A driving force behind the rise in shareholder activism has been the striking outperformance of activist hedge fund strategies. Activist hedge funds have, as an asset class, sharply outperformed their non-activist peers and market indices, generating a nearly 20% annual return since 2009, relative to 7.5% for hedge funds as a whole. This outperformance has spurred large capital flows into new and existing activist funds, and assets under management in such funds have grown by over 50% in the past twelve months alone, further fueling the pace of shareholder activism. The outperformance of “pure-play” activist funds has also led many traditional investment managers to adopt a more active stance with respect to their investments. As a result, the number of “occasional activists” has risen sharply and the activist shareholder playbook is gradually becoming a standard part of the asset manager’s tool kit.
This transformation of the activist investor landscape has overturned a key belief about shareholder activism — that only smaller firms are vulnerable to activist campaigns. Since 2009, the number of campaigns targeting firms $10 billion and larger has more than tripled, and 2013 has on average seen more than two such large-cap firms targeted every month.
Several factors have increased the exposure of large-cap firms to activism. Many smaller and underperforming firms have already been targeted; particularly in the U.S. Expanded funding has given activist investors the financial capacity to take meaningful equity stakes in larger firms. Activist investors also exploit with increasing sophistication the intense media scrutiny that large-cap companies are subject to, writing open letters to boards and management, releasing detailed presentations in support of their agenda, and even using social media to publicly pressure their target companies.
Most importantly, however, traditional institutional investors are increasingly receptive to activists’ agendas and will engage with and occasionally publicly support them in pushing for change at their portfolio companies. With the advent of annual “say-on-pay” votes in the U.S. and UK, these investors have also begun to vote more frequently against management. This has allowed activist investors to pursue firms where it would otherwise be difficult for a single activist investor to gain influence without the leverage provided by institutional investors who are sympathetic to the activist’s agenda.
In light of these trends, it is imperative for companies of all sizes and in all geographies to consider whether they are vulnerable to approaches by activist investors, to evaluate the potential sources of such vulnerability, and to formulate proactively strategic plans that optimize financial and operational performance and, ultimately, to create shareholder value. To shed light on some of the factors that may contribute to activism vulnerability, we conducted an extensive analysis of over 1600 shareholder activism campaigns across the globe since 2006 and evaluated the company attributes driving activism trends and how these trends are evolving across time and geographies.
We found:
* Share price outperformance does not automatically insulate a company from activism threats. Since 2006, targeted firms displayed stock price underperformance of 8.0% relative to their GICS industry group in the six months prior to being targeted and had firm-value-to-EBITDA multiples that were 2.0x below their industry peers. However, over a third of the targeted firms actually experienced share price outperformance prior to being targeted.
* Weak top-line growth is a significant driver of shareholder activism in both the U.S. and globally. Firms are more susceptible to activist overtures when they are investing little in future growth prospects and therefore companies wishing to avoid activist pressure need to develop credible growth plans when organic opportunities for growth may be lacking.
* In the U.S., companies that have low top-line growth and possess substantial but undeployed financial capacity are particularly prone to activist intervention. However, capital structure considerations tend to be less strongly associated with activism outside of North America, with non-U.S. targets holding only slightly more cash than peers and with payout ratios that are only modestly lower than peers.
* Firms with diversified businesses and multiple operating segments are increasingly exposed to shareholder activists, particularly if they trade at a conglomerate discount or if certain segments are viewed as being non-core.
* Corporate governance plays a role as U.S. and UK corporates typically have higher institutional shareholdings and lower insider holdings, making these firms more prone to activism risk. In other regions, concentrated ownership among insiders, family-owned firms and relatively smaller holdings by institutional investors make activism campaigns more challenging.
* Stock returns following the initiation of an activist campaign are, on average, positive with target stocks outperforming market benchmarks by an average of 15.1% in the year following the campaign and 33.8% in the two years following the campaign. However, a majority of targeted firms do not enjoy these gains in stock price, therefore the large average improvements are driven by a relative minority of activist efforts that result in outsized stock price gains. In addition, among the firms that outperform following an activist campaign, some do so due to an eventual acquisition of the firm that involves a takeover premium to shareholders.
Conclusion
Shareholder activism has spread to firms of all sizes in all regions and is here to stay. In this environment, we believe it is of utmost importance for boards and executives to stay abreast of the demands of their increasingly assertive shareholder base. Continuously engaging with investors, carefully considering their outsider’s perspective, and clearly articulating the firm’s strategy are all key steps to being “white paper-ready” and to being prepared to pre-empt any activist agenda that is not consistent with the firm’s strategy. Most importantly, developing and executing on a credible strategy to optimize a company’s growth trajectory and its operating and financial performance are of paramount importance to avoid being second-guessed by an activist investor.
*This is an excerpt from a larger report Rising Tide of Global Shareholder Activism, published by FSG in October 2013.
Ajay Khorana
