We may look back on Monday, 10 April 2017, as the day shareholder activism “US style” finally arrived on our shores. On that day BHP Billiton, one of Australia’s most iconic resource companies, became a public target for US Hedge Fund Elliot Associates, one of the largest and most established hedge funds in the world, with over US$32bn in assets under management.
Elliott penned an open letter to BHP, tabling a three-pronged strategy to (in its view) unlock US$46bn in value “trapped” inside the Anglo-Australian resources group. That strategy would involve the collapse of the BHP “dual listed company” (DLC) structure, the spin-off of BHP’s US petroleum assets, and adoption of a policy of “consistent and optimal capital returns” to BHP shareholders through buy-backs and dividends.
Although BHP’s dialogue with Elliott, which has amassed a holding of just over 4% of BHP Billiton Plc (the UK vehicle within the DLC structure), appeared to have been conducted behind closed doors for several months, it is now well and truly out in the open. Elliott has established its own website as a platform for disseminating information, and BHP was quick to respond with a very detailed rebuttal of Elliott’s arguments, which can be accessed here.
The game, as they say, is well and truly on. But is it fair for resource companies to be targeted in this manner? Are there particular characteristics of the resources industry that make activism either a greater or lesser threat than other industries?
What is Shareholder Activism?
First, it should be noted that there is no single definition of what shareholder activism actually is (although we distinguish here the form of “activism” associated more with lobby groups seeking to achieve non-financial ends, such as environmentalist groups encouraging a move away from fossil fuels). There are many strategies that could be bundled together under the “activism” umbrella. These include:
- lobbying the management of a company to sell or buy assets or divisions, or undertake capital management asset to realise undervalued opportunities;
- calling on shareholders to replace the board or add new members to it;
- attending AGMs and registering “protest votes” against key resolutions (including, in Australia, the remuneration report);
- bringing, encouraging, or financing litigation against the company;
- borrowing stock and selling short in an attempt to profit from the devaluation of a company; and/or
- launching a media campaign against a company, including creating websites to lobby other shareholders to support proposed actions against a company or, in the case of short selling, highlighting what the short seller sees as deficiencies in the company.
Shareholder activism is most frequently associated with self-styled activist hedge funds, headed by charismatic leaders such as Carl Icahn (Icahn Enterprises), Bill Ackman (Pershing Square) and Daniel Loeb (Third Point), with typically many billions in assets under management. They are sophisticated, have often taken a large stake in their target company (either long or short), aren’t afraid to use the media, and are often focus on generating short term gains (although many are prepared to agitate for many months or years if needed, and are often well funded and prepared to do so).
However, taking the wider view of activism noted above, reveals a much more complex and diverse ecosystem of hedge funds, corporates, institutional investors family offices and sovereign wealth funds, to name a few, many of whom are operating “below the radar” and prepared to take positive steps to encourage corporate change, and in so doing extract value for their stakeholders.
Elliot’s activism – and BHP’s response
So far, Elliot’s approach to BHP appears to be a textbook case of US-style shareholder activism, with a very public campaign to pressure the Board and management to act on its suggested proposals. And, to date at least, BHP has responded in the most typical of Anglo-Australian fashions – with a straight bat.
Within 24 hours of the Elliott proposals becoming public, BHP had published a brief ASX announcement noting Elliot’s open letter and giving a brief rebuttal to its proposed course of actions for BHP. Within 48 hours, BHP had released another two ASX announcements, one being a 29 page presentation outlining why in BHP’s view, Elliot’s proposal was flawed. There was nothing ad hoc in this approach - the presentation was accompanied by detailed graphs, statistics, valuations and costings.
BHP’s response has been relatively simple in the sense that it likely benefited from advance preparation. As noted in BHP’s ASX Announcements, BHP had been in discussions with Elliot for months, knew of the hedge fund’s plans, and undoubtedly, had prepared an action plan to counter any escalation of the debate into the public realm.
What steps can Elliot take from here? As we have noted elsewhere, “Shareholder Activism – More Than One Way to Skin a Cat”, shareholder activists generally have three key rights in this situation - to vote, sell or sue - and Elliott is no different:
- Vote: Elliott is close to the point (being 5%) at which, as a shareholder in BHP Billiton Plc, it can requisition a meeting of shareholders. However, under the voting rules of a DLC, those shares will be swamped by the votes attached to shares in BHP Billiton Limited (the Australian entity owns a special voting share in the UK vehicle, providing its shareholders with an indirect mechanism to vote on proposals put to the English entity). So Elliott’s rights under UK law are largely ineffectual as a practical matter.
- Sell: Elliott can sell, or threaten to sell, its shares. If the shares in BHP had increased materially from the acquisition price, this could be a perfectly legitimate outcome from the perspective of Elliott’s own investors. It was the tactic employed in 2016 by KKR to yield a healthy profit on its investment in OZ Minerals, and may well be what Elliot has in mind. Bear in mind that Elliot has accumulated an interest in approximately 4.1% of BHP Billiton PLC, the shares of which have traded at an average discount of 12.7% to BHP’s ASX listing price, so a collapse of that structure (or even speculation that it is coming) offers the prospect of a short term re-rate in the Plc share price, with resulting profits to Elliott – albeit BHP disputes this.
- Sue: At the point of litigation, things potentially get more interesting. Relative to the US, Anglo-Australian law is not particularly supportive of shareholder litigation. The Board and management has reserved a good deal of discretion in managing the affairs of the company. Interestingly, however, the question of minority oppression has recently been raised in litigation by shareholder activists seeking to attack the cross-shareholding between Soul Pattinson and Brickworks. At the time of writing, this action was still being heard, but in time we may see the emergence of case law that gives some heart to activists.
Should resource companies be worried about shareholder activism?
Resource companies operate in a fundamentally cyclical environment. For a range of complex and inter-related reasons, from demographics, to geo-politics, broader economic cycles and even weather events, over the long sweep of history, commodity prices have tended to follow repetitive cycles, albeit ones the amplitude and duration of which has proven difficult or impossible to predict.
In such a cyclical environment, a resource company’s asset valuations do fluctuate (and quickly). Commodities fall in and out of fashion. Technological change unearths value in metals no-one has ever heard of (you could be excused for being unable to tell your neodymium from your niobium). The value investors place on a resource company can change without the company itself having to do anything. Indeed, for many investors, gaining leverage to these cycles is precisely the reason they invest.
At any point in a commodity cycle, it is therefore relatively easy for an activist shareholder to argue that any asset (particularly in a broader portfolio) is either “hot” or not, and that a company should sell or spin off assets, distribute cash or restructure operations, to generate short value.
Herein lies the dilemma for directors of resource companies who attract the attention of shareholders activists. Resource companies, by their very nature, are constantly destroying their asset bases, and must look to replenish reserves in order to generate sustainable returns for shareholders. They are in the business of deploying large licks of capital over lengthy period: often several years, and occasionally decades.
In this context, shareholder activism often comes down to a debate on the trade-off between short term value realisation, and long term value creation. Directors of most resource companies are likely to be doing their shareholders a disservice by depriving their companies of the very characteristics which make them attractive to investors.
This is not to say that directors should not constantly assess the efficiency of their asset portfolios and capital structures, with an eye to maximising shareholder value. However, they also need to be prepared to justify their actions by pointing to the inherent need to make decisions over long-term horizons. Ultimately, attracting and retaining the support of investors who understand this dynamic – and having the discipline, patience and sophistication to educate those who do not - is the critical element in successfully responding to activist advances.