From the outbreak of Covid-19 to the subsequent contraction of the global economy, corporations have faced unprecedented challenges in 2020. Yet there is another evolving challenge on the rise: shareholder activism.
In this paper we will define what shareholder activism is and what’s the main motivation, we will assess what makes a company a good candidate for becoming an activist target and finally what best practices can be adopted to reformulate their communication strategies to enable reaching a middle ground with activist shareholders.
Understanding Shareholder Activism
Technically defined, shareholder “Activism” represents a range of activities by one or more of a publicly traded corporation’s shareholders that are intended to result in some change in the corporation.
Shareholder activism covers two main categories:
- Economic Activism that advocates for changes to create gains within the company, focusing on operational inefficiencies and opportunities for quick shareholder returns in the form of stock buybacks or increased dividends
- ESG Activism, or socially conscious investing, that works to change boards and policies to make a company’s practices more ethically and ecologically sound.
In addition to these categories many activists may target executive compensation and other governance practices as key areas for change. The compensation of top executives is one of the more visible corporate policies over which shareholders seek to exert influence.
Note that if an investor acquires more than five percent of a company with the intent to influence management, it is considered an activist investor and must publicly file a Form 13D filing with the U.S. Securities and Exchange Commission (SEC). In addition to alerting management and the board of the investor’s ownership stake and intentions, a 13D filing may also serve to alert other investors that an activist is targeting your company.
Raiders of the Lost Corporation
Activists investors have been engaged in this type of activity for decades (think Kirk Kerkorian, Carl Icahn, Nelson Peltz). In the 1980s, these activists frequently sought the breakup of the company which has given rise to their frequent characterization as “corporate raiders.” These activists generally used their own money to obtain a large block of the company’s shares and engage in a proxy contest for control of the board. In the 1990s, many new funds began to enter this market niche (think Robert Monks’ LENS Fund, John Paulson’s Paulson & Co., and Andrew Shapiro’s Lawndale Capital). These new funds raised money from other investors and used minority board representation (i.e., one or two board seats, rather than a board majority) to influence corporate strategy. While a company breakup was still one of the potential changes sought by these activists, many also sought new executive management, operational efficiencies, or financial restructuring.
Major Activist Campaigns carried out in 2020 (so far)
- 797 campaigns;
- 9% successful or settled;
- 38% either unsuccessful or withdrawn; and
- 53% announced but were unable to gain traction or are ongoing.
Note that whether activist campaigns are successful or not, it is important to recognize that activist campaigns may bring negative publicity, takes time to arrange, and in many ways disrupt the activity of a business and its management.
“Activism, at present, shares something with global warming: Its tide is rising, not just in one place but across the globe. Whilst the US remains the principal market for activist investors, the number of companies targeted around the world has been increasing faster.”
– Be Your Own Activist | Developing an Activist Mindset
What to Expect
Today, the combination of a favorable regulatory environment and abundance of funds to invest, means activists have become a force to reckon with for companies of all sizes. Activists are better prepared than ever, they have more funds to deploy, spend considerable time undertaking analysis to finesse their demands, adopt complex hedging strategies and have stepped up their strategy by courting passive shareholders well in advance in order to influence crucial votes in their favor.
What Makes a Stock a Good Candidate for Activists?
- Wide shareholder support for changes to the board and management team
- Large executive salaries rewarding poor performance
- Insiders own less than 10% of the company
- Cash is being spent on frivolous acquisitions
- Quality employees are leaving due to poor management
- Management has lost its focus and is not driving growth
- Management is misstating financial results
- Valuable patent portfolio value is being squandered
- The company is trading for less than the sum of its parts
Note that the tactics used by activists to accomplish their goals vary widely. Strategies range from closed-door negotiations to very aggressive public encounters with management.
Small Caps & Activist Activity
In many ways, activism is more valuable at small public companies than at large caps. A small cap company may not get the same press when it makes a bad business decision. Operating activities can be less transparent to investors. Board members are more likely to be friends of management who were placed on the board to be agreeable. Finally, smaller companies often have shareholders with less buying power. The smaller funds and investors may not have the resources or the expertise for a proxy fight. Without an activist partner, these investors cannot gain the publicity and the public pressure needed to convince management to agree to improve things.
A Best Offense is a Good Defense
Yet small cap companies frequently have less experienced management teams and board members, and therefore may not be as well equipped to combat the activists activity as their large cap brethren. This also makes small caps such lucrative targets for many activist campaigns.The best starting point for small-cap CEOs and Boards is to first understand the different types of activist investors. Ultimately, the best defense requires understanding what the activist wants.
“If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat.”
― Sun Tzu, The Art of War
CEOs and Boards might want to understand the motivations of activists, ask themselves questions about the company’s performance and future direction and then take concrete steps to address and improve the situation especially as it related to shareholder returns. Executives and Boards who understand and apply activist techniques might be better placed to meet the demands of activists and simultaneously drive shareholder value.
Maureen Wolff, President and Partner, Sharon Merrill Associates writes: “For many companies, a looming activist shareholder is no longer the exception – it’s the rule.”
Here are 10 tips for dealing with small cap activists.
- Understand the triggers that could make your company a target
- Know your shareholder base
- Respond promptly to all investor inquiries
- Know who among your investors is unhappy and develop a dialogue
- Prepare yourself before speaking or meeting with an activist investor
- Be proactive when it comes to good corporate governance
- Be careful in making governance changes
- Know the proxy voting guidelines of your investor base
- Seek common ground to avoid a public proxy fight
- Performance is priority number one once a campaign begins
Remember that private equity firms and hedge funds are greedy. It’s a given that smart small and microcap investors know that you make money from exploiting inefficiencies in the market. Activists investors see more favorable risk reward profiles that investing in smaller capitalized firms can bring. The success of a company’s Board/ Management team will be to act in the interest of the company’s long-term growth (and interests of all stakeholders, not just a single shareholder) whilst also seeking to incorporate the ‘goal congruent’ parts of the activist’s strategy.
Activist investors may have sound ideas about how management can use the company’s assets better, improve its operations, or enhance shareholder value. Management may or may not be receptive to such ideas. However, the dialog could be productive of positive changes for the individual investor as well as the activist.
Activism & the Outbreak
Finally, focus on and cultivate your company’s relationships with your shareholders, analysts and even the media. Ensure that throughout the ongoing pandemic you maintain and further strengthen a robust communication strategy in order to build and maintain your credibility across these relationships. Activists are generally more likely to target companies that are poorly understood and/or subject to public criticism. One of the best defenses to an activist attack is to have a long-term strategy that is supported by your shareholders and is publicly communicated clearly and often by management.