KEY TAKEWAYS

  • There has been a recent wave of shareholder activism in the United States, including board spill proposals and other tactics to influence the strategic agenda of companies.
  • This trend should flow on to Australian companies and we have identified three key reasons for this.
  • We also outline steps that Australian companies can take to prepare themselves.

BACKGROUND AND US TRENDS

Many global hedge funds are turning their attention to shareholder activism as a way to generate increased returns. Their success in the North American market is leading new entrants and additional capital flows into this area. Of course, the result is increased scrutiny of underperforming “target” companies as these funds proliferate and their pockets become deeper.

The most lethal form of shareholder activism is a proxy battle to spill a company’s board, by removing some existing directors and/or putting a new slate of director candidates forward. These battles can quickly become personal and each side will usually have its own perspective on the facts and who has the moral high ground. The activists may see themselves as change agents for companies that are underperforming, while incumbent directors may argue the activists motivations are not aligned with other shareholders and they are trying to secure influence or control of the company without paying for it.

As a practical matter, finding the right slate of candidates for a board spill can be problematic given the associated reputational risks for candidates. In the United States this problem has been solved with money – in the Hess and Agrium cases, hedge funds offered each nominee director an upfront retainer of $50,000 plus future success fee payments potentially worth millions (depending on the company’s performance). Given hedge funds are investing billions of dollars in these opportunities it’s not difficult to see why they are prepared to offer this type of compensation to the right candidates.

Shareholder activism can also take other forms and may simply involve shareholders putting public pressure on a company rather than a proxy battle. David Einhorn’s Greenlight Capital filed a lawsuit against Apple and put public pressure on Apple to pay out some of its $137 billion cash balance to shareholders. While the lawsuit was dropped, Apple responded by significantly increasing its share buyback programme and dividend payout. This demonstrates how shareholder activism can be used to influence a board’s strategic agenda and capital management plans.

REASONS FOR MORE ACTIVISM IN AUSTRALIA

In Australia board spill attempts have generally involved small or mid-cap companies, although we have seen activists put pressure on larger companies such as Qantas and Washington H Soul Pattinson. In the REIT sector we have also seen a number of high profile attempts to replace responsible entities of those trusts.

Some of the US activists are already looking at opportunities in Australia. Consistent with trends in the United States, we believe there will be more high profile shareholder activism in the Australia for three key reasons.

Firstly, the legal battlefield in Australia is tilted towards the activists and they have plenty of ammunition to work with. By acquiring 5% of a company’s shares they can call a general meeting to spill the Board and the two strikes rule also creates opportunities for “forced” Board spills.

Activists can obtain a copy of the company’s share register to send materials directly to shareholders.

Secondly, shareholder activists are typically well funded and prepared for a fight. They may run aggressive public relations campaigns and also threaten legal action against the incumbent directors. By contrast, the incumbent directors will usually want to avoid a public stoush and have limits on their ability to use company funds to defend their position. These factors can lead incumbent directors to walk before the proxy battle has even started or may result in a negotiated outcome between the parties.

Finally, corporate bidders may consider using these rules as part of a multi-staged approach towards securing control of a target company. If a bidder is rebuffed by a target’s board, rather than launching a hostile bid or disclosing the proposed bid, a viable alternative path could be to buy a stake in the company and seek to replace the board with an alternative set of directors who may be more welcoming to any future corporate approaches. This is consistent with developments in the United States, where since 2011 hostile raiders have used proxy fights more often than tender offers as their tactic of choice.

In the REIT arena, the hedge fund attack on Charter Hall in 2011 showed the potential for activists to use cash-settled equity swaps to hide their presence until they are ready to pounce.

Control over management rights of a REIT can be achieved by purchasing them direct from the responsible entity, by buying sufficient voting power to enable the unitholders to remove the incumbent responsible entity or by gaining a controlling interest in the responsible entity. The Charter Hall case was a prime example of battles for control of REITs that have used proxies the battle ground for control of the REIT. In that case, hedge fund Orange Capital unsuccessfully proposed a resolution for Moss Capital Funds Management to replace the existing Charter Hall management team as the responsible entity of the listed trust.

Dexus Property Group also recently announced that it had aquired an interest in Commonwealth Office Property Fund through a forward contract arrangement.

LESSONS FOR AUSTRALIAN COMPANIES

So what can Australian companies do about this?

Most importantly, good performance will be the best defence against any attack, as underperforming companies will be the most vulnerable to board spill proposals or other forms of shareholder activism.

It is also critical that companies know who their shareholders are (by sending regular beneficial tracing notices) and have regular dialogue at the right level with key shareholders.

Many companies also have detailed takeover response plans in place in case they are lobbed with a hostile bid. They should consider extending these plans to board spills. In both cases the company can be caught off guard, there is a short response time and control of the company may be at stake.