By now every corporate board should realize that activist campaigns are on the rise and that no company is immune from public, and often messy, public fights with hedge funds, but that doesn’t mean they know how they will respond if activists come knocking. Strong inflows to activist hedge funds and more cooperation with other investors means that market cap is no longer a defense, and while the strategy is still most popular in the US it is quickly spreading to the UK, and starting to pick up in Germany and Japan.
“The best defense is a well-articulated strategy and a strong stock performance,” writes Deutsche Bank analyst Raj Hindocha. “Every company should assume they could be a target for activism and identify possible weaknesses.”
Two major crashes and equity underperformance driving activist campaigns: Hindocha
The first thing that executives need to understand is why activists are no longer seen as 1980’s corporate raiders and often find plenty of support from other institutional investors and the general public.
Most importantly, activism works. A study of 2,000 interventions between 1994 and 2007 found that target company’s return on assets (ROA) was typically slipping relative to its sector (adjusted for firm size and age) in the years leading up to shareholder action, and that it typically outperforms in the years following.
It’s also important to realize that equities haven’t done that well in recent years. Hindocha shows that equities have underperformed Treasuries and other low-risk credit by nearly half since 2000, to say nothing of risk-adjusted returns. Starting the comparison in the middle of savage bear market obviously skews the issue, but even if you start from 2003 the returns roughly track despite equities’ higher risk. A pair of serious in asset bubbles and crashes in such a short timespan may be an anomaly, but it’s also a reason for shareholders to question management’s judgment.
To avoid activist campaigns clearly explain your strategy, and then execute
Hindocha breaks down a six step process for dealing with activist investors, but you can really boil it down to two requirements: if you don’t want outsiders to interfere with your corporate strategy make sure that shareholders understand what you’re trying to accomplish – and then deliver the goods.
Activists are pretty open about what they are looking for: streamlined businesses; healthy balance sheets that are neither weighed down with debt or sitting on too much cash; operational efficiency; good governance and reasonable executive compensation; open communication between management and large stakeholders. If any of the common activist complaints apply to your company, you may want to remedy the situation.
Beyond addressing strategic or financial shortfalls, anticipating shareholder activism should be a part of the company’s PR strategy. That means keeping track of activist hedge funds and which ones are most involved in your sector; tracking shareholders and identifying those who are building a large stake; and staying engaged with social media even when you don’t think activist campaigns are on the horizon.