Given Starboard Value LP’s unprecedented success at Olive Garden parent Darden Restaurants Inc. in 2014, where they won all 12 board seats up for election, this phrase (one of the many mismanagement claims leveled against Darden leadership) may become the rally cry for all activist investors in 2015, and there are a lot of them. Depending on the source, there are between 100 and 400 activist funds looking to invest between $100 billion and $400 billion. According to a report recently released by Activist Insight and the law firm of Schulte Roth & Zabel LLP, 344 companies were targeted by activists in 2014, up from 291 companies in 2013. This trend is expected to continue in 2015.
Having participated in many activist situations and proxy contests and having witnessed many others from the sidelines, it has become apparent, to me anyway, that both activists (notwithstanding their success) and companies need to revise the way they approach activism and shareholder engagement. Both activists and companies should attempt more meaningful dialogue to collaborate, if possible, before engaging in destructive behavior simply designed to obtain, or keep, board seats.
Unfortunately, it seems not everyone agrees that collaboration is the best first step. There are plenty of commentators who have staked a position on either the company side or the activist investor side, without seeming to acknowledge a middle ground. The running dialogue between Marty Lipton, a leading corporate governance lawyer and a founding partner in Wachtell, Lipton, Rosen & Katz, and Lucian Bebchuk, Professor of Law, Economics and Finance at Harvard Law School, serves to scope on the diametrically opposed views on the utility of activism.
There is no question but that there are some unscrupulous activist investors out there. It’s probably even fair to say that the vast majority of activist funds operating in the first decade of this millennium were deservedly considered bad actors. Even those who were not patently bad actors were selfdescribed event-based funds with a clear agenda to have something happen. Their business model did not include dropping millions of dollars into a company’s stock to tell management to stay the course. Thus, it is not surprising that most companies, when initially confronted with a shareholder accumulating a large position, are suspicious of the shareholder and its motivations.
But times are changing. Today, many activists are investing vast sums of time and money to understand the companies they invest in. They are finding independent directors to serve alongside nominees that work for the funds—not just proposing the same slate for every company. They are suggesting creative strategic options to companies—not just the standard platform of distribute cash, buy back stock, divest assets or sell the company. It is this change in approach that has allowed activism to go mainstream and allowed institutional investors to support activist funds.
In some cases, however, this time and effort is lost with the messaging by the activist investor. The Barington Group’s current situation with OMNOVA Solutions is a good example. Because Barington has less than 5% of OMNOVA’s outstanding shares, it is not required to file a Schedule 13D, and thus we don’t have the actual text of the letter. However, in its preliminary proxy statement, Barington summarizes its letter as follows: “In the letter to Mr. McMullen, dated December 3, 2014, Barington noted that the Company’s shares have dramatically underperformed its peers and the market as a whole over the past one, three, five and ten-year periods, as well as during Mr. McMullen’s entire 14- year tenure as CEO. Barington stated in the letter that it is its belief that OMNOVA’s poor share price performance reflects the market’s dissatisfaction with the Company’s lack of strategic focus, disappointing organic growth and return on invested capital, frequent earnings shortfalls and poor executive compensation and corporate governance practices.” Barington apparently concluded the letter by threatening to run a proxy contest, couched in terms of proposing three board candidates “who can assist the Company in improving long-term shareholder value.” A week later, Barington commenced its proxy contest by nominating three directors to the OMNOVA board. Interestingly, one of those candidates is the CEO of a company Barington targeted a decade ago. Of course, we don’t know the tone of the dialogue before Barington sent its letter, but it’s hard to fault OMNOVA for its reaction. There are many similar examples out there. 1
On the flip side, as surprising at it may be, there are still companies that just refuse to engage with their shareholders. Management’s time resources are finite. The vast majority of management’s time should be spent on running the day-to-day operations of the company and planning and executing business strategy. Managing shareholder relations cannot become a full-time job. That said, many companies put tons of time and effort into avoiding shareholder engagement even at the annual meeting. I have seen scripts for annual meetings that are on a single sheet of paper, that don’t include a management presentation and that have not allowed for Q&A or any shareholder discussion. I have seen annual meetings moved to locations designed to make it difficult for any shareholder to actually attend.
Even those companies whose management engages with shareholders around the time of the annual meeting do so simply to solicit votes for the meeting, in particular if they are seeking approval for a management-sponsored initiative. It’s not meaningful dialogue about the company’s business, and it usually does not continue past the annual meeting. In a similar vein, in many cases the investor relations function at a public company is managed by the chief financial officer. The company views the investor relations function as merely the means by which to convey the financial results of the company, nothing more.
With that background and experience, it is little wonder that when a known activist comes calling that there is a failure to meaningfully engage with that shareholder. Again, there is the distrust factor. Then, there is the lack of experience having meaningful dialogue with shareholders. Management is used to having guarded conversations, at best, with anyone other than directors and other management. There is also the Regulation FD factor, which circumscribes how much management can even share with an activist seeking engagement.
Activists are not going away anytime soon, if ever. While some people like to tout Warren Buffet and Berkshire Hathaway as the consummate long-term investor, by all rights Mr. Buffet started out as an activist investor. Similarly, Carl Icahn has been around for decades. There is no reason to think that activist investing won’t continue in some form or fashion as long as there is money to invest.
Of course, it doesn’t help that the jury is still out on whether activist investors create value for anyone but themselves. In arguing that increased restrictions should not be put on activist investors, Professor Bebchuk has allegedly demonstrated that activist investors do not have an adverse effect on the longterm interests of shareholders, and may even have a positive effect. Conversely, John Coffee, professor of law at Columbia University, conducted a study that concludes that there is little evidence that the operating performance of companies targeted by activists improves.
But, while there are studies on both sides of the debate, these studies seem to focus on average returns or average performance. That is, the studies examine the universe of activist situations and come to their competing conclusions. Of course, they are studying the activist movement in general, and in Professor Bebchuk’s case, he is simply arguing to leave activists alone.
If you were to randomly select activist situations where the activist obtained board representation, and look at the stock price of the target companies before and after the activists obtained board seats, you would see that some have improved, some have fallen, and some have remained relatively flat. This completely unscientific analysis demonstrates what most of us would conclude intuitively, which is that some activism is successful and some is not. Activist shareholders and companies need to actively work on improving their dialogue.
Activists don’t target companies that have no room to improve. Boards and management of targeted companies need to honestly assess their situation when an activist comes calling. Activists need to approach companies with an honest attempt to work with management first. While there may be some successful activist situations that started and finished hostilely, and some situations where companies survived an activist charge and turned performance around, I’m willing to bet there are more situations that resulted in a win for everyone where management embraced the views of the activist, and the activist truly tried to work with current management, and that collaboration reaped better dividends for everyone involved. Morgan’s Foods and Fidelity National Financial are two situations worth reviewing in that context.
We need to end the debate over whether activism is good or bad, acknowledge it is here to stay, and the participants need to engage collaboratively, and not destructively.