRock voted with activists 39 percent of the time.”

Other asset managers are also jumping on the bandwagon and taking an active stance toward underperforming companies as compared to their peer group. In a Reuters article from September 25, 2015, Rakhi Kumar, head of corporate governance at State Street Global Advisors (SSGA), explained, "We engage with activists. It's part of our policy to talk to both sides. We recognize that activists have been successful for a reason, but it is time for us to say we are here for you provided you take us seriously too." As an example, SSGA supported Starboard Value when the company wanted to replace the entire board of Darden Restaurants, Olive Garden’s parent company.

Vulnerability to Activism

A number of factors make companies vulnerable to shareholder activism. These can include a depressed stock price compared to a company’s peer group, underperforming business units, a corporate strategy that shareholders disagree with, deficiencies in corporate governance or in board composition and structure, excessive management compensation, an unattractive balance sheet, overall negative shareholder sentiment and frustration with the company, among others. 

If companies meet any of these criteria, they should consider conducting a vulnerability assessment and monitoring the ecosystem. Some key areas to focus on include monitoring the landscape for activist activity, identifying changes in the shareholder base or signs of investors buying and selling in tandem, understanding negative investor sentiment and frustration, and addressing possible corporate governance inefficiencies. Companies need to be prepared to clearly articulate a strategic plan to key stakeholders about how they will fix any deficiencies.

Tactics to Produce Shareholder Returns

Activists employ a number of strategies to drive a company to greater shareholder returns and operational efficiency. As our interviews showed, an investor can utilize several techniques depending on what is needed at the target company. Options to improve financial performance can include boosting operational efficiencies, such as by selling off underperforming divisions; optimizing capital allocation through dividends and share repurchases; or fixing corporate governance deficiencies, such as board reform. In many sectors that have experienced M&A consolidation, such as technology, pushing to sell the “target” company or orchestrating a merger with another company have also becoming prevailing tactics.

Quicker Settlements

Many companies targeted by activists are deciding to settle quickly in an attempt to lessen the business distraction of a public activist campaign. According to Activist Insight, the average number of days it takes companies to reach a settlement with activists threatening a proxy contest from the time of disclosure is 56, which is down from 83 days in 2010. Some of the common settlements reached between activists and companies include board seats, management changes, corporate governance improvements, and operational changes, such as divestiture of underperforming lines of businesses. According to Shark Repellent, based on 2015 data, activist campaigns that resulted in board seats is at an all-time high.

When Activists Become Engaged

Once an activist is engaged, chances are they are not going away. It is important to keep in mind that the activist has typically completed a lot of research and most likely has spoken with many of your top investors and analysts before reaching out to the company. Further, many activists have become highly sophisticated and often work in tandem with other activists, sometimes called a wolf pack; it is not uncommon to see two or more activists working together on an activist campaign to build a position in a stock.

With these considerations in mind, if an activist reaches out to your company, you should be professional and timely in your responses. In addition, investor relations, senior management, and board members need to be open and willing to objectively listen to the activist’s perspective and possible demands. The company will have enhanced credibility in the market if the activist’s requests or proposals are handled in a proactive and professional manner. It will also help minimize the PR chatter that can come with an activist campaign.

How IROs Can Add Value

As activism becomes more prevalent, it is more important than ever for boards to be continually informed of Wall Street’s perspective on the company. It does not serve the company well to have a board surprised by negative shareholder sentiment and perception of the company, especially as an activist is mounting a public attack. Many boards are requesting annual independent perception studies to clearly understand the sentiment of Wall Street; third-party and confidential perception studies help companies gain a clear and unbiased understanding of key issues that may impact perception and valuation. Also, conducting corporate governance roadshows with both management and select members of the board, not just during proxy season, is a good way to have board members and key members of management communicate proactively with shareholders before a problem arises.

Over the past few years, shareholder activism has been one of the fastest growing, and often, best-performing asset classes. Therefore is it unlikely we will see any reduction in activism as a strategy. There is a strong need for companies to be proactive and anticipate the changing environment that may bring an activist to their doorstep. With activism becoming more commonplace, companies will benefit from IROs being more involved with communicating with boards on an ongoing basis. IROs can bring a Wall Street perspective and empathy on important issues that face the company and industry, as well as provide valuable feedback on potential corporate governance vulnerabilities.