July 8, 2015 Bruce Goldfarb comments on the rise of activism in Global Investor Magazine
Global Investor (incorporating International Securities Finance)
By Pádraig Floyd
17 June 2015,
Activism is increasing rapidly, fuelled by some spectacular successes. Pádraig Floyd considers the merits of minority shareholder-led action for long-term investors
There has been increased activism from investors in the US – often hedge funds – seeking to impose their will on corporate boards. These high-profile battles between boards of public companies and investors seems to be going the way of the activists, who are receiving concessions or, in some cases, having their terms met in full. These concessions often include seats on the board for themselves or their confederates, giving them the power to affect change from within.
The issue of activism tends to polarise opinion, but it is nothing new. Shareholder activism became a part of the investor landscape before the financial crisis as hedge funds pushed for deals or higher prices for corporate actions, says Bruce Goldfarb, president and CEO of Okapi Partners, a New York-based proxy solicitation firm, which engages key shareholders on behalf of its clients.
“Large shareholders went along with the activists and they had some good success-winning campaigns,” says Goldfarb. “Now we are surpassing previous levels of activist activity, but some of the changes activists are pushing for are different. We are seeing many activists push for changes in a company’s fundamental business strategy.”
These changes are often geared towards creating long-term shareholder value, says Goldfarb, which flies in the face of the activists’ detractors. He also expects to see more activism in the future.
The statistics bear this out as the number of activist campaigns pursued in 2014 increased by almost 30% over the previous year (see table 1), repeating a year-on-year trend.
Up to the end of May this year, 148 campaigns had been launched in the US, largely in the finance and electronics sectors (see table 2). The reason for the greater number is simple – the activists are getting what they ask for.
In any given year going back to the turn of the century, an activist seeking board seats in the US had a 50:50 chance of succeeding. Since an historical low in 2012, where fewer than half of dissidents were successful, 63.3% got their way in 2013 and last year the figure leapt to 73.1% (see table 3).
Success breeds success, or so they say, and activist hedge funds have seen vast inflows of capital as investors back the activists to deliver them returns. Market data company eVestment shows that to the end of April 2015, activist hedge funds had amassed $98.68bn, though others put the figure at £120bn or more.
There were inflows of $14.4bn into these funds during 2014 and there have already been $1.06bn of inflows this year.
Last year was particularly busy for activist investors – Starboard Value led a campaign that resulted in the entire board of Darden Restaurants being dismissed, and Icahn Enterprises successfully maneuvered eBay into spinning off its PayPal business as well as winning seats at car hire firm Hertz.
The most punishing victory of 2014 must go to Daniel Loeb’s Third Point after it forced Sotheby’s capitulation on the future of its business, its strategy and even its CEO. To rub salt into the wound, it gave the activist board seats and paid the legal costs to the tune of $20m.
This year, H Partners has forced out three senior board members at mattress manufacturer Tempur Sealy, while Third Point is pressuring food group Yum to spin off KFC and Pizza Hut.
It does not always go the activists’ way, of course.
Trian failed in its campaigns with Coca-Cola in 2014 and DuPont this year, despite receiving support from proxy adviser ISS. And while much of the consolidation in the global pharmaceutical industry was driven by activist interests, their activities resulted in the largest near misses in the sector as the companies made their own matches.
More recently, digital photo website Shutterfly received support from two proxy advisers – Glass Lewis and Proxy Mosaic – in its battle against Marathon Partners.
“Activist investors can play a crucial role in shining a light on weak governance structures at some of the largest publicly-owned companies,” says Oliver Parry, senior adviser, corporate governance, at the Institute of Directors in London. He also accepts that some hedge funds may use corporate governance as a Trojan horse to increase their leverage.
Opposition
Opponents claim activists are short-termist investors. Parry says a hedge fund’s purpose is to increase the returns from its investments for its investors, and it can lose patience with those they are trying to engage.
However, Paul Robinson, CEO of Alquity Investment Management says that with the odd exception such as Warren Buffet, activism is almost by definition short term in nature.
“A lot of the recent activism we have seen – such as Carl Icahn at Apple – seems to focus on financial engineering around the company balance sheet,” he says, using surplus cash to releverage or even issue debt to pay dividends to shareholders.
This, he says, is often designed to deliver short-term gains and we should have learned our lessons about additional risk-taking and leverage as we continue to pick up the pieces from the global financial crisis.
What is needed now is capital expenditure to drive real growth, says Robinson: “The likes of Icahn look to run highly cyclical businesses in a very aggressive way for short-term gain. If this forces companies to be short term and take aggressive risk, then there is a significantly greater chance that they blow up in a downturn.”
How do these activist investors sit with other asset managers, and indeed their clients, who are likely to find the value of their investments greatly influenced by the actions of minority shareholders?
Actually, there is a very good chance they are aware of the campaign and may even support it, as such actions are rarely initiated alone, says Daniel Romito, senior analyst of advisory services at Nasdaq in Chicago.
“As the market begins to cool down in the latter half of the year, alpha will become harder to attain, so if the activist makes a compelling and reasonable case to a current traditional – growth or value – investor, you could see an increased willingness to support an activist engagement,” says Romito, adding that support is assisted in no small part by the market’s recent run.
As this ebbs towards a market correction, management teams will need to persuade investors from taking profits, or at least mitigate the degree to which they do. “Shareholders may be more willing to entertain an activist focused on enhancing yield if they feel the marginal benefit of realising additional yield exceeds the opportunity cost of taking profits,” says Romito.
It should be noted that not all activists are hedge funds. In the past year, there has been increasing activism in the US and elsewhere among large institutional investors – largely pension funds – on the platform of governance, particularly on matters of environmental, social and governance.
A number of large pension funds, including the two largest US public funds, Calpers and Calstrs, have upped their game in this arena, campaigning on issues such as board diversity and executive pay.
Both supported the biggest campaign launched by New York City comptroller, Scott Stringer – who is responsible for $160bn of pension fund money – on proxy access, to increase the influence minority shareholders can have on the appointment of board members.
Lodged with 75 of the largest companies, few have resisted the proposal and some adopted it before the AGM season began.
“We are witnessing more active involvement in the voting process overall from all types of investors, from large mutual fund managers to retail investors,” says Goldfarb.
In the past, management could rely on votes from certain types of shareholder – S&P 500 boards have approval ratings of almost 100%, so any large-scale dissent is very apparent.
But shareholder voting is becoming less predictable, says Goldfarb, and this is indicative of an engaged process. “In the campaigns we have worked on, we have seen big fund managers take a lot of time and consideration in their voting. Index funds in particular have to own many of these companies for a long period of time, so their vote is very important and their process in some instances is quite thoughtful.”
That said, some large institutional investors are less than enamoured of their activist cousins. Larry Fink, CEO of BlackRock, recently criticised the short-term financial approaches of some activist investors when he said: “Corporate leaders’ duty of care is not to every investor or trader who owns their companies’ shares at any moment in time, but to the company and its long-term owners.”
It would seem to rest on whether you believe some activists do pursue long-term investment strategies but, says Goldfarb, logic dictates that there are those who do. “If good activists cannot see a path to create shareholder value in the future, they likely will not engage in targeted campaigns. An activist may only see value in trying to shake things up when particular companies are undervalued relative to peers. For good activists, their research and process are market neutral.”
The headline deals could lead one to assume that activism is very much a US-centric phenomenon, but that would be wrong. Activism is alive and well everywhere, it is just that some people do not make such a song and dance of it.
Sam Pearse, a partner in Pillsbury’s corporate and securities practice, has advised clients on activist campaigns and says different jurisdictions have different regulatory regimes. “This means investors have different tools available to them and that lends itself to adopting different strategies.”
Cultural differences undoubtedly play a major part in how activists ply their trade. The confrontational approach may have arisen in part due to the regulatory process, but also due to the corporate structure at play in the US.
Though some investors have sought to split them in two, the roles of chairman and CEO are typically held by a single individual in the US. This makes that person a figurehead, but gives him or her considerably more power.
Where activists cannot make headway through private discourse, a public show of dissent may be necessary to drive the debate forward. However, that kind approach does not work everywhere. Europe and Japan are very different markets and a confrontational approach would generally prove to be counterproductive, says Steve Brown, CEO of activist Go Investment Partners.
“Where there is a strong core business, activists often only bring division and this does not add value,” he says. “In those circumstances, the company is better owned by someone else who could be a lot more successful or valuable to shareholder value, by revisiting the company’s structure.”
Brown favours dialogue and seeking to be a catalyst for the board revising its thinking. This works better in the European context and even more so in Japan, he says, where the US-style of activism has resulted in unsuccessful engagement.
Greg Konieczny, fund manager of Franklin Templeton’s eastern Europe focused Fondul Proprietatea, says his companies – particularly in formerly nationalised industries – face a number of governance issues as they transition to the private sector. “Corporate governance is very high on the agenda and, in Romania, there are laws governing corporate governance requiring a professional board and independent advisers,” he says.
However, political influence remains prevalent, and often he will take action over appointments that fall outside this legislation to align the board with company performance so it understands there is a reward in driving shareholder value. “Though we always start with private conversations, if we get no results we are not shy of using our public relations team and add some additional colour to explain why we are seeking these changes.”
Gains without frontiers
It would appear that when it comes to activism, the genie is out of the bottle. It is not a mainstream approach, but its application is widespread albeit with variation in the strategy employed and targets set between different markets.
Romito believes growth will not only continue but escalate, as there are no constraints to restrict activists – market cap, returns and growth are all secondary considerations to perceived potential.
“The activist operates with the mindset that the balance sheet belongs to them and if that balance sheet is not optimised, they take issue,” says Romito. “In other words, it really does not matter who you are or what space you operate within, if there is a divergence between potential and performance, you will be targeted.”
There is no such thing as perfect information about markets, nor perfect companies that operate within them. As a result, though there are thousands of high-quality companies delivering longterm shareholder value, it does not mean they cannot be improved in some way. Boards do not always hold the blueprint for eternal growth.
“There are always some strategies that are too shortsighted or not the right fit for a particular company,” says Goldfarb. “Those types of strategies can come from management or from an activist trying to add value to a company. Nobody is infallible when it comes to investing.”