Hedge Fund Activism: Staying Out of Activist Cross Hairs

Lessons/Primers

Understanding the Big Picture: The Emergence of Activism

  • Over the last decade, activist hedge funds increasingly started to populate the US investing scene
  • With the scale of assets under their management and their willingness to shake things up, institutional investors have been quick to ride their coattails
  • Activists will often look for a company’s weakness and then rally other investors who are also concerned, presenting to them their analysis of how they can improve shareholder value. Others will outline their concerns directly to the company, through white papers or letters to the board or CEO
  • If an activist launches a campaign, the target company shouldn’t be surprised to learn that the activist already has backing from its biggest institutional investors
  • In most cases, activists seek changes to company strategy, the capital allocation plan, or even the CEO or members of the board
  • Responding to some of these requests may result in dramatic changes, such as divestitures of underperforming businesses, increased share buyback programs, or changes to board composition. Activists frequently demand board seats in order to continue to drive their agenda and provide oversight to management

Thinking Like an Activist to Shore Up the Business

  • Companies may not see things the way activists do. They may think their strategy is working and everything is on track. Most often, activists do detailed reviews and analyses of the companies they target, looking at their cash balances, CEO performance, company holdings, operating margins, and even board composition
  • Red flags for activists might include unprofitable non-core assets, revenue growth that isn’t in line with that of peers, acquisitions that haven’t panned out, and overall poor performance
  • Management and boards must take an honest look at their businesses. They also need to consider where activists might see a weakness, even if they do not
  • Companies should analyze where and how customers, products, and areas of the business create value for shareholders and then determine which areas have the highest potential for growth
  • In early 2016, BlackRock CEO Larry Fink called for S&P 500 company CEOs to have a strategic framework for long-term value creation – one that articulates management’s vision and plan for the future – and share it with shareholders
  • Companies need to demonstrate how focusing on creating enterprise value – by building new products, engaging with customers, making smart capital investment decisions, and optimizing operations – will lead to improving shareholder value
  • Companies that regularly outline how they’re doing this and how their plan is more valuable than a short-term gain should be able to garner the support of their institutional investors

Getting Shareholders on Your Side Through Ongoing Engagement

  • Company management should engage with their biggest shareholders about company strategy, its capital allocation plan, how executive compensation is linked to strategy, and why the board is made up of the right directors to oversee the company in the future
  • Explaining how certain decisions are directly linked to strategy can address concerns
  • One company was able to fend off a hedge fund activist’s calls to split into two by having a strategic plan in place that delivered growth and defending that business model
  • The key here is to get your shareholders to understand and buy into your plan before the activists show up
  • One hedge fund activist lost a proxy battle after shareholders re-elected all company board nominees, thanks to its strong history of engaging with and responding to shareholders
  • Companies will want to consider engaging with activists, too. Listening to what an activist has to say can foster negotiation and prevent what could become an antagonistic situation down the road
  • Not all interaction with an activist is contentious; some companies negotiate with activists to prevent the disruption that comes with a long and expensive proxy fight, sometimes offering them a board seat

Three Steps for Staying Ahead of Activists

  • Companies and boards need to check their vulnerabilities, prepare for the threat of an activist attack, and engage with shareholders on a regular basis
  • Board also needs to emphasize its independent oversight and be able to withstand scrutiny regarding its tenure and composition, including diversity
  1. Tap your knowledge of the inner workings of the business
    1. Details and nuanced information about operations, customers, markets, and competitors, and which are driving profit
  2. Build better relationships and increase transparency
    1. Some companies are starting to outline how they’re engaging with their shareholders in their annual proxy statement or other reporting, listing topics they discuss, the purpose for direct dialogue, and the frequency of engagement
  3. Create robust processes to assess vulnerabilities and engage with investors
    1. Companies can use a risk assessment tool to spot weaknesses and then evaluate their gravity. They can frame informed responses to explain why they are making certain decisions or to change track

PWC: 10 Minutes on Hedge Fund Activism, June 2016

Image Source: PWC

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