Investor Activism: IR’s New Rules of Engagement
The shareholder activism landscape has changed dramatically over the last few years. Activist hedge funds today manage roughly $100 billion, almost three times as much as they managed just five years ago. Why? Because activism was the best performing hedge fund style in 2013. And as large organizations increasingly support activists, it has become critical for Investor Relations (“IR”) not only to step up its shareholder engagement practices but to change them so they are more transparent and anticipatory to accommodate this new environment.
FTI Consulting recently brought together a panel of experts at the National Investor Relations Institute’s annual conference to discuss the present and future of investor activism. Moderating the panel was Victoria Sivrais, a Managing Director within the Financial Communications practice of FTI Consulting, who has more than a decade of experience providing counsel around best-practice investor relations programs and critical issues, including capital-raising activities; crisis and issues management; mergers and acquisitions ("M&A"); and strategic transformations. Our panel included:
Managing Director at FTI Consulting, who for 20 years has advised public companies and hedge funds of all sizes on contested proxy campaigns, corporate governance issues and M&A.
Partner in the activist group of Olshan Frome Wolosky, who represents some of the nation’s most prolific activists.
Chief Executive Officer and Managing Partner of PW Partners, who manages the PW Partners’ Master Fund and Atlas Fund and currently sits on the Board of Directors at BJ’s Restaurants and Famous Dave’s. He has conducted six public activist campaigns in the past few years.
VICTORIA SIVRAIS: Recent research that FTI Consulting completed in partnership with Activist Insight found that activists are looking at M&A activity for more opportunities. Eighty-nine percent of the activists we surveyed believe that, by the end of the year, 2014 will see an overall increase in M&A activism. And although the survey reported that 87 percent of the activists see no shortage of targets in North America, Europe and, more specifically, the United Kingdom M&A activism is becoming a greater focus.
In short, activism has gone mainstream.
So let’s talk about the present and future of activism.
ANDY FREEDMAN: I think my invitation to this panel is a sign of how far things have progressed. Activist investing has been accepted as a credible asset class. This year alone, we’ve nominated 35 public companies; 26 of those have resulted in a settlement for board representation. So if you think about those numbers, around 75 percent of our threatened proxy contests on behalf of clients are resulting in a settlement.
That tells you quite a bit about the unprecedented levels of engagement among the shareholders, the activists and the companies. In all, over the past decade, we’ve advised on 400 public company situations, and we’ve seated somewhere around 450 directors at public companies.
It’s a new day of shareholder activism. Old labels have been shed, and the lines are being redrawn. IR programs also have come a long way in the last 10 years. There were times when some of my clients couldn’t even get a meeting with the chief financial officer — or the IR coordinator sometimes would totally ignore an activist. That’s completely different from what we’re seeing today, and it’s a testament to the greater sophistication of companies and IR programs and how they’re being advised.
PATRICK WALSH: My firm commonly will take an investment stake in a target company and attempt to create value by engaging and working with the board and management. That’s done through getting board representation. I’ve been through several campaigns, the first of which was Denny’s Corporation, where I met Steve Balet — we were on opposing sides. Steve taught me how contentious the process can be. After that, I hired him, and he helped mold my current thinking on engaging and working with companies and getting board representation in an efficient manner with less animosity. Typically, I try to find companies that have been underperforming but are very good. Our goal is to significantly increase cash flow in a short period of time. We have been able to do that for the companies with whom we’ve been involved.
So they’re starting to target better performing and much larger companies than ever.
STEVE BALET: Activism hasn’t changed much over the past 20 years. All the strategies you see today almost always have existed. Pat has more of an operational focus. Certain companies that Andy represents are engaged in balance sheet activism, where activists engage in strategies designed to push for a dividend increase, share buyback, spinoff, etc. Merger activism has been going on since the ’80s and ’90s, but it’s how the institutions and the market have reacted that has changed.
The change is about functioning more efficiently and engaging with the shareholder base before an activist arrives. That way, if an activist shows interest in the stock, he or she understands not only the strategy that you’re pursuing but the thought process that the board has undergone. Activists settled or won at about a 70 percent clip in 2013, and that success rate has continued into 2014. The difference is that, last year, there were 30 total proxy contests that went to a vote: Seventeen were won by activists, 12 were won by management and one was split. And there were 34 settlements during 2013.
In 2014, there have been only nine proxy contests to date [June]: six of them won by management, three by activists. However, there already have been 35 or 36 settlements. So a settlement has become more the norm. Pat was talking about working with management teams and trying to foster a relationship that’s void of animosity. That’s completely changed from 10, 15 years ago when boards wouldn’t talk with activists. There often will be circumstances where you are not going to agree with the plan the activist has presented, but if you’ve already engaged your institutional shareholder base concerning issues the activist raises, you’re in a good position to win that battle. It’s difficult, but most of the groundwork has to be done prior to an activist showing up as a shareholder.
ANDY FREEDMAN: I think you would say, Steve, that a company that has an activist shareholder and is issuing public letters and press releases is at an inherent disadvantage. That’s because the activist investors and hedge funds have done their research and have found companies that are fundamentally undervalued and vulnerable on specific aspects of their makeup, whether it’s compensation practices or bylaw provisions that are defensive or shareholder unfriendly. Generally, there’s underperformance relative to peers over a five-year basis.
I think there’s a misconception that activists are looking to bring a proxy contest for board representation. But that’s not the case. Board representation is a means to an end: the board or the company management agreeing to undertake certain actions to unlock value. The clients have done their work, and they know that value can be unlocked. It’s when the board doesn’t want to listen when things start getting contentious.
STEVE BALET: There’s also the trend that Pat mentioned that activists today are looking to take a good company and make it great — it doesn’t have to be an underperforming company. Right now, there are $100 billion in activist funds; by the end of the year, there’ll probably be $125 billion. There was $65 billion in 2012. It’s escalated tremendously, and the activists need to put their money to work in order to make money. So they’re starting to target better performing and much larger companies. Activists also are investing in each other’s activist campaigns. FTI Consulting talked with 20 activists, anonymously, at major activist funds, and 70 percent say they invest in other activist campaigns. Such investments may never show up on a Form 13F [a quarterly Securities and Exchange Commission (“SEC”) filing required of institutional investment managers with more than $100 million in assets], but activists believe this is an area where there will be a good return.
The Battle Is Joined: Denny’s
VICTORIA SIVRAIS: Steve, Pat, you were on opposite sides for the Denny’s contest. Can you talk about some of the strategies that were used and some lessons learned?
PATRICK WALSH: Sure. Denny’s was my first proxy contest. I was fairly young and inexperienced, and, in retrospect, it was a good lesson for me. It was a full proxy contest where the vote went down to the wire. We ended up losing the vote by 1 percent.
STEVE BALET: I should mention that I wasn’t advising Pat when I won!
PATRICK WALSH: It was nasty and truly shaped my thinking that life didn’t have to be that way. There were a lot of public letters and huge legal bills. There wasn’t a lot of engagement with management, and we could have acted in a more collaborative manner. That was a mistake because if we could have acquired a seat on the board and had our ideas heard and implemented, we could have created more value.
The company ended up taking up a lot of our agenda anyway. That made me realize that, hey, I didn’t even get on the board, yet the stock doubled, then tripled. I lost and didn’t achieve my objectives — and we still made money for the shareholders. Can you imagine what could have happened if I actually had attained a board seat and had my ideas heard?
So the biggest lesson from going against Steve was to focus on working with top executives to build a relationship instead of fighting them — because, in the end, we all should have the same objective: to create value.
STEVE BALET: What did I learn from my victory at Denny’s? Well, at that point, Pat was young and inexperienced, and the advice I gave the company was based upon those facts. It probably wouldn’t work today, as Pat is more sophisticated. I advised the company to put the activist on the defensive — talk less about the company and its performance and more about the activist’s tactics that certain investors had issues with.
Each activist is different in how he or she pursues a company. The mistakes I’ve seen boards make include not having the proper people in the meeting — a board member or a higher-level management person — and being either too defensive in the initial meeting or just not saying anything.
Engagement, which we’ve talked about for five years now, is not simply a tactic — it has to be real. Even if the two parties are never going to agree, sharing with your institutional investors how you engage with the activist may result in your getting the vote rather than the activist, who says: “I went into the meeting. The board members asked me what my plan was. I presented it, and then they said, ‘Well, we can’t comment on that because of Regulation FD [an SEC rule that prohibits privately disclosing a company’s material information before it’s publically available].’ Then Pat will leave the meeting, saying, “Okay, this board’s engaged. I’d probably still like to be on the board; I’d probably still like for members to make certain changes. But this is a board I can work with.” Maybe this never needs to go public because if you do some of what the activist wants or agree that some of his or her ideas are good and you can reach an arrangement, you can avoid a nasty public situation that affects the morale at your company. That could result in suppliers and customers asking questions, which is what you’re trying to avoid.
Activism in Action: Flavors and Strategies
VICTORIA SIVRAIS: From a company perspective, how does the engagement differ with an operational-type activist vs. a balance sheet activist?
STEVE BALET: An operational activist will produce a 40- or 80-page whitepaper on the changes he or she believes the company should make. The document typically is very detailed about, for example, how the company is managed or where it should be placing its resources. That’s the type of activism in which Pat engages. It’s a long-term approach. ValueAct Capital operates in this manner so it doesn’t do proxy contests anymore. It was involved with Microsoft for several years before it attained a board seat, and, throughout those years, it was slowly working on the company from the outside, never actually engaging in a public process at all.
With balance sheet activism, there still are some activists who use an informal, back-of-the-envelope approach.
And then there’s merger activism, which we believe will pick up. If you’re a public company and you’re looking to purchase another public company or if you’re a public company that is in a friendly take-private transaction, there’s a huge chance you will be approached by an activist investor saying that the deal isn’t as valuable as advertised — or that it’s more valuable. Or an investor might be against making the purchase because, for some reason, he or she doesn’t want you to enter that business.
ANDY FREEDMAN: That is an important point. Four or five years ago, I could have counted on two hands the universe of activist investors. Since then, we’ve entered a golden era of shareholder activism. We’ve seen it embraced in the media, and we’ve seen activism enjoy unprecedented credibility. That means that any investment firm can be a one- time activist investor, and there are new activists coming out of the woodwork on a daily basis. So, whereas in the past there were 10 to 15 activist investors that a company or an IR program would track, now a company has to monitor its shareholder base continuously and recognize that the barriers to entry for activist investors are quite low. You have to understand that it’s a little bit of a minefield out there. So even if you’re one of the healthiest public companies imaginable, you always should be looking at yourself from the activists’ point of view.
The Institutions: Rules of Engagement
ANDY FREEDMAN: I believe it’s of fundamental importance that the activist constantly poll and meet with the institutional investors and nurture their support. Over the past three to five years, there’s been more institutional support for activism. That’s been a key driver in creating this age of activism. You, as the activist, may think you have a good idea of what a given institution believes and that you have its backing, but that could change suddenly. So you must have a continuous dialogue with the company, almost to the point of being annoying.
STEVE BALET: You probably know that the voting decisions at certain institutions are housed in a different place from where the investment decision is made. So if you have a solid relationship with your portfolio manager, it’s important to find out how much influence he or she has on the voting decision — or whether there’s no influence at all, which is the case at some companies. There recently was an interesting situation involving Warren Buffett and Coca-Cola.
Some shareholders did not want a particular compensation package to pass, and they petitioned Buffett to support them. He met with top executives and learned they had decided to vote for the compensation package. Buffett didn’t like the plan, but he was going to vote for the suggested proposal because he trusted management. That’s how a lot of these votes take place.
For example, let’s say you have a board member who announces that the decision on a proposal to divest has been turned down. The board member explains in a way that makes it obvious that a thoughtful process about the strategy of the company had been engaged, relates that all aspects for divesting had been considered and states the reasons why it is felt that this is not the right move at this time. Since management has gained trust and credibility, activists will have a very hard time getting the vote.
When investors don’t have access or when they’ve been told only about the strategy you’re pursuing but not about the process by which that strategy was developed, then an activist can go to an institution and say he or she never had an opportunity to evaluate the proposal.
ANDY FREEDMAN: Right. A lot of times during any given campaign, we’ll see a press release where it’s obvious there’s been a set of changes. We know those things don’t happen randomly. They happen because the company has been reaching out to the investors. It’s all part of the engagement process.
The Best Advice: Companies, Activists and IR
VICTORIA SIVRAIS: Steve, what’s the best advice you’d give a client to stay off the radar of activists? By the time they’re involved, it’s a lot harder to defend against them.
STEVE BALET: The first piece of advice is to perform in the 99th percentile of your peer group. Then it’s about being more transparent.
Twenty years ago, there weren’t a lot of people who were investment relations officers. They weren’t taken seriously. That’s radically changed. Regulation FD limited communications, but there are ways to be transparent and to have discussions with shareholders so they have confidence in your process and your thoughts. The biggest change I expect to see — and which already has started — is board member involvement in IR.
For example, if you’ve had compensation issues, having someone from the Compensation Committee talking with institutions is an important and growing aspect of engagement that will help companies immunize themselves against an activist.
VICTORIA SIVRAIS: Do you have any final thoughts on where activism is heading — things that the IR team should be avoiding?
STEVE BALET: I think the activism you see today is going to continue. Traditional target companies are more difficult to find, thus better performing companies will be targeted in the future. Even if you’re at a company where you don’t think activism is going to happen, it would be foolish not to prepare for the possibility or at least inform your engagement process within the organization with an eye toward what an activist would think. Then make sure the messaging incorporates that process in order to put the company in the best position. If you’re at a smaller market cap company and are approached by an activist, I firmly believe that the next step probably is going to be a contest coupled with a tender offer.
ANDY FREEDMAN: If there is one piece of advice I would give to IR in dealing with or trying to prevent an activist from becoming interested in your company, it would be to demand a holistic, interdisciplinary approach. Legal needs to work with IR, which needs to coordinate with management and the board. For example, IR can’t go into an initial meeting with a potential activist and not know the answer to a question like, “Why did ISS Group withhold on two of the directors that served on the Compensation Committee two years ago?” It’s only with an interdisciplinary approach that IR can be empowered to engage with the activist and set the right tone.
PATRICK WALSH: I would say that if you did meet me, it’s not a bad thing: It’s a good thing, and you should look to engage with me. That could be the catalyst that the company needs in order to unlock value. Engagement and communication are critical; the more of each, the better. It’s going to be your job and the board’s job and the management team’s job to evaluate an activist to see if his or her arguments make sense. If they do, I think it’s a very positive thing.
© Copyright 2014. The views expressed in this article are those of the author and not necessarily those of FTI Consulting, Inc., or its other professionals.