Beware Of Activists Bearing Formulas: Activist Investors And The Success Of Financial Engineering by Proxy Mosaic

H/T ActivistStocks.com

Over the past several years, activist investors have grown considerably in prominence and firepower. Since 2010, 15% of the members of the S&P 500 have been the subject of an activism campaign, and in 2014, more activists targeted more companies than ever before. Investors, attracted by the promise of strong returns from this burgeoning asset class, have rushed in to the sector. During 2014, activist stock holdings increased to nearly $250 billion, and there is even more dry powder available for future campaigns. Despite its apparent explosion in popularity, however, activism is hardly a new strategy. Instead, its basic tenets have shifted over the years, to the point where there is now a fairly well-defined “taxonomy” of activism strategies. Of these, “financial engineering” has been one of the most popular.

According to Activist Insight, there have been 2,426 activist investments in North America since 2010, more than a quarter of which have been concerned with some kind of financial engineering. In the prototypical situation, an activist will take a position in an underperforming company and argue that it is undervalued. This value may be “unlocked” through a transaction that monetizes a portion of the company’s assets, typically via a divestiture or spin-off of a business unit. More exotic transactions, such as a sale-leaseback of a company’s real estate assets or a conversion from a C-corporation to a master limited partnership (MLP) or real estate investment trust (REIT), are also possible.

At the other end of the spectrum, companies that have been performing well have also found themselves in activists’ crosshairs. In the years following the financial crisis, corporations had been hoarding tremendous piles of cash, making them fodder for activists to enter the scene and advocate for that cash to be put to more efficient use, such as via share buybacks or acquisitions. The flow of “cheap money” enabled by ZIRP has also fueled this phenomenon.

But amidst the proliferation of activist investing in general and its sub-strategy of financial engineering in particular, few have stopped to ask what is, to us, an obvious question: Do these financial engineering transactions – share buybacks, divestitures, spin-offs, and acquisitions – actually “create shareholder value” like activists claim? In many respects, there is an unbridgeable divide between activists and issuers. Activists will claim that issuers and their management teams are too self-serving and resistant to change; issuers will claim that activists have only short-term goals in mind, and are hardly concerned with long-term shareholder value. However, we believe that by looking at the data objectively, we can begin to bridge the divide. We have examined a sample set of approximately 100 cases of activism campaigns involving financial engineering over five years. Rather than having to rely on rhetoric, our data-driven approach to this question can help determine whether claims of unlocking shareholder value are just hot air, or whether activism truly does what it says on the tin.

A Background on Financial Engineering

“Financial engineering” is somewhat of a pejorative term that refers to a sub-set of activist investing that encompasses a range of strategies. There are two activist investing “taxonomies” that we can use. One, posited by Michael Levin, includes categories of social activism, governance activism, operational activism, and financial activism. The second, used by Activist Insight, includes board-related activism, balance sheet activism, business strategy activism, M&A activism, and governance activism.

Activists Types of Activism

Broadly speaking, financial engineering activism represents a cross between purely financial or balance sheet activism, business strategy or operational activism, and M&A activism. Specifically, financial engineering activism deals with activist campaigns where the primary goal of the shareholder is to pursue one of the following:

  • Dividends
  • Share repurchases
  • Capital restructuring (e.g., increasing leverage)
  • Acquisitions
  • Divestitures
  • Spin-offs
  • REIT/MLP conversion
  • Pursue sale to third party (e.g., private equity buyout)
  • Mergers

 

Overall, financial engineering strategies are used in approximately half of all North American activism campaigns. The reasons for the popularity of financial engineering strategies within activism are manifold, but boil down to several factors at both the macro and micro levels.

Activists Campaigns

See full PDF below.