In 2013, I attended the annual Activist Investor Conference in New York, and had the chance to learn from a variety of top North American activists. Here are some of the highlights.
Portrait of an Activist Investor
Aside from the well-known names (such as Nelson Peltz and Carl Icahn), most activist funds are small with concentrated holdings. Often they are family funds, as big institutional clients don’t want the association with activists.
Most activists focus on small and micro-cap companies as this is often where the most egregious management practices and extreme opportunities are to be found.
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They are mainly value investors, looking for cheap and troubled businesses with turnaround potential. Activists do lots of fundamental research into their holdings in order to really understand their problems and potential, and have fairly long time horizons.
There are close parallels with private equity (long-term, detailed knowledge and active turnaround plans). However, position sizes aren’t necessarily very large (typically 3-8%).
Typical activist situations are:
- Companies that are constantly shifting strategy or diversifying.
- Sub-optimal financing – especially convertible or equity issuance.
- Boards of directors who lack the skill set / are too sleepy / have misaligned interests.
- Poor cost controls.
- Diversified Businesses that can be broken up to release value.
Often, several of these factors occur together.
Successful activists also have a lot of specialist knowledge and experience, and often have to rely heavily on legal advice. Good PR is also important, as are good industry contacts (to help with the turnaround or to install on the board).
Activist campaigns can be complex and protracted, as it involves navigating minefields of corporate law and company articles, as well as working with other shareholders and management. All this specialist knowledge probably explains why activists tend to focus on specific countries rather than globally.
Actually going on a board of directors as an activist can be a nightmare. There are onerous regulatory and fiduciary obligations as well as disclosure. It also makes dealing in the stock very difficult (insider rules) and opens up a whole can-of-worms in terms of conflicts of interest.
Co-operation is the name of the game
Because of these difficulties, most activists achieve their ends through behind-the-scenes cooperation rather than public fights or proxy battles. Hence you often see an activist fund take a position in a stock, but never hear anything from them.
Carl Icahn is not the typical activist. He is much more short term and is looking for a quick hit (typically selling or spinning off a business) by relying on his reputation and the publicity he can attract.
Most activists are much more long-term and cooperative. By way of example, one of the case studies was from a small activist fund called Barington Capital, who had made about 100 investments of which only four had ended in proxy fights. They were generally able to get what they wanted through co-operation rather than confrontation.
Indeed, aggressive activism is seen as a last resort by almost everyone, because it is expensive for both parties (lots of lawyers), incredibly time-consuming, unpleasant, risky (it often doesn’t work), and can often damage the reputations of both parties. The negative publicity is an especially powerful threat, as managers’ and directors’ careers are very dependent on maintaining pristine reputations.
Hence, both parties typically want to cooperate quietly from an early stage, and so tactics are far more important than aggression. This typically involves a friendly approach, and establishing two-way dialogue from then on: it isn’t about charging in guns blazing.
Often improving governance (board competence, alignment, independence and conflicting interests) is the best way to fix operational problems.
Specific plans are essential
When activists fail it is often because they either do not have the power (large inside ownership or multiple classes of stock) or where they don’t have a clear or viable proposal (the target is troubled but not fixable).
So rather than being critical, good activists aim to present a specific plan and a timetable. This means they have to really understand the businesses they’re dealing with, and will normally start talking to management from an early stage to be sure any suggested changes will work and aren’t being considered or executed already.
The Power of the Letter
While lots of activist tools were discussed (Section13D filings, PR and publicity, board nominations, shareholder proposals, proxy advisors), there was almost unanimous agreement that the most effective tool by far was a well written letter to the board of directors.
The feeling was that most boards of directors are actually pretty good. They are usually smart, reputable people. Most have done some sort of training in director’s duties, so are well aware of their legal obligations and keen to protect their reputations. However, they tend to be pretty inert, as they only hear from management. If you send them a well-written letter, outlining good ideas, they will almost certainly take it seriously, especially as they will rarely get such a thing. The key is to present a good idea to them rather than expecting them to take the initiative.
The best method is to write a letter to all the directors personally (not just the Chairman) and to send it to them directly (so the Chairman or secretary cannot delete it, edit it or attach a memo discrediting it).
The tone of the letter is important. It should be polite, personal rather than public, and should avoid vitriol or personal attacks. Publicity and personal attacks tends to result in defensiveness and panic, actually making the activism less likely to be successful.
It should also aim to encourage a two-way dialogue between the activist and the board.
A suggested checklist for Activist Letter Writing
- Send a private letter to management or the board (send it directly to the individuals not via the Secretary or Chairman).
- Make sure they know who you are and what you want.
- Be polite and thoughtful.
- Let them know what you like about the business as well.
- Show you understand the business and have researched it.
- Avoid confrontation / personal attacks.
- Have a specific plan or recommendations rather than criticisms, and where appropriate a timescale.
- Make clear you want dialogue and are willing to evolve your stance – to develop a plan together.
- “It is easier to win the war in twenty small steps than one big one.” Rather than trying to be too shocking (e.g. “the CEO should be fired”) propose several small steps (e.g. steps to isolate him or improve his supervision and incentives).
I think what really surprised me is how most activism tends to be fairly private and co-operative. The aggressive and public spats are the exception rather than the norm.
It is really about persuasion by diplomacy: getting the tactics right and using a friendly approach works most of the time.
Andrew Hunt is a portfolio manager with one of the UK’s leading investment managers. His new book, “Better Value Investing: A Simple Guide to Improving Your Results as a Value Investor” is available from Amazon.com and in good bookshops.