Activist investing - is your board ready?
For listed companies across the world, the threat of an activist has become an everyday hazard of corporate life.
However while activism can be highly disruptive, well-prepared boards can defend against it and even use it to strengthen their strategic purpose.
It’s a phenomenon tracing its origins back to the infamous U.S. corporate raiders of the 1980s.
But today shareholder activism is on the march in jurisdictions across the world, an increasingly common feature of corporate life for listed companies not just in the U.S. but in Europe and Asia too. All the signs suggest that it is here to stay and will only continue to grow.
Indeed, the statistics point to a seemingly inexorable rise in campaigns by activist funds, with a recent report by the Harvard Law School Forum on Corporate Governance and Financial Regulation declaring 2018 to be the new high-water mark for global activity by activist investors.
The report suggests that some USD65bn was deployed by activist funds in 2018, up from a previous high of USD62.4bn in 2017, with more companies targeted than ever before across an increasingly broad range of sectors. The number of funds involved in this activity shot up to a record high of 131 too, with 40 launching campaigns for the first time.
Perhaps more tellingly, the report highlighted the increasing global reach of this activity as (mostly) U.S. activists go in search of new targets outside the still very busy, but increasingly crowded, U.S. market. There were 58 campaigns in Europe and 30 in the Asia Pacific region, accounting respectively for 23% and 12% of global activity during the year.
Yet while the trend is growing and spreading, the tactics employed by activists remain basically the same.
A fund will build a position in a target company then allege that the business is underperforming or that the management is pursuing the wrong strategy and should change direction.
Usually the criticism will be made privately at first, perhaps in correspondence with the board. Then – if the argument fails to cut through behind closed doors – the campaign will be taken public, with the activist trying to undermine not only the management but the rest of the board, hoping to build support among other key shareholders for the campaign. Activism can become very personal, very quickly.
The aim is to make a return on the initial investment by moving the share price. This is done in a number of familiar ways, such as exposing fault lines in governance procedures, arguing for greater value to be returned to shareholders, advocating for an increase in debt, or by lobbying for a significant change in strategy.
In a buoyant M&A market campaigns are increasingly focused around transactions, particularly disposals of underperforming businesses.
In fact, a third of campaigns last year were M&A-related, according to the Harvard report.
Some funds like to present themselves as playing a constructive role on behalf of shareholders and, therefore, the company. But campaigns are rarely benign and almost always highly disruptive, even if the attention of the activist fund lasts only as long as it takes to bump the share price so that it can cash out and walk away with a profit.
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Commentators have wondered for some time when the deal market would end its record-breaking bull run. The question is whether the latest data marks that turning point or a temporary pause for breath before the market picks up again.
Preparation is all
Companies need to be prepared, aware that, while campaigns may well follow a similar tactical pattern, different dynamics are at play in different markets.
As activism spread from the U.S. to new markets, funds tended to favour ‘Anglo Saxon’ markets such as the UK (now the second port of call for activists after the U.S.) and Australia.
The UK capital markets are seen as open with few restrictions on investment – particularly on minority stakes. In addition, the UK Takeover Panel is usually reluctant to rule that activist shareholders and their supporters constitute a so-called ‘concert party’, unless there is clear evidence of acting together to bring about board changes.
The proliferation of regulation and governance rules has also helped the activist cause, exposing additional fault lines that can be exploited. There does not seem to be any particular sector focus but traditional consumer and industrial companies have been particularly popular targets, especially conglomerates.
By contrast, rules on change of ownership for financial institutions have provided some protections for financial services companies. However, Edward Bramson of Sherborne, with a stake of around just 5% in Barclays, has proved how much disruption can be caused even with a holding below the regulatory water line despite failing to obtain sufficient shareholder support for his own appointment to the board. Litigation activity is limited in the UK compared with the U.S. where we have seen a constant stream of, often bitter, litigation. Under UK company law, the primary responsibility of directors is to the company rather than to individual shareholders, which discourages legal action. Campaigns therefore tend to be fought out through PR or proxy battles rather than in the courts.
But the need for boards to prepare is now acute even in markets traditionally regarded as more closed.
Japanese companies experienced a spate of activism ahead of the financial crisis, although most campaigns proved unsuccessful with the exception of a limited number of cases involving ‘Murakami funds’.
As the crisis slowly receded – and following government corporate governance reforms – the activists returned in force targeting companies across sectors, even impacting on enterprises where the founders retain a significant holding.
Three key factors make Japan an attractive hunting ground for activists. Companies are sitting on historically high levels of cash, many have undervalued non-core businesses, and there is a lingering culture of minimal shareholder engagement by boards. That’s changing and the annual general meeting season in June has seen increasing shareholder activity, with a record 42 companies facing proposals from investors in 2018, and with even more expected this year.
Recent high profile cases include Alpine Electronics, where activist fund Oasis campaigned against its merger with Alps Electric. The fund argued that the merger ratio was unfavourable for Alpine’s shareholders, eventually forcing it to make a special pay out in conjunction with the tie-up. Interestingly it was world’s most active fund, Elliott Management, which swung behind the merger, building a significant stake in both companies and quashing opposition from Oasis.
In France, big listed companies with multiple business lines are proving increasingly vulnerable to activist attack. Big family enterprises and national champion companies are no less safe, as we have seen with campaigns against drinks giant Pernod Ricard by Elliott, and media group Lagardère by rival UK fund, Amber Capital.
Pernod has proved what many companies across different markets are beginning to learn – that a quick and targeted response is often the best form of defence against activism. The French drinks giant seems to have successfully persuaded its investors that its long-term strategy was the most relevant to create value for all the shareholders. However, Elliott is maintaining the pressure and this remains an important test case.
In some markets, we’ve seen governments or sovereign funds build stakes to protect key companies and the French government has used a broad definition of what constitutes a strategically important business, as we have seen with the dairy group, Danone.
But intervention is far more likely to come through national interest merger controls than governance regulation, although France’s stock market watchdog, the AMF, is investigating allegations that activists disseminated inaccurate information to manipulate the share price of retailer, Casino. The new Loi Pacte statute meanwhile, agreed by Parliament in mid-April, also contains several provisions supporting employee share ownership – regarded as a strong safeguard against activism.
Concerns have been raised in the U.S. that activist funds lack transparency and that their actions might have a detrimental effect on minority shareholders, a case put strongly by SEC commissioner Robert Jackson. But again there seems little political appetite for intervention, especially in the current climate.
Here the Netherlands stands out in contrast to many jurisdictions, with its approach to corporate governance built around the stakeholder model emphasising long term value creation.
Having experienced a number of very high profile campaigns since 2004 at significant companies such as ABN Amro, Stork and Ahold, the Dutch Corporate Governance Code was strengthened in 2008 to give boards greater powers.
This includes the right to call a 180-day standstill before responding to activist campaigns to make board changes. After unsolicited approaches for Dutch national champion companies including Unilever and AkzoNobel (which included an activist campaign by Elliott), a legislative proposal is imminent to extend this to 250 days.
In addition, there are a number of specific defensive measures boards can deploy, including issuing special voting shares to a “Stichting” or foundation. This tactic is used most often to defend hostile takeovers as we saw with KPN in its defence against América Móvil and Mylan when facing a hostile bid from Teva. But it can also be an effective protection against activism.
Although activists can resort to legal action in the Amsterdam Enterprise Court, the cards are heavily stacked against them as long as the Dutch target board is seen as carefully protecting the company’s best strategic interests.
Don’t stonewall – engage!
The onus is on companies to develop their own defence strategies. A number of clear lessons have emerged that apply to companies across sectors and jurisdictions.
Boards need to spend time preparing for an activist attack well in advance of it actually happening, just as they would prepare for a hostile bid.
That means keeping strategy under regular critical review – looking at it as if through the eyes of an activist to identify points of vulnerability or likely angles of attack.
Maintaining regular contact with current shareholders to explain strategy and key governance issues is also critical since their support will be vital in the event of a campaign.
When a campaign is launched, the natural tendency of some boards is to stonewall or refuse to engage with the activist but this is rarely a good idea. Even if campaigns are negative in their intent, activists often come with well thought through and clearly articulated views on strategy.
While a hostile bid is binary – win or lose – activism can result in many different outcomes.
A well-advised board will be ready with clear counter arguments.
That doesn’t necessarily mean changing strategy. However, clearly demonstrating that the board is in “listening mode” can make all the difference in securing the support of shareholders and can, in the end, help to strengthen the strategic purpose of the business. It’s important too to learn from the experience of other companies that have come under attack, particularly those in the same sector, and to take regular stock of trends in other jurisdictions.
Boards should also be refreshed regularly to make sure they contain an appropriate array of skilled people who can really understand the risks and opportunities facing the company and defend the board’s strategy robustly.
Our experience of helping clients prepare for campaigns – including running activist attack simulation exercises with boards – shows that levels of readiness among companies are improving. But many have further work to do.
At a time of great flux in global economic and political affairs and with M&A markets showing some signs of deceleration from record levels of activity, that work will be all the more important. In a distressed market, activists are likely to find more, not fewer, opportunities to exploit strategic vulnerabilities and we believe activism will only increase in the near future. Boards need to be ready.
Defending against activists - some dos and don'ts
- Establish effective lines of communication with shareholders and activists
- Study the activist’s case objectively and carefully and be open to (partially) adopting possible improvements to the existing strategy
- Dismantle the activist’s arguments and very quickly – to avoid lasting misperceptions – put your case strongly to shareholders when you have your arguments in place
- Establish contact with decision makers at key shareholders and other stakeholders and seek regular feedback on strategy and governance
- Decide carefully whether the chair and selected non-executives or the management team should be the main Contact point with leading investors
- Continuously (re)assess the existing strategy looking to pre-empt attacks and make improvements at the company’s own initiative
- Work with advisers to get your defence in place well in advance of an attack to allow a careful and appropriate response, possibly within the first 24 hours
- Ignore or stonewall an activist
- Attack an activist’s case in the media without a carefully built PR plan agreed with legal, financial and PR advisers
- Ignore the potential for compromise
- Assume you “know” where your shareholders stand
- Allow the financial projections underpinning your strategy to go stale