The growing issue of shareholder activism continues to make global headlines as activist investors target new companies, and new geographies. While the US remains the focal point, activism in Europe is on the rise and some of the UK's largest companies are increasingly being targeted by activist investors pushing for corporate change. Activist campaigns have unprecedented amounts of capital and are now launched in a broad range of sectors, on an array of issues, and it appears that no company is seen as too large to avoid attacks, with companies such as Apple, Danone, Rolls Royce, UBS, and Vodafone all being subject to activist campaigns in recent years. Mega caps are no longer immune.
Once regarded as opportunistic and aggressive 'corporate raiders' with a short-term focus on returns, today's activists are increasingly welcomed by institutional investors who view them as voicing legitimate concerns or pointing out hidden value opportunities. This changing dynamic necessitates a change in the way companies prepare for and respond to activist campaigns. This article outlines some of the key considerations for directors and senior executives seeking to mitigate the risks of shareholder activism.
The activist landscape
Activists, particularly those based in the US, have historically been known for their aggressive tactics, including public campaigns aimed at forcing company management to adopt specific changes. Publicity campaigns launched by activists are still well reported in the press, with activists deploying a range of media, including open letters, press releases, and social media, as well as more traditional communications, to bring about change. Activists with sufficient shareholdings or sufficient institutional support have also requisitioned general meetings to put forward resolutions for change and in some instances, activists have brought or threatened legal action (such as derivative actions or claims for unfair prejudice) as part of their campaign. As a result, activists have previously been characterised as "corporate raiders", with high profile hedge fund activists such as Carl Icahn (of Icahn Enterprises) and Nelson Peltz (of Trian) and more recently Bill Ackman (Pershing Square) typifying the phenomenon. This has enabled target companies to use strategies aimed at depicting activist investors as negative agitators concerned with immediate returns, rather than longer-term shareholder interests.
However, today's activists have been able to successfully rebrand themselves as positive influences on shareholder value, eschewing hostile tactics in favour of more discreet and collaborative measures. In the UK, shareholder activism is often less adversarial and activist investors typically approach a company's senior figures directly, putting forward suggestions and engaging in constructive conversations with management in the hope of reaching a negotiated consensus. Activists, with the support of advisers such as investment banks, are now well prepared and will often seek to engage with a company's other shareholders in order to gauge receptivity to proposed changes prior to a campaign.
While there are some commentators who continue to view activism, and in particular hedge fund activism, as a negative influence with a short-term focus on financial metrics, the perception of institutional investors and the general public has changed. In an era where institutional investors are under greater pressure to deliver returns, there is a willingness to support activist initiatives that aim to increase shareholder value and governance standards. Longer-term investors are increasingly involved in the activist dialogue. There are several factors that have contributed to this growing support for activism in the UK, including regulations promoting stronger corporate governance and giving greater access to investor information, and the influence of organisations such as ShareAction, which promote responsible investment. This has been supported by the inflow of capital into activist hedge funds, which have outperformed other hedge funds in recent years. The number of activist funds has increased dramatically and, in the second quarter of 2015, it was estimated that assets under management had reached approximately $130 billion, a 177% increase from $46.8bn in 2010.
As a result of the shift in attitude towards activist shareholders, it is imperative that companies adopt a different approach to activism and consider less confrontational responses in order to secure the continued support of investors.
Objectives of activists
The aims of activist investors are broad, however, the primary goal is usually to bring about one or more of the following forms of change:
- changes to governance practices (such as executive compensation plans) or the composition of the board or senior management either to allow for strategic control, to 'refresh' a long-standing team or to replace individuals that are considered to be under-performing;
- seeking control of the board to alter management policy or the strategic direction of a company to improve business operations;
- special interest activism on other corporate social responsibility issues, such as environmental practices, on the basis that changes bringing wider social value will ultimately enhance shareholder value; and
- measures aimed at unlocking value for shareholders, including requiring companies to return capital and unreserved cash to shareholders (for example, through dividends and share buybacks) and engineering strategic M&A transactions (such as spin-offs or divestments of underperforming business units) or organising a takeover of the company to realise a share price premium.
In a recent European trend, activists are trying to align themselves more closely and collaborate with mainstream investors.
Hurdles for activists
Launching an activist campaign is not without its risks, and although the UK has a comparatively open system (with no US-style 'poison pill' option), there are a number of legal and regulatory challenges for activists in the UK.
Stakebuilding and transparency rules represent a major obstacle to investors seeking to launch activist campaigns. The FCA's Disclosure and Transparency Rules (DTR 5) require a shareholder to notify a listed company of the percentage of voting rights that it holds if the percentage of these voting rights exceeds or falls below certain thresholds. This acts as a useful early warning for target companies. Rules on parties acting in concert (including DTR 5) also assist companies looking to identify potential activists. The Companies Act allows a UK public company to send a notice to anyone it suspects is interested in its shares requiring that person to confirm the nature and extent of its interests. In those instances where activist shareholders work in concert with other investors as part of a campaign, coalitions should be wary of triggering the mandatory bid obligation of Rule 9 of the UK Takeover Code where their shareholdings (individually or combined) are close to 30% of a company's voting rights.
Activists are also at risk of falling foul of the rules on insider dealing and market abuse. This is particularly relevant where investors disseminate false or misleading statements about the target company that may affect the share price. A target company may report suspected breaches to the regulator. An activist's own unpublished agenda can also be inside information.
Activist shareholders should also be wary of claims for defamation or libel where statements are made during campaigns which may result in damage to the target company's business reputation and cause financial loss.
With regulated companies, changes of direct or indirect shareholdings may also require the regulator's consent.
The defence against activist attacks; dos and don'ts
In this new era of increased activist campaigns, what should target companies do to address this risk? The following guidelines should assist management teams and company boards seeking to pre-empt activist campaigns and respond to activist scenarios accordingly.
To ensure board preparedness, directors and senior management should be alive to current shareholder dialogue, key themes of activist attack and the commercial drivers for potential activism. From an internal perspective, this requires regular board updates on issues such as investor sentiment, as well as operational matters. A board that is kept well appraised of these issues will be able to formulate suitable policies to address shareholder concerns. Management should ensure that this is a proactive process through which any changes that need to be made to the company's strategy or operations can be identified and addressed pre-emptively.
- Control the conversation and use publicity positively
The board should articulate clearly the company's strategic vision and explain how this will maximise long-term value for shareholders. Companies should aim to get their message out ahead of activist campaigns. Management should put forward a strong investment thesis that provides adequate justification for the company's strategic and financial decisions. Doing so publicly can reassure the investor base and the wider market. At a practical level, this will require maintaining good relationships with key financial or industry journalists. Senior figures should coordinate and align their response in order to insure that a uniform message is communicated externally.
- Perform regular risk assessments
It is essential that companies perform periodic risk assessments, and analyse their market and business lines from the perspective of an activist. Directors and senior management should be aware of the company's vulnerabilities and seek to address issues that could attract activist attention. These include financial underperformance, maintaining significant divestible assets, conservative balance sheets, under-leveraging, large cash reserves, low dividend pay-out ratios and failures to adhere to governance best practice. Directors should consider their approach to non-core or non-aligned business units. They should also seek to identify business units that generate significant contingent liability or regulatory risks. Engaging external advisors to prepare a critique of the company and anticipate lines of attack will prove useful when responding to activist 'white papers'.
- Review corporate governance
Companies should undertake regular reviews of their governance framework and maintain high corporate governance standards, including compliance with regulatory requirements as well as best practice policies. The board should also ensure that compensation is properly aligned with performance. Reform of executive compensation packages is an area that currently draws particular interest and preventative steps will enable companies to pre-emptively address one of the most likely criticisms of activists.
- Monitor activity
Companies should continually monitor shareholder behaviour (such as unusual voting patterns) and changes in the composition of their investor base. Analysing the shareholder register carefully to note activity such as unusual transfers in the run up to shareholder meetings, or significant changes in the size of shareholdings, can help to identifying activist movements within the shareholder base.
Companies should also assess the wider market, taking note of peers that have been subject to activist campaigns and the type of proposals that are typically put forward by activists within that sector.
- Establish a response team
Assembling a team that can form a response strategy, manage relationships with stakeholders and gather intelligence on behalf of the company can prove critical to surviving an activist attack. In addition to internal personnel, this will include external advisers that are well acquainted with management, familiar with the business and, most importantly, lined up in advance. Adviser teams (typically including financial advisers, lawyers, accountants and public relations specialists) should have clearly allocated responsibilities, enabling them to form a cohesive response team. Internally, companies should seek to attract and retain top talent in their investor relations teams.
- Communicate with stakeholders
Support from investors can swing the balance of an activist campaign. It is important that management, as a matter of good corporate governance, engage with investors on a continual basis to gain a greater understanding of shareholder concerns. A high level of engagement with the investment community can help to pre-empt attacks, as this enables companies to address concerns prior to activist attacks.
Companies should aim to create a tailored programme of engagement, timetabling opportunities to engage with shareholders outside of general meetings. These will create avenues for directors to articulate publicly the company's strategy and to gauge shareholder sentiment. These pre-emptive measures will strengthen management's long-term credibility with key investors and boost confidence among shareholders that management is promoting their long-term interests
- Have a response plan in place
This should include a detailed protocol with clearly defined responsibilities for those who will assist the company to manage activist scenarios and enable the board to act quickly and avoid missteps.
- Stonewall or rely on generic responses
Companies should seek to engage in constructive dialogue with activists, particularly bearing in mind the potential for activists to escalate private discussions to public campaigns. Ignoring a powerful activist may escalate its lines of attack. Directors and senior management should seek to control the dialogue, rather than leaving engagement with activists to investor relations personnel only.
- Be quick to characterise activists as hostile agitators
Given the currently receptive sentiment towards activists within the investment community and the general public, immediately attacking activists could eventually lead to embarrassing climb downs. Boards should adopt an open and reasonable position on proposals put forward by activists and avoid becoming embroiled in media attacks. Companies should not underestimate the ability of today's activists to gain widespread support among shareholders.
- Reject activist proposals out of hand or immediately characterise activists as hostile
Activists will usually have spent significant time developing proposals for increasing value and perhaps discussed these with other shareholders, and so management must be seen to take a considered approach, embracing compromise where necessary. Activist 'white papers' can be constructive critiques of a company's financial or operating position, which boards should evaluate objectively. Management should always seek to evaluate strategic alternatives and adopt measures that are in the best interests of the company and its shareholders, regardless of the origins of the measures.
- Be reactive
All company officers should keep up-to-date with the latest activist themes and tactics on an on-going basis, and management should discuss defence strategies regularly rather than only in response to a specific activist attack. Being the source of change rather than having change forced through by activists will help to ensure confidence in a company's leadership.
The future for target companies
Shareholder activism is on the rise globally and this seems likely to continue for the foreseeable future. In a climate where activists are seen as potential agitators for positive investor returns it is imperative that company directors and senior management prepare for activist interventions and adjust their response strategies accordingly. Companies should take a proactive stance in managing activist risks and seek to adopt some of the defensive measures discussed above.
Whilst activist proposals can improve a company's operating performance (at least in the short term), company directors should ultimately consider their fiduciary duties to the company and their responsibilities to the shareholders as a whole, and take into account the long-term viability of the company's mission and strategy when contemplating corporate changes recommended by this growing class of investors.
Recent examples of shareholder activism in the UK include the following:
- In January 2016 Karin Forseke, chairman of the FTSE 250-listed Alliance Trust, resigned as part of a major governance overhaul following pressure from the US activist hedge fund Elliot Advisors. This followed a protected public battle between Alliance directors and Elliot, which had accumulated a 14% stake in the investment firm and lobbied for several changes to management and fee structures. As a result of a sustained campaign, Alliance agreed to split the governance of the investment trust and the listed company and to appoint two of Elliot's preferred candidates to the group board. Notably, Katherine Garrett-Cox was forced to step down as chief executive of the listed parent company under the reformed structure. In addition to the need for a governance overhaul, it was Alliance's poor returns (when compared to other trusts investing in global equities) that generated criticism from Elliott.
- The San Francisco-based hedge fund ValueAct is currently campaigning for reform at Rolls-Royce, the FTSE 100 jet engine maker. Rolls-Royce has issued a series of profit warnings in the last two years and investors have been concerned about the effectiveness of the group's board. In November 2015, ValueAct increased its stake in Rolls-Royce to 10% and engaged in conversations with other shareholders as part of its efforts to encourage increased cost-cutting in the core aerospace division and divestments in the group's marine engines unit.
- In 2015 the European activist manager, Cevian Capital, increased its stake in ABB, the Swiss engineering group, to more than 10%. This move, making Cevian ABB's second largest shareholder, is seen by many as part of a wider strategy by Cevian to push for a breakup of the engineering giant's business, with the rationale being that investors would ultimately benefit from higher valuations of ABB's separate business units.
"It is absolutely the case that the floodgates of shareholder activism have opened in Europe"
Gary Weiss, Vice-Chairman (Mergers & Acquisitions), JP Morgan