IT’S the stuff of boardroom nightmares. An activist investor appears on the shareholder register and everyone from the chairman, chief executive, CFO and the most recently arrived non-executive braces themselves for impact.
Everyone has seen the headlines when aggressive activists go public making demands for either board seats, changes in strategy, perhaps a merger or sale. And the tussles can last for months while activists argue their position to every reporter within earshot and executives defend their corners.
And activist action seems to be everywhere. US newspapers carry screaming headlines describing clashes making it seem only a matter of time before UK boardrooms become the next battleground.
In January a battle appeared to form around FTSE 100 drugs giant GSK. The Sunday Times reported that activist hedge fund Och-Ziff Capital Management has built up a stake in the pharmaceutical business and has urged Sir Phillip Hampton to shake up the board. The pressure follows calls from Neil Woodford, a top 20 shareholder through Woodford Investment Management, that the business should be split into four separate companies.
Nevertheless, the titanic clashes between activists and high-profile brands found across the Atlantic may not be materialising in the same way over here, though there have been notable examples. That may come as a relief to many, but it does not mean activists shouldn’t be taken seriously.
“Any sort of demand by the activist really should warrant the response of senior management,” says Daniel Romito, adjunct professor of finance at Carthage College and a senior specialist in advisory services for NASDAQ in Chicago. “Activists are sophisticated investors and a demand usually coincides with an actual substantial position, or the consideration of one.”
In one sense an activist can be any shareholder who wants a boardroom to do something differently. That might include innocuous subjects, such as accounting, or serious corporate governance issues, such as succession planning and remuneration.
More commonly though activists are investors, mainly hedge funds, who believe more value can be realised in a company through a change in strategic direction and are willing to push their point with tenacity. This is sometimes done aggressively, involving blunt statements to the press in an effort to win further support from other shareholders such as large institutions. Demands can be anything from a seat on the board to major M&A upheaval.
Last year saw a heavyweight bout between the board of chemicals giant DuPont and the notorious Nelson Peltz, founder of the hedge fund Trian. Internet headliner Yahoo is currently involved in a struggle with investor Starboard Value, which most recently involved a public letter suggesting the executive team at the search engine should clear their desks and go.
Needless to say, the business pages relish these spats involving, as they do, high emotion and big egos alongside technical management issues.
Britain has seen its share. Scottish investment house Alliance Trust butted heads with the US outfit Elliott Advisors throughout most of last year, while Rolls Royce’s run-in with San Francisco-based hedge fund ValueAct involved demands for a significant change in strategy at the engine maker.
Figures recently published in the Financial Times appear to indicate activists are ramping up their activity with engagements across the world between 2011 and 2015 increasing 170%.
More detailed figures from research house Activist Insight reveal that the UK has not seen the much predicted upsurge in confrontations. Last year, 24 companies were subjected to activist demands, the same as in 2010. That said, 2012 witnessed a peak of 32. Activist Insight says 62% of 2015 demands were successful, up on 2010’s 58%, but falling slightly on 2013 when the figure was 62.9%.
According to Piers Prichard Jones, a partner at law firm Freshfields, the expected spike in confrontations may not have materialised because UK business culture is more conservative. It is easier to call a shareholder meeting here and unlike the US and its “entrenched” boards, UK executives have to stand for annual re-election. But he says UK board leaders should still be wary.
“While there have been some high-profile recent examples of activism in the UK… they are relatively isolated examples,” says Prichard Jones.
“Activism in the UK is less widespread than many thought it would be a few years ago when there was a sense that it would rise significantly. But it is still around in the UK and there will always be companies that activists will look at for a turnaround or a quick return.”
Course of action
Prichard Jones’ key advice is that company executives should avoid being caught in a “highly emotive war of words” with activists, even though the instinct may be to doggedly defend their position with an insistence that the activists’ analysis is flawed. (It is worth bearing in mind that activists rarely appear empty handed. When Trian launched its battle with DuPont, at its core was a 96-page analysis of the company’s shortcomings).
Josh Black, editor of Activist Insight, says studies of US stocks indicate that where boardrooms and activists reach a compromise, companies often perform better.
“Rejecting an activist’s demands can be a disastrous course of action if other shareholders share their concerns,” he says. “An activist confident that it can win support from large institutions may seek to remove the CEO.”
Black warns of “diminished authority” for management, even if they win, and of costs running into substantial figures.
“It is much better to invite an activist to present its views, offer constructive criticism and immediately get on the phone to large shareholders to understand their views of the business,” he says.
According to Daniel Romito, public confrontation more often takes place only after “all other avenues have been exhausted”. In short, an activist is more likely to seek a resolution behind closed doors than out in the full glare of publicity. Surprisingly, this is true of the US, he says, and even more so in the UK with its more reserved way of doing business.
Once made, an activist proposal will force a finance director into considerable effort evaluating the financial components, and potentially across multiple scenarios. But managing activist engagement, according to Romito, does not begin when the name lands on the shareholder register, but well in advance.
“I am surprised by the number of companies that simply play the odds or naively think an engagement will not happen to them,” he says.
The first step for a CFO, says Romito, is an “objective assessment” of the gap that may exist between a company’s financial performance and the form of incentives on offer to management. The suspicion of activists is raised when they see incentive schemes they believe are not necessarily working in favour of shareholder value, which creates vulnerabilities for management.
Typical red flags for activists also include undervalued stocks, large amounts of cash on the balance sheet or groups made up of disparate companies that might raise more value if spun off.
Romito’s warning is that executives should analyse the company through “the lens of the activist” to see whether or not alternative strategies have merit.
Once the analysis is complete, a response strategy needs to be put in place and updated, including the creation of a response team. That means there will be less of a surprise when an activist comes calling.
“I can reflect on a variety of occasions where the CFO and the IRO (investor relations officer) were aware of a perceived weakness, but internal counsel, the board and even sometimes the CEO were never really notified. Everyone has to be on the same page,” he says.
Romito says the trick for company executives is to remain “diplomatic and objective”. The longer a negotiation with activists goes on, the more likely it is to sour.
However, he says: “If management has already proactively identified the vulnerability, established the framework around a collective response, educated the necessary internal parties of the likely scenarios that stem from the vulnerability, studies the tactics and track record of likely activist candidates and have maintained ongoing communications with current shareholders, the odds of an activist engagement moving in a frenzied and frantic nature are minimised.”