By Cas Sydorowitz, Chief Executive Officer at Georgeson Corporate Advisory
Activists are investors who have their own investor clients, some of whom are high-net-worth individuals, family offices, pension funds, endowments and, even, sovereign wealth funds.
The activist charges more for this asset class and often requires longer holding periods. The typical fee structure they charge their clients is two and 20 which relates to two per cent of assets under management and 20 per cent of the profits on any specific trade or the fund’s performance. Understanding how an activist makes money helps frame their specific demands and provides a hint as to what their ultimate aims are and, ultimately, how to get them to go away.
Consider for a moment when an activist nominates a candidate to the board, their election will often not, by itself, unlock the full value they see in the target company. It is what they achieve once that person is on the board that will create the value release, which may include – but is not limited to – cash returns, asset disposals or sale of the company. It may take one to two years, if not longer, to achieve their goals, which challenges the common argument that activists are short-term investors.
“Proxy solicitation firms can assess which shareholders regularly vote and who influences their voting decisions. Any dissent from the shareholders in the past can spark additional points that the activists pick up in their arguments, knowing that there is existing dissent”
An activist building their position may take time, allowing them to acquire stakes at their target in-price without spooking the market or causing the stock price to move against them. To achieve their target returns, the activist needs to control their purchase price, which may mean that they take a long period to acquire the shares. Unless they achieve their objective quickly through direct communication with the board, they will likely try to appoint one or more board candidates who will consider alternative views that may challenge the status quo within the board. The game clock continues to run until they can get enough support within the board and from other shareholders to achieve the actions that will generate significant returns – allowing them to charge the 20 per cent performance fee.
Level of commitment
According to David Trenchard, an advisor on shareholder engagement and corporate governance, as well as chairman of the advisory board of Highgate Capital and former vice chairman of Knight Vinke: “The board needs to recognise the level of commitment that most activist investors make towards really understanding the companies they are targeting. Frequently, I have found that the level of forensic analysis we do when we take such a concentrated position has meant that we often believe we understand the company better than many insiders and advisers. It is rarely the case that the board does not at least benefit from hearing the perspective that an engaged investor can bring.”
The detailed analysis is more like private equity style analysis, given their focussed portfolio. To be taken seriously by management, the board and other shareholders, the activist needs to demonstrate they are intimately familiar with the company, the market place and the key drivers of cost and revenues. From the company perspective, the analysis is probably more comprehensive than any sell side research the company has ever seen. The analysis, however accurate or inaccurate, is designed to create or unlock value in the stock price, which is a goal for all shareholders. The debate then becomes about who has the most compelling argument and who will win the hearts and minds of the other shareholders.
Whether the company agrees with some or none of the arguments, it is critical to start assessing the threat and their public and private response. Ignoring the activist is probably the worst thing that the company can do. Failure to recognise or engage with the activist will often get them to shout louder than before and take their fight to the media. Only through direct engagement with the activist can the company start to understand what they ultimately want to achieve. The company should:
■ Understand how the activist did their research and what their source material was
■ Listen to the activist and review their presentation or demands
■ Do further due diligence on their plan with your bankers
■ If there are board candidates, ask how they selected them, what made up the search criteria and if they used an external party to find those candidates
■ Ask for their full CVs and availability for the nomination committee to speak or meet the candidates
■ Set a timetable for the company to come back to the activist
The list above refers to the company’s response to the activist, but behind the scenes the company must be vigilant in preparing for what can be a very public, time intensive and invasive process. To best handle the different stakeholders the company needs to have the relevant experts around them to provide counsel around the public relations and the media sensitivity and public perception of the company and the key individuals.
Proxy solicitation firms can assess which shareholders regularly vote and who influences their voting decisions. Any dissent from the shareholders in the past can spark additional points that the activists pick up in their arguments, knowing that there is existing dissent.
The financial press plays a vital role in a number of activist situations. There is little doubt that the press can significantly influence public opinion and even affect opinions around the boardroom table. No director wants to have his wife or family read their name smeared inthe press or challenged on their integrity. The tolerance for pain when the fight becomes public is very limited. This could address the reason why so many US proxy fights are being settled before going to a fight in 2015. According to Activist Insight, last year there were 112 settled proxy fights in the US compared to 102 from 2014. This number should go up even more in 2016.
Stakeholder engagement strategies
While many people may think of the very obvious media tactics of some of the more aggressive US funds, such as Pershing Square, that may use a highly public campaign, including advertising and prime-time TV appearances, there is also a more subtle approach, which is embraced by many more activists. The impact of a well-timed article can be significant – and the activist will be well-versed in how to work with the media on an ongoing basis to ensure they are able to influence the discussion. This includes identifying other market commentators the journalists can approach to get a quote. The wider audience of stakeholders and opinion leaders is growing and the activist tactics include identifying those individuals and connecting them with the relevant journalists, including former directors, politicians, shareholders and employees.
Companies need to audit not only their press relations but also their shareholder relations to ensure the corporate strategy is well understood by the various stakeholders. It is not just the strategy but the timeline and key milestones to measure the success of achieving that strategy that are important – taking a detailed inventory of who the company has met with recently and the nature of those engagements, whether it was only about the financial results or more broadly about strategy; and identifying which of the investors the company has not met with recently to highlight the priorities of whom the company needs to speak to.
“Activists need to demonstrate that they can be trusted with third-party funds, allowing them to continue to make the two per cent of assets under management”
Key decision makers in a proxy fight are the governance analysts at the institutional investors, who may not be sector or company experts. They don’t look at the financial performance or the relative performance against peers. Their focus is on board structure, independence, shareholder rights, remuneration and audit integrity. Their focus is on corporate governance-related matters and will take a view based on their past engagement with the company, whether there have been any issues left unaddressed in the past and how progressive the company is towards the governance sensitivities of their shareholders. What the activist is asking of other shareholders will frame the questions around whether change is warranted and whether the changes put forward by the activists are credible and have a reasonable chance of success. Economic change in isolation is not enough for many governance analysts to support the demands of an activist, they need to see the governance failures, the absence of the appropriate checks and balances on the governance side.
Running the numbers for a proxy fight requires looking at the voting turnout the previous year, who has voted in the past, and whether any of them voted against management. Any shareholders who are index managers or ETF managers will not have a fund manager or analyst for the company to meet with, but they will have a governance analyst to engage with. Even though their positions are passive, they do take an active role when it comes to voting and that audience becomes a very important community of investors to include in your outreach. Looking at any activist holdings requires further examination to determine if they are working with anyone else on the campaign. Co-invest vehicles allow other investors to benefit from the activist campaign without having to do any of the heavy lifting of engaging with other shareholders or the media. They only need to agree to vote a specific way to directly benefit from the campaign. These co-invest vehicles mask further support an activist may have when they initiate their campaign. Unless they are disclosed as co-signers to the letter sent to the board, the company may never know of their involvement.
Activists will look widely to determine stakeholder groups who may be supportive – whether or not they are obviously influential in proxy voting. Examples include working with customers, employees, trade unions, trade bodies and any other parties who may be willing to come out in support of the changes being proposed. That an influential body such as the UK’s Institute of Directors is willing to publicly support criticism of poor corporate governance and excessive executive remuneration in multiple cases, demonstrates that the activist may get public support from the most unlikely sources. These other stakeholders provide momentum and support to an activist’s claims as an independent third party. Their endorsements help the activist get a step closer to their objectives.
Activists need to demonstrate that they can be trusted with third-party funds, allowing them to continue to make the two per cent of assets under management. With that in mind, activists will be very selective in the fights they choose and will often not initiate a campaign unless they know they can win. The activist will spend a significant amount of time engaging with other shareholders to understand their concerns and their expectations for the future share price, given the market conditions and what is possible if certain changes are made. Their trade and activist campaign needs to unlock significant enough value for them to make the 20 per cent upside. Will a campaign to get a board member elected satisfy that criteria? Probably not. What do they ultimately want to accomplish? Looking at who they are nominating and the skills those individuals have will intimate their true objectives.
Companies need to determine if there is a position that will allow the activist to claim success to their clients without caving in and giving the activist everything they ask for. Proxy fights are very cumbersome and distract management from the day-to-day running of the business. Expert advisors can take a large part of the burden away from the company, allowing them to focus on the business, while providing experience in how activists run their fights and who they bring in for support. The best defence against an activist is a robust and improving stock price.
“Those who are victorious plan effectively and change decisively” – Sun Tzu
About The Author:
Cas Sydorowitz has been with Georgeson since 1998, bringing with him five years’ experience in international investor relations and shareholder identification. Cas is responsible for Georgeson’s Northern European Proxy and Corporate Advisory business.
Cas has an expert knowledge of global proxy voting mechanics and key governance matters affecting issuers and shareholders globally. Having worked for several activists and against many more he has in-depth experience to support investors or issuers in complex, sensitive activist campaigns.
Cas, while a New Yorker, has been in London for 12 years. He maintains membership in the ICGN, a global governance-related organisation that set the agenda for the global governance debate between issuers and shareholders. He has participated in various industry organisations including the Shareholder Voting Working Group in the UK and European Industry working committees on Target 2 Securities, Legal Certainty and the Working Group for Market Standards for General Meetings