Activists Moving from Foes to Friends

By Ted Howard

Shareholder activism is growing and is an accepted and successful business. How can companies ready themselves?  

Success breeds success, as the saying goes, so it’s no wonder shareholder activism is growing and taking a foothold in the minds of investors and the markets. It’s also top of mind for treasurers of companies that either are the target of an activist campaign or whose companies are similar to the ones that are the targets. And up until recently, that activism put many treasurers into a defensive posture, causing them to circle the wagons and concoct (often extreme) ways to ward off the attack.

But attitudes are changing. Activists are increasingly seen by some as a necessary component to the market, and even a successful one at that. Activist funds have outperformed others, including hedge funds, often delivering double the returns of an average hedge fund and in some cases tripling assets undermanagement over the last four years, by some estimates. This means that activist funds now represent a new asset class in themselves.

“The returns for activist compared to standard institutional funds have been better,” says Chet Bozdog, Global Co-Head of Technology, Media, and Telecom Investment Banking at Bank of America Merrill Lynch. “Because of that there has been more money going into activist funds and hence the larger funds have more capital.” He adds that more, and smaller funds are getting into the market and expected to increase activity, noting that the success of activist strategies and fundraising is creating a “me too” effect.

This has resulted in many less established entrants pushing high-profile campaigns. “[We] expect activists will only become more prevalent as we go forward,” Mr. Bozdog says.

Weak and strong alike

And activists aren’t just going after weak companies. They’re also increasingly going after what some would consider good companies with best-in-class management teams. These companies, notes BofA Merrill Lynch, are ones with “a strong history of value creation and no significant governance issues.”

Nonetheless, companies aren’t rolling over, with many taking steps to clean up the books to take them out of activists’range. And treasurers are getting more proactive in their approach, too. “I think being educated on activists, knowing what they do and how they work” is important, says Mr. Bozdog.

“Second is to be prepared to act quickly if an activist gets into the stock,” Mr. Bozdog adds. And finally, he says, there are actions companies can take to proactively reduce activist interest in the stock vis-a-vis having reduced cash position, as well as potential sale of underperforming divisions.

“From a treasury standpoint,” Mr. Bozdog says, “having the right capital structure in place… can limit the chances an activist comes in.” Which argues for making sure the company has an optimal cash position (not too much, not too little) and strong overall capital structure.

Market support

One of the aspects of activism that has been working against companies is the widespread market support of the idea; it is said some activists are even recruited behind the scenes by larger institutional shareholders to “do the heavy lifting” of moving management of the company in a certain direction by creating a very public fuss. In fact, it is said that institutional investors often are supportive of activist agendas, even when management was led to believe the investors were initially supportive of their own efforts.

“From a treasury standpoint, having the right capital structure in place… can limit the chances an activist comes in.” 

There is also “little stigma in making a public statement for many funds,” according to BofA Merrill Lynch, although many activist actions are resolved with private discussions, often before an accumulation has even been made public. That it’s become more mainstream has been borne out by news reports that even established hedge funds are getting into the act in first-time campaigns, including funds like Eminence (Men’s Wearhouse), Glenview (HMA), Soroban (Williams) and Related Fund Management (CommonWealth REIT).

If it quacks like a duck

So what can companies do to prepare for an activist campaign that could strike them at any moment? Aside from being prepared in the cash and capital structure departments, BofA Merrill Lynch also suggests looking for clues.

For instance companies can get a whiff of activist activity by watching for an accumulation of stock by an investor. BofA Merrill Lynch says activists “may employ physical accumulation” or could combine it with derivative accumulations. Other clues include having a stock price that seems to hold up for no good reason in a down market.

For this reason, BofA Merrill Lynch says, “large derivative accumulations may result in transient run-ups in stock price and trading volume.” Also, BofA Merrill Lynch says to find out “which broker-dealers trading are the stock” or “any change in the historical traders of the stock.”

Be prepared

A company cannot create a precise plan for being the subject of an activist campaign, but it can prepare. BofA Merrill Lynch suggests developing an activist response plan that includes the possibility of it going public. Refine the company’s investor relations strategy by targeting key shareholders and preparing a solid and thorough business plan to trot out in defense. Also create a “response team,” BofA Merrill Lynch says, including an investment bank, proxy solicitor, a PR firm, outside counsel, and key company contacts.

“Companies are going to have to be prepared for it and to proactively take steps to be prepared for an activist to come into the stock,” Mr. Bozdog says. “More boards, CEOs and CFOs are looking at being prepared for it.”

Politics

“Activism tends to be as much a political campaign as it is a debate on the merits of the current team and strategy,” says BofA Merrill Lynch. This means that the company’s response should be buttoned up, with all actors reciting from the same script. That’s because the last thing a company and its management wants is to be on its heels, with no unity in opinion, and possibly being forced in directions it doesn’t want to go.

“When activists go into a stock, they plan to agitate for change,” Mr. Bozdog says. “They have a plan for why they’re going into a certain stock and what plan they’d try to agitate for.”

So to deflect an activist, it’s best to have a better plan.