Reiner Sachs – CEO, Shareholder Value Management AG
While activist shareholders have been a part of the picture in the US and UK’s equity capital markets for decades, in Germany they play a rather more secondary role. This is mainly due to the understanding of the roles of the management board, supervisory board and the shareholders’ annual general meeting.
In Germany’s dual board structure, the independent, authoritative management board has never been subject to the instructions of the supervisory board in terms of business leadership.
The idea of shareholders wielding influence or sharing corporate responsibility (either inside or outside of the annual general meeting) is very much unfamiliar. Correspondingly, the press regards activist shareholders as, at best, suspicious, and rarely as benevolent – instead, they are often presented as short-term oriented or predatory. Public discussions of their concerns have rarely taken place.
Yet this picture is gradually changing. Previously, the concept of an activist shareholder simply didn’t exist in the German corporate governance code, but there is now a suggestion under consultation to insert a new section 2.1.3: “Especially institutional investors are required to exercise their ownership rights actively and responsibly in accordance with a consistent and transparent framework of rules respecting also the concept of sustainability.” This recognises the fact that activist shareholders can indeed be a positive force for change.
The code is, therefore, following a real development; in Germany in the last few years, activist investors have been making headlines increasingly often. They have already targeted several companies – and not only DAX-listed corporations. The international trend has therefore also spread to Germany – indeed, this type of investor has been gaining ground since the turn of the millennium.
According to a study by the global management consulting firm Bain & Company, the number of activist investor deals worldwide rose on average 34 per cent a year between 2000 and 2014. Activist investors are managing around eight per cent of the capital invested in hedge funds worldwide, currently amounting to around $3billion. But beyond the large corporations, activist shareholders are setting their sights more and more on medium-sized and smaller companies. There are often sound reasons for this, since many companies don’t always work in the interests of their shareholders.
When you think of the leadership of a company, hard facts and figures are what spring to mind first and foremost: this involves the quality of the products, the market positioning of the company, sales development, profit – and, in a broader sense, the employees. It’s bad enough that these are rarely mentioned, but what is often completely missing in Germany with regard to the running of a business is how shareholders and their interests are handled. Management boards often forget that the company belongs to the shareholders.
Keeping investors’ interests in mind
As fund managers responsible for the interests of our investors, we search first and foremost for companies who keep their shareholders in mind and who do everything they can to increase the value of the company for its owners. On the other hand, we see the opportunity to influence a company in terms of its shareholder value, i.e. in the interests of investors. We at Shareholder Value Management AG therefore use this opportunity for our mandates – as activists. But that’s not always easy.
As well as the corporate structure outlined above, shareholders in Germany are confronted with the rather complicated situation that a publicly traded company’s supervisory board is not just made up of that company’s owners. It is influenced by the workforce of that company and also very much by unions and other interest groups. Direct contact with the supervisory board is – unlike with the management board – often difficult for the owner. And that is a problem, since that is where the strategic decisions are made.
Activist investors on the march
Regardless of this, activist investors from across the globe have, in recent times, been repeatedly attempting to influence German companies. Indeed, the hedge fund Knight Vinke from Monaco has written up a white paper addressed to the supervisory board of the energy company E.ON, pointing out how the company should be restructured. Cevian Capital has meanwhile pursued a rather more long-term strategy for its holdings in Bilfinger and ThyssenKrupp, in order to reposition the companies.
At sporting goods manufacturer Adidas, Southeastern Asset Management most likely stands behind the decision to move away from the golf sector – even though this is publicly denied by Adidas. Since its diesel scandal, the car manufacturer Volkswagen has also increasingly become the focus of activist shareholders. Indeed, London-based hedge fund The Children’s Investment (TCI) penned an open letter to the company’s top leadership, criticising the management board’s high salaries and the company’s close ties with Lower Saxony’s state government.
Second-line stocks come to the fore
As well as the large DAX-listed corporations, activist shareholders are now pursuing more and more medium and smaller-sized companies. Recent examples include the advertising group Ströer (Muddy Waters), the cable network operator Kabel Deutschland and the pharmaceutical wholesaler Celesio (Elliott Associates), the payment processing specialist Wirecard (Zatarra) and the pharmaceutical manufacturer Stada (Active Ownership Capital).
“What is often completely missing in Germany with regard to the running of a business is how shareholders and their interests are handled. Management boards often forget: the company belongs to the shareholders”
In the case of Stada, AOC has opened a new chapter on shareholder activism in Germany. Under the leadership of long-ruling CEO Hartmut Retzlaff, who was hardly controlled by a weak supervisory board, Stada in recent years remained well below its commercial potential. AOC has not limited itself to merely placing applications for the removal and re-election of members of the supervisory board on to the agenda of the annual general meeting; on the contrary, AOC has, for the first time in Germany, used the Federal Gazette’s shareholder forum to publicly invite qualified shareholders to participate in selecting candidates for the supervisory board. This has led to AOC garnering support from many of the larger minority shareholders. As a result, five of the nine members of the supervisory board have been replaced. The chairman of the supervisory board, Martin Abend, has been removed. The newly elected supervisory board member Eric Cornut, who was put forward by AOC, now leads the strategy committee of the supervisory body and wields significant influence over the strategic orientation of the company. There has been a quantum leap in the quality of the supervisory board’s composition. In the course of this development, the CEO also resigned his position.
AOC’s initiatives at Stada, which were also actively supported by US investor Guy Wyser-Pratte, have led to a new awareness on the part of many shareholders. On the one hand, there has now been public discussion over the influence that even minority shareholders can exert on the development of a company. On the other hand, this has also led shareholders of large mutual funds companies, such as the Deutsche Bank subsidiary Deutsche Asset Management or the investment company Union Investment (part of the cooperative financial services sector), to concretely speak out on staff matters in annual general meetings and have therefore made a public impact. Stada’s experience seems to be just the first of many further actions at other companies.
Forms of shareholder activism
The form of shareholder value activism which AOC showed at Stada comes close to our preconceived idea of it. For our mandates at Shareholder Value Management AG, we pursue various approaches in the interest of our investors, including, inter alia, the funds Frankfurter Aktienfonds für Stiftungen (Frankfurt Equity Funds for Foundations) and Prima Globale Werte (Prima Global Assets). Accordingly, in exceptional situations where we are not able to intervene structurally, our objective is to ensure that shareholders at least receive an appropriate compensation. This is the case with, for example, squeeze-outs or control and profit transfer agreements. Here we do not shy away from a judicial review in legal proceedings, or even a legal challenge.
In other cases we have pressed for the replacement of a supervisory board and, in one case, even supported a change of legal form into an SE (societas europaea).
For the mining logistics company SMT Scharf we agreed in a contract with several shareholders to act in concert to amend the agenda of the annual general meeting. In the AGM we therefore won a majority to replace the supervisory board with industry experts.
At Pulsion Medical Systems, the efforts of one shareholder led to the company being restructured from an AG into an SE. The reason: in an SE the management board and supervisory body can either remain on two levels, or can be combined into one. The latter option was implemented by Pulsion in order to streamline company management. In doing so, the disadvantages of the German dual board system described above were able to be resolved. As part of this restructuring, my board colleague Frank Fischer moved on to the board of directors and could thus participate in the very positive development of the company, which also generated value for all shareholders.
Influence on various levels
We have just begun to work together with the e-commerce solutions provider Intershop Communications AG. Together with the shareholder Beteiligungen AG we possess a 24.9 per cent share. We see ourselves as long-term oriented investors, who can actively support the company. For us, ‘active’ means constructively assisting Intershop as partners. We provide the management and supervisory boards with guidelines for positive development that will create value for shareholders, which I shall discuss below. We also encourage staffing the supervisory board with industry experts.
In the tradition of Warren Buffet
So, what principles and guidelines are important to actively influence a company and its management? As a new anchor shareholder, we want first of all to be a reliable partner, accompanying the company over the long term into a competitive, healthy and strong future. In this way we see ourselves in the tradition of value investors, such as Warren Buffet, who work alongside management in implementing their long-term business commitments.
For every company, it is an absolute necessity that the customer remains paramount. Creative and motivated employees are therefore the basis for long-lasting success. But beyond this, for us there are key levers that make a company a long-term success for its shareholders, too. It cannot be forgotten that the shareholders bear the whole risk of their capital contribution.
Creating sustainable value
To clarify something: many companies are focussed on short-term profits. But this means that the goal of sustainable growth, which is important for us, is often overlooked. Indeed, according to a recent survey of company leaders, an unbelievable 80 per cent of board members in Germany would cut necessary expenditure on research and development in order to achieve the desired quarterly figures. What is the result of such an action? The possibility of creating lasting value for the company and the shareholders is lost.
Eight principles for shareholder-friendly business leadership
So what must a company do in order to grow and be successful in the future? From our point of view there are some key factors in achieving this. For us, there are eight factors, which take priority.
First: It’s important to move your focus away from short-term quarterly expectations of the market and its analysts. To present great figures in the short term, many companies neglect the development of growth drivers, which would provide a company with long term, sustainable benefits.
Second: It should be ensured that the management board and other executives are personally invested in the company. Only in this way is it guaranteed that they think and act as an owner and carry the same risks as the other shareholders.
Third: Strategic decisions must be made to optimise the future value and growth of the company, even if it means that short-term objectives and targets will not be achieved. In practice this means that, when it comes to various strategic options, the management must always ask itself: which operational units have the greatest potential to secure growth in the future and thus raise the value of the company? Would investment therefore be necessary for this? Which units only have limited potential, and must they therefore be either restructured or even sold off?
Fourth: Only keep assets that will benefit the company’s value in the long term. Management should only concentrate on activities that will benefit the long-term increase in value of the company. This includes the research division but also entails recruiting new employees on strategic grounds. You should not continue to operate in sectors that have less potential.
Buybacks and dividends
Fifth: Efficiently allocating capital comes from weighing up alternatives when appropriating profits. Share buybacks can be one form of profit appropriation. We see share buybacks, however, not as a way of supporting the share price, but rather to consolidate value for existing shareholders. Here, however, we do regard it as a prerequisite that the market value would be significantly lower than the fair value. Share buybacks should always be seen against a backdrop of alternative investment opportunities for free cash flow. Also, with regard to the payment of dividends, it must be considered that a flat-rate dividend payout ratio, which remains the general rule for the time being, can by definition not be efficient. Consequently, we advise you to refrain from these. In cases of reasonable opportunities for acquisitions, you should not hesitate to consider not distributing dividends. In addition to this, we attach great importance to the efficient management of working capital.
“For every company, it is an absolute necessity that the customer remains paramount. Creative and motivated employees are therefore the basis for long-lasting success”
Sixth: Pay out surplus money as dividends to shareholders when it is not required for value-adding investments. If cash reserves are not needed for strategic investments, they should be distributed to shareholders as dividends or invested in share buyback programmes. On the other hand, we see it as an absolute necessity to maintain a continuously updated long/short list for possible mergers and acquisitions. A potential target for acquisition should, however, possess industrial logic and above all be affordable! The idea of ‘buy and build’ – i.e. buying in order to grow – must remain at the forefront. Often it is the takeovers of smaller, technology-driven companies that generate value.
Seventh: Board members, senior executives and leaders of operational units should be rewarded for generating consistently superior returns. Incentives that have a long-term effect must therefore be created. These figures do not just stand alone – they also set the share price in relation to the peer group. Indicators such as return on equity (ROE), the net operating income, free cash flow, EBIT to free cash flow conversion, and the return on capital employed (ROCE) are useful key performance indicators for evaluating performance. If these KPIs are positive, then management deserves a higher bonus. At the same time, if set targets are not achieved, then bonuses can also be taken away. Furthermore, management must make sure that employees can continue to develop. Top people must be given appropriate challenges and encouragement.
And last but not least, eighth: Regularly and reliably provide investors with figures concerning the value development of the company. Therefore we see it as efficient and opportune to organise a separate annual meeting for investors, analysts and media, separate from the annual general meeting. This takes place ideally at the company’s head office. This ‘capital markets day’ should provide open and transparent information about the progress of business and the current situation of the company, as well as targets and target attainment.
With our concept of shareholder value we help to establish strong, future-orientated companies that create long-term, sustainable value for customers, employees and shareholders. We will continue to recommend these principles and guidelines to the management and supervisory boards of our investments and, with this in mind, we will achieve good results for shareholders and therefore our investors. It is clear that shareholder activism is a useful and very effective instrument for implementing good corporate governance – which ultimately is the role of an active and responsible owner. This is a trend that fortunately is now becoming ever more prevalent in Germany.
About the Author:
Reiner Sachs, founded Shareholder Value Management AG in 1999 with Günter Weispfenning. He has been a member since 1999 and has been chairman of the board since 2005. In addition, he has been a member of the Management Board of Shareholder Value Beteiligungen AG since 2000. Reiner Sachs has been a member of the Foundation Council and the Investment Committee of the Share Value Foundation since 2003. Since 2012 he is chairman of the investment committee. He is a member of the executive board of the Förderstiftung Liebieghaus.
From 1992 to 1999, he was active in the Thuringian Savings Bank Supervisory Authority and later in the Parliamentary and Scientific Service of the Thuringian Landtag, most recently as the government director. There, he was responsible for the business unit of the Economic Committee. After completing his apprenticeship as banker at Commerzbank AG, he studied law in Giessen and Bonn.