Risk Management

When Investors Attack

With macroeconomic uncertainty lessening, but with companies still hesitant to part with cash cushions, the time is ripe for shareholder activists ...
Vincent RyanFebruary 13, 2013

Apple and Hess aren’t the only companies that have to worry about activist investors prodding them to return cash to shareholders, throw out senior management, revamp the board, or slash executive compensation.

As of last fall, investor-activist campaigns increased almost a third in 2012 over 2011, according to SharkRepellent.net, which found 152 instances of financial- and board-seat-activist campaigns last year. Other surveys of corporate executives and institutional shareholders predict more activity against corporate management in 2013. And activist shareholders are not just attacking: indeed, most of them are winning concessions from management, say two attorneys from DLA Piper.

Attorneys Sanjay Shirodkar and Christopher Giordano of DLA Piper, and Paul Schulman, executive vice president of MacKenzie Partners, a mergers-and-acquisitions services firm, looked at 41 campaigns against companies with market capitalizations of $1 billion or more. In 78% of the cases (of campaigns that began in 2012), the activist emerged with some kind of positive outcome, the three say. “Most of the gains came as a result of a settlement or some form of engagement between the two sides that satisfied the activist to the point of standing down,” they wrote in a paper published in December. Moreover, in 44% of the battles that reached some kind of resolution, management ceded at least one board seat.

With macroeconomic uncertainty dissipating somewhat in the United States and the euro zone, but with companies still hesitant to part with their cash cushions, the time is ripe for shareholders to stir the pot.

Hedge funds were involved in 37 of the 41 situations the DLA Piper attorneys examined. Activist-driven funds such as Relational Investors, Corvex Management, and affiliate firms of Carl Icahn were all involved in multiple campaigns in 2012.

But executives and boards seem to be handling activist situations with more civility than in previous years. In many instances in 2012, companies engaged the activist shareholders in discussion, and many gave up a board seat or two. “In the old days, if [an investor] came knocking on the door, you would adopt a [poison] pill, shut down everything, put up all your defenses, and say, ‘I’m not talking to you,’” says Shirodkar.

Some of that is out of necessity: fewer public companies have shareholder-rights plans — antitakeover measures commonly called poison pills — than had them 10 years ago, says Shirodkar. That leaves them more exposed to investor attempts to accumulate a large amount of shares and demand change. Sixteen of the 41 large companies studied by DLA Piper had a shareholder-rights plan in place, but 12 of the 16 didn’t adopt the plan until after the activist announced its campaign.

Poison pills are still useful, but most are event-driven: designed simply to thwart the current threat, explains Shirodkar.

In the garden-variety poison pill, existing shareholders have the right to buy newly issued shares at a discount if the activist or another shareholder buys a percentage of the company’s shares above a threshold. The current plans are short term: 1 or 2 years, while the plans of a decade or more ago usually stayed in place for 10 years or more.

The thresholds that trigger the rights plans are also lower: only a little bit higher than the amount of shares already owned by the activist. “If you adopt a long-term pill without shareholder approval, Institutional Shareholder Services and Glass Lewis [two large proxy-advisory firms] will recommend voting against management,” Shirodkar explains.

They “are still 900 pound gorillas,” he adds. “If they tell shareholders to vote [a certain way], more often than not that’s the way it turns out.”

The lower-trigger threshold plan makes sense if a company wants to engage with the activist. That’s because it can bring the parties to the table earlier, before the investor accumulates a sizable position in the company’s securities, says Giordano.

But the best defense against activist investors is for management to conduct an operational and strategic review before ever being targeted by investors, says Shirodkar.

His Takeaway for CFOs
First look at the business plan with a critical eye on potential angles of attack: if the company has many business segments, do they work as a cohesive unit? Does the market fully recognize the potential of the company in its entirety, or will the breakup of the company bring more value to shareholders? What are the company’s plans for the surplus cash it may be hoarding? Should it declare or increase the dividend? Repurchase shares?

In the strategic review, management must examine what proxy advisers and institutional investors are saying about the company’s stock, and continually monitor the changes in the institutional and hedge-fund shareholders. It also doesn’t hurt for management to be vigilant about the tactics activists are using to gain a toehold at other companies.

Creative Tactics
Activists are using some creative new tactics to fly under the radar and avoid detection, including “the use of total return swaps and other derivatives to avoid disclosure requirements or to acquire voting power that does not correspond with their economic equity investment in a company,” according to a December blog post on The Harvard Law School Forum on Corporate Governance and Financial Regulation. The post was by Martin Lipton, founding partner of Wachtell, Lipton, Rosen & Katz. (Lipton created the poison pill in 1982.)

So although more activists and managements may be reaching some kind of mutual understanding more often, executives still have to keep their company’s defenses up.

“The reason the activists acquire securities and agitate is to create value that they perceive isn’t being reflected in the stock price,” Giordano says. “They have one mandate: to return as much money to their investors at the greatest rate they can.”