It’s been a turbulent August for Boards. Not only have global markets gyrated but activists have refused to take a Summer break. In Europe, activist investors attracted attention as they built their holdings in Rolls-Royce and Glencore. In the US Mondelez and even the mighty Apple have been subject to activist pressure in recent years. If flagship companies such as Apple and Rolls-Royce are targets for activists, is no boardroom safe? We argue that Boards should be taking activism very seriously. Smart Boards will be prepared.
Fidelio’s Board Development practice has seen a rise in Boardroom anxiety about the activist threat. This anxiety is not misplaced.
Dodd Franks in the US and the Stewardship Code in the UK unleashed a wave of corporate governance activism. Activists are hedge funds which go considerably further. They seek to bring about radical structural or strategic change within the company, thereby increasing its value. To do so activists exert influence on the running of the company and the Board.
Activist investors have some US$ 120 billion of direct fire power in terms of assets under management. Once the pariahs of the investment community – the original “Barbarians at the Gate”, activism has grown up into a recognised, if not respected style of investment. The impact has been increased by the backing of mainstream investors such as Blackrock, Aviva Investors and CalSTRS.
The US is a fruitful environment for activists and the majority of activist investors and the bulk of their engagements are within the US. US activism is confrontational in style with activists typically seeking a seat on the Board and in some cases replacing the entire Board.
“Buy ‘underperforming’ companies and ‘make things change’.”
Carl Icahn, Founder of Icahn Enterprises, Interview with CNBC, 29th March 2012
However, the US no longer affords sufficient investment opportunities and activists are increasingly looking to Europe and Asia with the UK and Japan proving the most attractive destinations. The complexity of legal systems and listing requirements across Europe creates something of a deterrent for activism.
European activism has traditionally been more consensual working behind the scenes and not pushing for a proxy fight. In reality, however, the distinction between US and European activism is more of a spectrum and some recent activist interventions in Europe have been far from consensual, for example Elliott Advisors’ much publicised investment in Alliance Trust.
When assessing the activist risk, Boards do well to focus on two key characteristics:
Firstly, by the time the activist appears on the radar screen, a very significant amount of research has been done. The activist will know very much more about the company it is investing in than the company does about the activist. Moreover the activist may also know things about the company that the Board is not aware of. While a recent US ruling against Third Point’s investment in Yahoo may force activists to disclose their hand earlier, it is unlikely to change their level of preparedness.
Secondly, even discreet and consensual activists are perfectly capable of using the media to great effect if they need to.
Is any company immune? Not really. Over the years activists have attacked some of the largest and best known companies in the world including Apple, Microsoft, HSBC and Volkswagen. But they have also targeted much smaller companies – being below the radar screen does not provide immunity.
And while activist attacks may seem random, there is a very clear methodology. Activists are by nature systematic. Boards do well to understand how activists screen. Here are some typical scenarios in which a company becomes vulnerable:
1. A company is underperforming
Companies are most at risk when they are underperforming against peers. The activist identifies a stock that is cheaper than peers and an action or inflexion point that will enhance valuation – frequently a divestment or merger. Value investors like Carl Icahn describe ‘Cigar Butt’ stocks that “no one wants”. Activists, however, see the opportunity.
2. Sitting on cash
Activist investors are lured by cash on the balance sheet. Technology companies unsurprisingly have been a favourite target here. Critics argue that this type of activism prevents Boards taking decisions and making investments in the long-term interest of the company. The tide may be turning. Larry Fink, CEO of Blackrock, recently wrote to CEOs in the US urging them not to cave in to activist pressure and to ensure cash is available for investment in the business.
3. M&A
Activists see opportunity during the M&A bidding process. Typically the activist takes a stake in the target company and pushes for a higher bid price.
4. Change in capital structure
Changes in capital structure create investment opportunities. For example, activists may also seize upon a distressed capital raising to dilute existing shareholders and to increase influence.
The Board has a duty to act in the long-term best interest of the company and all shareholders. How can it fulfil this duty with activists pounding at the boardroom door?
Without a doubt the Board’s best defence against activism is healthy valuation. This is typically driven by performance and a well understood equity story.
“Activists wield disproportionate power… On one side is the lazy money… owned by index managers such as BlackRock… At the other end of the spectrum is the bossy money… run by Warren Buffet and Private Equity… Activists provide a way for lazy money to outsource the messy task of fixing subpar firms.”
The Economist, “An Investor Calls”, 7th Feb 2015
A wise Chairman will care deeply about the quality of communication with the market. All Boards should keep a close eye on the register. Smart Boards will also ensure that there is an experienced executive team in place, typically comprising the CFO and the Investor Relations Officer (IRO), which is well versed in the capital markets.
Expectation management is critical. Experienced Chairmen frequently have a dotted line to the IRO to ensure that unvarnished investor sentiment can find its way to the Board, even if it makes uncomfortable listening for management.
Boards should provide proper oversight of how the company engages with its shareholders. To do this well, the Board will include directors who are familiar with the markets, institutional investors and valuation. Merely having sat on a quoted Board does not guarantee this expertise.
If it is too late and the activist appears on the register, what should the Board do? However great the sense of indignation, the Board would do well to listen. Activists are typically smart and, while the Board may not want to hear it, the activist may well have a point.
A wise Chairman will be careful to engage appropriately. The high profile spats between activists and Boards that we read about in the press are just the tip of the iceberg. Many companies engage and achieve resolution out of the public glare, which is surely the desired outcome.
A Board that has been doing its job in ensuring high quality communication with shareholders will be considerably better positioned to respond to an activist attack. Good lines of communication between management, IR and the Board will be in place.
Importantly major shareholders will understand the investment proposition, have faith in the management and the Board and will therefore be considerably less likely to side with the activist. A well prepared Board will also be able to reach out at short notice to trusted advisors.
Boards are right to be on guard against activist investors who can derail strategies and demand radical change. A good Board will not only be supervising performance; it will also insist upon highly professional communication with shareholders and the market. To achieve this the Chairman may well include capital market experience at Board level.
And beyond this a wise Chairman will listen carefully when the activist calls – the activist may just be right!
Fidelio High Notes
- Fidelio delivers its inaugural Development Programme for the Senior Female Executives “A Seat at the Table” at the Royal Military Academy Sandhurst.
- Fidelio successfully delivers independent Board Search for leading international body. See press.
- Fidelio Board practice – recent focus on Board composition; shareholder consultation; and activism.
- Fidelio to host its 2nd Stakeholder Engagement “Brexit” Breakfast for Communications Directors on 17th Sept.
- Fidelio to co-host IR Roundtable Breakfast with Citi Depositary Receipt Services 16th Oct.
- Fidelio to speak on IR careers at forthcoming conferences in Copenhagen, London and Frankfurt.
Please contact us with comments or for more information at info@fideliopartners.com