When activist shareholders threaten to spill your board, it pays to be prepared.
There has been a very significant increase in shareholder activism recently and in particular an increase in Board spill proposals. A Board spill is really a situation where an activist takes a position that the existing directors of a company should be replaced by a new set of directors.
We have seen this globally, and in particular in the United States there has been some very high profile Board spills including one recently for Hess Corporation. We are also seeing globally the emergence of specialist funds in this area who are specifically looking for undervalued companies and targeting those companies through Board spill proposals.
In Australia we have seen a number of Board spills but they have tended to be at the smaller end of the listed market. We think there will be an increase in Board spills and that will be across the board, both small companies and large companies going forward.
There are really three drivers for the continued increase in shareholder activism and any particular Board spills in Australia.
The first driver is the legal framework in this area and it really is tilted towards the shareholder activist rather than the incumbent directors. One of the key rules in this area is that if you own 5% of a company, or if you can solicit the support of 100 or more shareholders, you can send a notice to the company requisitioning a Board spill and that’s, in my view, a very low threshold to have to meet. The introduction of the two strikes rule again will create more forced Board spill situations with companies going forward and there are a number of other rules as well that help activists including the ability to access the company’s share register and send PR materials directly to shareholders. So that’s the first reason – the fact that the legal framework really is tilted towards the activist rather than the incumbent directors.
The second reason we think there will be an increase in activity in this area is around the cost of a proxy battle. The activists are generally companies or funds who are well funded, they have deep pockets and they are ready for a proxy fight – they are happy to have their names in the newspapers. On the other hand you have directors who have limits around their ability to use the company’s funds to defend themselves – they generally don’t want their reputations and their names in the newspapers in relation to the proxy battle and in that situation with that dynamic you can see why in many cases an incumbent director forms a view fairly quickly that in fact they would prefer just to step down gracefully rather than go through a difficult Board fight.
The third reason we think there will be an increase in shareholder activism and Board spills in Australia is that it may be a viable alternative to the traditional hostile takeover bid.
In the past where a bidder has knocked on the door of a company and hasn’t been able to get the support of the target Board – in many cases they have just launched a hostile takeover bid and there are a number of problems with that. One of the problems is that you do need funding in place upfront for the entire equity value of the company. You generally don’t have due diligence at the beginning of the process and it’s a very protracted and long process – it often takes three to six months to finish and in most cases you need to increase the offer price to actually succeed. So that is quite a problematic and difficult path.
On the other hand, a bidder may well want to use a Board spill resolution as the first step towards a change of control transaction. So they could put forward a new slate of candidates which may be more open to consider a proposal down the track. They don’t need much capital to do that – they only need a very small shareholding and they are really not taking much risk at that point in time. If the Board spill resolution is successful they can then move forward with the conventional offer letter, access to due diligence and also a friendly proposal hopefully with the support of the Board. So we think that’s quite a viable alternative that may be considered going forward by companies.
So what can companies do about this? Well one of the key things is to understand that you need to be prepared because if you have performed badly then you are a company who is vulnerable to a Board spill.
And there are a few specific steps you can take. One is to make sure you know who your underlying shareholders actually are and that involves sending regular beneficial tracing notices out to your shareholders. Another key step is to communicate regularly with those shareholders at the right level. And finally a number of companies that we are involved with are very good at defence preparation and are extremely prepared in the event of a hostile bid including through takeover response manuals.
In our view the breadth of that preparation should be extended to Board spill proposals and takeover response manuals should include the rules around Board spills and how the company’s proposing to respond to any Board spill that may emerge.
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