Agitators And Reformers: How To Respond To Activist Investors by Josh Hinkel, Henrik Poppe, Martin Toner and Chuck Whitten, Bain & Company
Arguably, the single best way to ruin a CEO’s day is to report that an activist is on the phone and has just taken a position in the CEO’s company.
More and more CEOs are getting this call, as activist investing has exploded in recent years. We examined more than 400 activist engagements and found that the targets are getting larger and the industries more diverse. We also found that the activists’ attention is not limited to so-called laggards; it includes a number of high-performing companies as well. In short, few, if any, management teams are immune to an activist challenge.
Bain’s analysis highlights the tough dilemma management teams face when they confront an activist. What the activist says is often right, and activists’ overall track record indicates that they do, on average, create shareholder value. But such a result can come at a high cost for the organization. Moreover, many of the rewards are front-loaded, leaving others to cope with the aftermath. Hence the dilemma: A company cannot and should not ignore activists, but it also should not immediately accept or reject their ideas. It must be ready to evaluate the activist’s investment thesis quickly-and then decide where to cooperate, fight or negotiate.
How to get ready for the call? The first key step is to understand the common patterns and investment theses of activists in general, and of those in your sector in particular. That will help you pressure-test your strategy and your relationships with your investors. The other key step is to create a comprehensive “break the glass in case of emergency” plan. With a plan in place, you will not be caught by surprise-and when an activist engages, you and your team will know exactly what to do and who will do it.
What activists want
Activist investment theses typically fall into seven categories (see Figure 1). Most activists still lead off with a demand for changes in corporate governance, such as new board members or a new CEO. A minority—those whom many companies view as agitators—have no publicly stated thesis beyond that. They just want to stir the pot, in hopes that somebody will address what they see as an undervalued stock.
The majority of activists are different, and might better be called strategic reformers. They have a well-defined program for reshaping the company they are pursuing. That program may include specific changes in the company’s financial structure, business strategy and executive compensation. It may propose the sale of the entire enterprise or reevaluation of the business portfolio. Strategic reformers’ demands are often carefully researched and highly detailed. When the activist firm Starboard Value engaged with the restaurant company Darden, its diagnosis and prescription ran to nearly 300 pages, including plans for real estate sales, franchising and asset spin-offs.
A growing number of activist engagements are falling into the strategic reform category, as our study indicates. The study also shows why understanding the activist’s demands is so important: Outcomes depend heavily on the activist’s investment thesis. Strategic reformers as a group typically produce significantly better returns than others. Those who propose the sale of a company or another M&A–based strategy tend to turn in the best results of all. By contrast, the agitators—those with no explicit investment thesis or pure corporate-governance issues—produce little or no differential return compared to industry indexes.
So it is essential to unpack and evaluate the specific investment thesis of the activist who is challenging your company. But if you are simply reacting to the activists once they arrive, it is likely too late.
Preparing in advance
The plan you put in place before the activist calls should anticipate what they are likely to say, and it should lay out your initial talking points.
Stress-test your strategy. Long-term value creation is a function of fundamental performance. Most successful companies have a sound strategy linked to specific objectives and measured by total shareholder return. A company that creates a sustainable competitive advantage, executes well and reinvests to solidify its strategy will find that its share price accurately reflects its value. That is critical: If there is no arbitrage to be had, most activists will hunt elsewhere.
But you will need to stress-test your strategy against the common activist plays in your industry. Ask yourself: Are we underperforming against our peers in key operational metrics? Is our management compensation congruent with company performance? Ask similar questions about the value of your business portfolio-would it be worth more broken up into its constituent parts?-and about the strength of your balance sheet. If you monitor activist investments closely, especially in your own industry, you will find that much of what they look at is highly predictable. And if you pose the same questions an activist would ask, you can take action before you are confronted with an activist. When McGraw-Hill faced restructuring demands from activist investor Jana Partners, for example, it could announce it was already pursuing a complete portfolio review and share repurchase plan. The company thus avoided a costly proxy battle and settled with Jana for one additional seat on the board.
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