A boom in large cap situations in 2017 hides a complicated picture for activism as dedicated funds targeted fewer companies. More than ever, activism looks like a tool destined to become commonplace, rather than a strategy for the skilled few.
BoA: 50% of S&P 500 Could Be Extinct Within A Decade
Unperturbed by rising markets in the first half of 2017, activism continued to be an ever-present danger. The number of companies publicly subjected to economic or governance-related demands hit 485 by the end of June. Projected figures show that 2017’s activity looks set to fall behind the record pace set in 2016.
Walter Schloss isn’t a name many investors will have heard today. Schloss was one of the great value investors who trained under Benjamin Graham and specialized in finding cheap stocks. His track record was outstanding. In Warren Buffett’s 1984 essay, the Super Investors of Graham-and-Doddsville, he noted that between 1956 and 1984, Schloss’s firm returned Read More
This drop may also be the case for dedicated activist funds. Last year saw the first fall in activity for such funds in the U.S. and with only 89 companies publicly subjected to demands in the first half of 2017, they seem unlikely to achieve last year’s total of 203, let alone 2015’s peak of 226. Europe and Asia show more sign of catching the activism bug. With assets under management stable after dropping to around $180 billion worldwide between 2015 and 2016, dedicated purveyors have something to prove if activism is to remain a strategy at the same time as becoming a widespread tool.
“Dedicated activists seem to be piling into industrial stocks, almost doubling the relative amount of activity in the sector.”
Activists continued to set the tone for management teams, and when executives failed to heed their warnings, they often paid a price. Sally Smith at Buffalo Wild Wings and Klaus Kleinfeld of Arconic both lost their corner offices in the middle of proxy fights in which activists claimed partial victories, while Jeff Immelt’s near-16 year tenure as CEO of General Electric came to an end just months after he struck a deal with Trian Partners to modify his bonus structure amid fears that the industrial conglomerate was well-behind on plans to generate annual profits of $2 per share.
Meanwhile, Hunter Harrison became CEO of his third major railroad as the figurehead of an activist campaign, sending shares of the company, CSX, up dramatically. Despite commanding a $300 million price tag, including $84 million in retirement benefits forfeited from his previous employer, Canadian Pacific Railway, shareholders ratified Harrison’s compensation package with barely a whisper of discontent.
Not by industry alone
As with the tightening grip of activists on CEO tenure, some trends continued to play out. Still-weak commodity prices meant a less favorable environment for activists in basic materials companies, allowing Marathon Petroleum to resist a breakup. Real estate continued to attract attention, including campaigns by Jonathan Litt’s Land and Buildings at mall operator Taubman Centers and Canada’s Hudson Bay, though a collapse in the share prices of other retailers caught some unawares, including at Macy’s.
Dedicated activists seem to be piling into industrial stocks, almost doubling the relative amount of activity in the sector against the same period in 2016. In Europe, the number of companies subjected to public demands in the sector has already outstripped last year’s total as American giants General Electric and PPG sought cheap growth opportunities overseas, often resisted by shareholders. M&A may present opportunities for bumpitrage, but if the aim is operational improvements the path ahead may be hard. Trian Partners has been seeking to double General Electric’s profits for two years, to little avail.
“On average, between 2013 and 2016, large cap stocks accounted for roughly one in every four U.S. companies targeted by activists.”
Activism in Europe has maintained a steady pace, despite signs that the U.K. is less attractive in a year when political uncertainty has increased dramatically. Only six contests went to a vote, down from 17 last year, though activists won a board seat in four. Last year, activists also edged fights nine-to-eight and settled six more. With proxy season over, 24 U.K. companies have been subjected to public demands in 2017 so far, compared to 43 in the whole of last year. Only 5 of those companies were targeted by dedicated activists, however, whereas 2016 saw 17 companies in their crosshairs. Europe-based companies in the industrial sector attracted more attention than in prior years.
Rest of the world
A raging battle between Elliott Management and the Australian miner BHP, gave the lie to the relatively stable levels of activity down under, where most activism has been domestically driven. Excluding Australia, 38 companies had been targeted across Asia, suggesting the year-end total would likely come in just under 2016’s total of 88. A dearth of large cap targets suggests foreign activists may be less interested in Japan, where stocks underperformed the S&P 500 Index until April. Since their nadir, however, shares are up sharply and an activist won a rare proxy contest at Kuroda Electric.
Big is back
In other respects, however, shifting market conditions led to a breakout of new targets. On average, between 2013 and 2016, large cap stocks accounted for roughly one in every four U.S. companies publicly targeted by activists. In 2017 so far, their number has exceeded past years’, accounting for almost one in every three targets. Driven by bullish markets after the November 2016 presidential election on hopes of corporate tax reform, activists seem to be deserting smaller targets for larger bets with deeper-rooted problems.
Not every case has worked out though. General Motors, facing its second activist campaign in three years, destroyed Greenlight Capital’s proposal for a dual class stock in a proxy contest as ratings agencies voiced concerns and the board claimed that the proposal would raise governance issues.
In the U.S., proxy season saw markedly better outcomes for management despite high-profile activist victories. Activist Insight Online data show management winning 11 fights, two less than last year, and dissidents winning at least one seat in eight fights - slightly over half last year’s total of 12.
Given the new leadership of contested situations at influential proxy advisers Institutional Shareholder Services and Glass Lewis, this proxy season was closely watched. Proxy Insight data suggests the overall picture was little changed for ISS with management’s slate backed in 44% of fights, down from 48% last year. In close fights, however, shareholders backed change at Citi Trends and Buffalo Wild Wings, while index funds were said to have pushed hard for a settlement that gave Elliott Management moderated influence at Arconic.
Uncertainty may still have played a role given that the number of settlements was also slightly down for 2017. Only 23% of contests settled this year, down from 30% over last year as a whole.
The activism landscape
An interview with Andrew Freedman, co-head of the Activist & Equity Investment Practice at Olshan Frome Wolosky.
Why are activists going after CEOs more?
Activists are beginning to set their sights on what they perceive to be the root cause of a company’s underperformance. The board oversees management, and where you have a board that is blindly supporting an underperforming CEO, sometimes you have to bypass the board and get straight to the issue, and I think that’s what we’re seeing. It’s the path for the quickest change, if you can make that change happen.
Also, we’ve been at a point now for several years where activists in the top tier are able to attract, recruit, and retain top talent like never before. There’s no taboo with being associated with an activist like there was maybe a decade ago. Activists who have the means and wherewithal are able to go out there and find supremely qualified, transformational leaders who are willing to take up the cause. You saw that at CSX with Mantle Ridge and Hunter Harrison, as well as at Arconic with Elliott and Larry Lawson.
Are there any downsides to having a CEO anointed?
There’s a monetary side to all of this. Regardless of how talented and how strong the resume may be of that CEO candidate, any time there is perceived alignment with an activist, you are going to see companies defensively argue that the CEO candidate is in the activist’s pocket as a tactic. It could disadvantage the activist, but we haven’t seen it become an issue so far. It’s been mostly just side noise.
What else was different about this proxy season?
An interesting thing we experienced firsthand advising on the Arconic contest was that activists are harnessing social media - LinkedIn, Facebook, Twitter - in getting the message out in a targeted fashion. I think it was also a factor at Buffalo Wild Wings, although we didn’t advise on that.
For us, that was a first, because for a long time there was a question mark over how the SEC would perceive and handle those kind of social media communications. We now have a firmer understanding about how you can use that type of messaging. Social media messaging tends to be depicted in a more colorful way, so you have to steer clear of the red flags from the SEC about how you portray a board or management team. Also, there’s a lot of legalese built into SEC solicitation disclaimers, so appeasing the SEC’s requirement for compliance in a manner that is practical in the context of, say, a 140-character message can be a challenge, but we were able to work through it with the Commission.
Presumably part of the reason for social media becoming more popular is the importance of the retail vote?
That’s true. It started with DuPont [in 2015] and has continued to this day. You don’t want to leave any shares out there in management’s bucket so you go out there and aggressively mail if you have the resources to do so. It’s an expensive business.
Retail has traditionally been more procompany, more pro-status quo. But I think there’s been a bit of a shift in that. It’s situational - if you have a company that’s been reeling where management has been paid exorbitantly while shareholders have been feeling it in their pockets, they’re more likely to align with the activist. I think we’re going to see what was traditionally a 70:30 split in favor of management get closer to 50:50 where activists have the resources to repeatedly deploy their proxy materials to a broad swath of the shareholder base.
Are non-traditional activists still interested in going public?
As much as ever. A large portion of our practice these days is walking these newcomer activists through their first situation. And those situations can be rewarding on both sides. It’s a whole new animal for these investment firms, going through board engagement, 13D filings, public letters and ultimately the proxy process. But I think you are going to continue to see non-activist firms go public on a name and you may even be surprised about some of the firms that do file a 13D in the coming year.
These newcomer, reluctavist-types are not only getting a taste for agitating, but they’re realizing there’s an avenue for enhancing value rather than sitting back and waiting for the company to do the right thing, which rarely materializes. By following a certain game plan they can either use public pressure to compel the company to make positive changes or can seek to enact those changes themselves through a campaign. Once you see how that can work as a newcomer to the space, you keep turning to it because you realize that in other underperforming portfolio companies there’s a pathway to value creation. Take our client Harvest Capital, for example. They went through their first proxy battle last year at Green Dot, and have just inked a settlement with The Meet Group for new directors.
Are companies less likely to settle with first-time activists?
They are because of what’s happening on the other side of the table. There’s a certain set of defense advisers that are on the lookout for 13D filings, letters and press releases by these new-styled activists, and they’re reaching out to the companies right away with entrenchment-minded action plans looking to get retained. These are the type of advisers who peddle themselves as “non-settlers,” and they tend to get hired by the small to mid-cap companies where you tend to see the new activists appear. It does create a different dynamic, and we have to explain to our new activist clients how the dynamic differs from situations involving the likes of Starboard or Third Point, where you can have an expectation of a highly constructive dialogue and early-stage settlement in many cases.
And what other strategies might these activists use?
Withhold campaigns were highlighted this year as one of the tools for these newcomer activists. We saw it from Horton Fund, and I think you’ll see more of Horton Fund in the future, and Tenzing Global Management, who had one of the most successful withhold outcomes this year at Brightcove. A withhold campaign is attractive to an activist where you can do it in a lowimpact manner without a full-blown solicitation and where a 25-30% withhold vote against directors still serves as a referendum and a platform for next year. It lays the groundwork for future engagement.
Wells Fargo was a great spotlight for highlighting the virtue of a withhold campaign, but it is hard to convince the institutions to vote against directors absent egregious circumstances. People still look back to H Partners’ seminal withhold campaign against Tempur Sealy in 2015 and we still field calls from people curious about how that worked.
Are traditional activists as busy this year?
They’re every bit as busy. They may seem less busy because they are less public in certain circumstances. They’re less public because they are able to achieve behind the scenes the kinds of changes that years ago they were having to agitate for. Suffice to say, they are extremely active, you’re just not reading about it in the newspaper headlines as often as you used to. The number of situations that our activist clients are involved with hasn’t changed, some of them just don’t have to wage proxy contests as often. At the end of the day, activism is a means to an end. It’s about finding the causes of a company’s underperformance and catalyzing change. If that can be done ithout a fight, then it may be the ideal way to get things done. On the other hand, if you get the sense there is a board or management that is feigning being open to change, you very well may need a mandate and the way you get a mandate is through the polling of shareholders that you get in a proxy fight. Top-tier activists now have the depth of experience, and the experience of interacting on many a public board, to get a feel for when their involvement needs to be more publicly escalated or where cooperative, behind-the-scenes changes can get the job done.
What was the most egregious entrenchment device you witnessed this proxy season?
Rent-A-Center changed the record date1 after the preliminary proxy. They filed a preliminary proxy with an April 10 record date on April 11, then filed a revised proxy on April 24 with an April 24 record date. They did the required 20-business day broker search for the first record date, but only a two-business day broker search for the second record date. They said it was because they announced a new business plan and wanted to give shareholders the opportunity to vote on it, but they had announced the business plan before the initial preliminary proxy came out so their reason didn’t wash. Needless to say, they didn’t get away with it.
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