Shareholder activism has evolved from the leveraged raiders of the 80s to a more collaborative approach, without losing its assertiveness of purpose. The big picture changes in the world have aided this shift. Good governance has become a mantra for businesses, and it has been proven to be the key for corporate efficiency and shareholder democracy. Nowadays, given the instability of markets, there is no room for questionable management in the corporate universe. And due to business cycles, this pocket of inefficiency is here to stay. In the next few years, activism will be a major strategy for alpha-hungry investors, but only a few capable of engaging with credibility and expertise will be able to produce meaningful results.
People tend to stay away from areas of complexity and intense risk. Activism is in bed with both. Corporate governance issues, poor capital allocation, inept management and strategy, all incredibly complex problems that carry significant costs to economic prosperity. And the solutions to them are risky. Legal mechanisms, financial engineering, M&A proposals, and the like, may lead to high losses in case of poor execution. On the account, the recipe for success in activism is a treacherous one. A good idea, careful risk management and preparation, are not sufficient. Investors require the scale of capital, great alignment with their LPs, an excellent team of lawyers and consultants, and a great track record, to earn credibility in corporate boardrooms and withstand the probable downturns along the way of the campaign. This means high barriers to entry for aspiring activists and weak competition for the select few who have deep expertise and excellent organisation to engage successfully in activism on a consistent basis. The result of this for the economic world? Greater efficiency from the campaigns of top activist funds, and the broadening of mandates of aspiring activists, which will seek to fill competitive voids by applying activism in other regions like Europe and Asia as well as in smaller companies.
Increased Competition; Lower Returns?
The increasing limitations to shareholder activism as a source of alpha have been a key topic of discussion lately. Firstly, due to macro instability – regarding gluttonous monetary stimulus, paralysed M&A activity, increased tail risks, and potential droughts of liquidity – the activist space has seen more players competing for opportunities. This has been argued to be a trend that will decrease the relevance of activism in regards to the alleged escape it provides from the recent middling returns, towards a more fertile ground for largely uncorrelated returns to the overall macroeconomic environment. Secondly, due to the past successes of activist actions and pressures that this has placed on the corporate sphere, many companies have been proactively creating value for their shareholders. Some argue that this trend will also continue, decreasing the role of the activist investor in catalysing value creation.
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An example has been General Electric in 2015, where its management team restructured their businesses through dynamic cost cutting and divestitures of assets, strategy changes, and financial engineering, initiating a transformation of the financial services conglomerate into an industrial powerhouse. However, Nelson Peltz’s Trian Partners, which acquired a stake in GE in Q3 of 2015, believed that GE could repurchase more shares and generate more value for its shareholders if they borrowed outside capital. This argument is further reinforced by what Cliff Robbins of Blue Harbour Group, stated in March 2016 interview with Value Investor Insight: “Even with more companies aware of the importance of practising “self-help,” it’s rare even for the best-managed companies to pull all the levers without a push from external capital. And very often we want the value-enhancing changes to be bigger, bolder and faster…There always will be a need for that outside catalyst.”
Still Room for Growth
Just as the financial markets in general, the activist space is not completely efficient. There are thousands of companies that may benefit from activists helping unlock value and many regions in the world that remain underexplored. According to data from Activist Insight, demands made by activist hedge funds, large asset managers and other institutions in the US were 262 for 2016 as of May 9th, compared to 43 in Europe and 19 in Asia. Understandably, there are legal frameworks and cultural issues that impede the rapid development of activism in those regions. Nonetheless, according to the same piece, “Activism Grows In Europe And Asia” by Activist Insight, from May 9th, 2015 to May 9th, 2016, the number of demands in Europe and Asia grew 30% and 73% respectively.
It is clear that we are living in the golden era of activism. Fraudulent activities stemming back to the Enron days and also the lack of oversight evident after the 2008 global financial crisis, demanded shareholder activism as a vehicle for accountability to ensure economic prosperity in the long run. This is only set to continue, with the compounding effects of globalisation and the Internet of Things. Additionally, the increased awareness in the corporate world of the benefits of activism and the willingness of companies to partner with activist investors, point towards an exponential development of this type of business activity.
Activism within the Bigger Picture
What will be carrying this evolution is the renewed focus of activist investors, which have shifted from predating vulnerable companies into projects of turning lagging assets into high return assets. Amid the bewildering macro backdrop of today and the constant stream of unexpected technological disruptions, activist investors may help companies survive among this uncomfortable landscape. This shift is evident by ValueAct Capital’s February letter to investors, where Jeff Ubben writes the following:
“One common theme we have explicitly chosen to invest in across multiple industries is direct customer engagement and disintermediation. Said another way, we look for opportunities where a company can remove intermediaries that distribute, resell, install, service and maintain their products.”
Therefore, activist hedge funds will increase efficiency in the corporate world in two key ways: (i) by protecting ‘strong’ companies’ competitive position through business cycles, and helping them thrive within the current economic instability; and (ii) finding a place for the assets of ‘weaker’ companies, either by transferring them to better competitors (through ‘deal’ activism and M&A) or by dissolving them into value for shareholders. Indeed, this development is highly Darwinian, but with the sluggish growth that is expected in the next few years, it might be necessary to ensure productivity growth in the long run.
The relevance of shareholder activism will continue to take shape in two ways. Firstly, it refers to the most dominant force in the economy today – technological innovations, which are disrupting every industry, one at a time. This means that companies will struggle to keep competitive. So, activist investors will play a role in safeguarding companies which yield value and utility for society, by re-engineering their business models and their governance strategies. Secondly, it is a fact that the current macro instability has made excess returns a rarity and superior risk management a necessity for outperformance. Therefore, an investor’s ability to influence an outcome will be more relevant than ever; engaging in activism will carry just as much value for the protection of capital as for alpha generation.
*This article was first published by myself on June 2, 2016, on The Market Mogul.