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To help investors better understand how shareholder activists operate and also potentially profit from their campaigns, Shares launches a four-part series examining their activities. We will analyse what activism can mean, how the big names operate, who they are, what sort of results they get - and above all how you can piggy-back off their analysis and expertise.
Activist investors play for high stakes. Big money and big reputations are on the line. And if their names are not familiar to you now, they soon will be, because they are coming. Activists are well-known in the USA as they challenge management teams and frequently spark improved operational and share price performance, to the benefit of those who have cash in their hedge funds - including the activist money managers themselves.
Carl Icahn of Icahn Enterprises is one of the reasons Apple (AAPL:NDQ) is returning $130 billion to shareholders via share buybacks and dividends. Bill Ackman of Pershing Square and Jeff Ubben of ValueAct Capital are working to orchestrate Valeant Pharmaceuticals’ (VRX:NYSE) $45 billion takeover of Botox-maker Allergan (AGN:NYSE).
Data from the website www.activistinsight.com shows the incidences of shareholder activism is on the rise. No fewer than 237 firms were publicly targeted worldwide in 2013, a 9% increase on 2012. America may be leading the way but Europe and Britain are likely to see the next wave of activity. The US law firm Schulte, Roth & Zabel has even opened a new office in London in anticipation of more work in this field. The legal eagles are sponsoring a high-powered conference on activism which will take place in London’s West End on 2 June.
The UK already has home-grown activists such as Chris Hohn of the Children’s Investment Fund and Laxey Partners while Europe has both Cevian Capital and Knight-Vinke Asset Management, but the really interesting trend is the one spotted by Schulte, Roth & Zabel.
US-based hedge fund Elliott Management now owns stakes in both Morrison (MRW) and F&C Asset Management (FCAM) and Sandell Asset Management is agitating for a break-up of FirstGroup (FGP) while SpringOwl Capital controls 6.1% of the equity in Bwin.Party Digital Entertainment (BPTY).
Rules of engagement
Always remember: as a shareholder in a business you are one of its owners. Management teams are your agents, there to work for you and employ the capital you have provided to create value, generating returns which more than compensate for the risks involved.
This can lead to the so-called agency problem, whereby the interests of capital providers and capital users are not always perfectly aligned - executives may want to do one thing, such as line their pockets with fat salaries, while shareholders’ interests may be better served by putting that cash to work in the business.
The UK Corporate Governance Code asserts companies must comply with its principles or explain themselves but if shareholders are dissatisfied with what they see or hear they have three possible courses of action.
• Stewardship. The Stewardship Code puts the onus on fund managers to engage with management if they are unhappy. The idea is an active dialogue provides better policing of management behaviour, improved alignment of interests and ultimately better operational performance to the benefit of both stakeholders and shareholders. The 2012 Kay Review further developed this concept as part of its 17 recommendations.
• Pro-activity. Here investors again engage with management via regular meetings, talking to executive and non-executive directors and even providing advice. They will also express their views by voting at Annual General Meetings and can press for changes of strategy of even management, an approach taken (ultimately without success) by Neil Woodford at Stobart (STOB) while he was still at Invesco Perpetual. ‘Stewards’ may decide their preferred time horizon for their investment is forever, pro-active money managers can and will ultimately take the decision to sell their shares if they are not happy with management’s efforts or strategic thinking.
• Get active. Activists go further still. They often seek representation on the board or even take a hands-on approach to running a company. Calls for changes of management are a staple tactic, while activists will often demand a new strategy, asset sales, shift in dividend policy or even the break-up or sale of a company.
In the case of activist involvement, they may be disgruntled holders of a stock but it is more likely the hedge fund in question believes a company is underperforming or being mismanaged and therefore ripe for a shake-up. In these cases, the activist will quietly build a stake at what they consider a depressed valuation and then loudly engage with boardrooms in a public bid to force change and unlock what value they believe is hidden by poor operational and managerial performance.
Man the barricades
In a speech at Oxford University’s Said Business School in autumn 2013, Pershing’s Bill Ackman argued the UK was a decade behind the USA when it comes to shareholder activism. He also emphasised his view it would become an increasing trend.
Not everyone welcomes this and many executives, fund managers and commentators view activists as no more than Barbarians at the Gate to borrow the title of Bryan Burrough and John Helyar’s 1989 book about the leveraged buy-out (LBO) of RJR Nabisco. Opponents of activism argue:
• It encourages a short-term approach which is not always to the benefit of the company
• It can mean management kow-tows to a shareholder who, while important, will exert greater influence than those with larger stakes simply because they are making more noise.
• Activists can distract bosses from their job, namely running the company. In Shares’ eyes the merits of the Apple buyback are debatable. The Californian giant should be focussing on new products and its cherished brand to maintain its competitive advantage, not indulging in financial engineering to ensure it makes the quarterly numbers.
• The activists are not always right. Bill Ackman’s intervention in US retailer JC Penney (JCP:NYSE) was an outright disaster. The standard hedge fund ploy of returning cash to shareholders and even using debt to gear up the balance sheet and fund dividends would have destroyed many a firm in 2008 to 2009 as the credit crisis swept the globe and demand plunged across many industries.
One particularly trenchant critic is Martin Lipton, a partner at US law firm Watchtell, Lipton, Rosen and Katz who has publicly attacked activists’ lobbying tactics and even sued Carl Icahn and his firm Icahn Enterprises. Lipton argues their focus is too short-term while Delaware’s chief justice, Leo Strine, argues in an issue of the Columbia Law Review this year that a deluge of voting battles started by hedge funds only serves to prevent management from doing their job properly.
A results business
Investors looking to follow the activists should also note they do not always win. Besides the reverse suffered by Ackman at JC Penney, sceptics will point to the rebuff received by Icahn in his attempts to get American internet giant eBay (EBAY:NDQ) to spin-off PayPal. The activist argued, to no avail, eBay was cheap on a sum-of-the-parts basis and this value would be realised by establishing PayPal as a separate, pure-play on financial transactions, given the lofty market cap it could have attracted. Icahn did manage to get a seat on eBay’s board but the share price has done little, despite some explosive rhetoric from the activist. He derided eBay’s claim to have a world-class board, asserted it was run like a ‘totalitarian state’ and accused his target’s management of ‘multiple lapses of
corporate governance.’
Not all activists are so vocal. ValueAct reportedly had a big say in the removal of Steve Ballmer as the head of Microsoft (MSFT:NDQ) but Jeff Ubben is nowhere near as high profile as Icahn, Ackman, Daniel Loeb of Third Point Partners or Trian Fund Management’s Nelson Peltz. Yet activists do call for and frequently get decisive action, a factor which earns them the support of many, including those investors who pour money into their hedge funds.
According to Activist Insight, 77% of all resolved activist campaigns started in 2013 saw management meet at least some of their demands.
There are tangible, financial returns as well. Activist Insight’s proprietary index of 30 activist funds recorded a 22% gain in the first nine months of 2013, against a 16% rise in the MSCI World benchmark over the same period. Better still, an academic paper released in summer 2013 by Bebchuk, Brav and Jiang, entitled The Long-Term Effects of Hedge Fund Activism rebut the concerns of Lipton and Strine. The trio, who hail from Harvard Law School, Duke University and Columbia Business School, argue targets show improved operational and share price performance for up to three years after an activist intervention.
This may not be enough to satisfy the Kay Review and supporters of the stewardship concept but it bears further scrutiny. Next week’s second part of this series will look in greater detail at how activists operate.
Jonathan Cobb is governance and stewardship director at Standard Life Investments in Edinburgh.
‘It is important to draw a distinction between activism and pro-active investing and stewardship. Activism is a concept that is enjoying wider currency than previously and it is often associated with the alternative investment community and distinct investor behaviours,’ says Jonathan Cobb, who is part of the seven-strong team dedicated to issues of corporate governance and stewardship at Standard Life Investments. ‘For example, they will take a stake and then agitate for seats on the board or a change of strategy. You see this quite a lot in the US with some well-known funds and individuals who often appear on a share register after a period when a company’s shares have been in relative or absolute decline.’
Cobb then explains activists tend to look for absolute returns while a mainstream fund manager’s mandate is often quite different. ‘We are active investors in that we make portfolio decisions, taking material positions on the basis of the opportunities available relative to the benchmark set by our clients. For activists, the benchmark is often the return relative to cash, which partly explains the way they behave and why we behave in a different way.’
That said, the experienced fund manager notes it would be unwise to caricature activists as nothing more than short-term performance jockeys. Cobb accepts activists are interested in the concept of stewardship and the manner in which a company is run, with a focus upon the additional value that can be released from a firm. ‘They can often see a way to crystallise value left on the table by other investors, where a company may itself be amenable to an approach, and they take the opportunity presented by a lowly valuation relative to the inherent risks.’
Held to account
The Standard Life expert says there are two aspects to the concept of stewardship. ‘First, company managers have an obligation to use and develop the resources of the company in a manner that creates sustainable long-term shareholder value. Second, investors should hold executives to account for their stewardship and also use their share of the equity capital to vote in an informed way.’
Standard Life is assiduous in how it votes at shareholder meetings and the fund management group also holds regular face-to-face meetings with management teams. ‘This enables us to hold companies to account for what they have been up to and judge the risk profile of the company and the opportunity cost of investing in that company versus another with a similar risk profile,’ says Cobb. In this context, Shares notes with interest a report in the Financial Times newspaper which states Standard Life voted against Barclays’ (BARC) remuneration report at the FTSE 100 bank’s annual general meeting (24 Apr).
If Standard Life’s money managers do not believe their interests are being served well, they will let a company know, although they will use different tactics from activists. Meetings are one forum used to express concerns and AGMs another and ultimately a stake can be liquidated, although any such decisions are not taken lightly. ‘Selling is always an option,’ accepts Cobb, ‘but owing to the scale of our assets under management we can have big stakes and it is important to ensure value is being delivered to our investors.’
