By Cydney Posner
This article from CFO.com discusses the recent trend of institutional shareholders throwing in their lot with activist investors. The article suggests that management should no longer assume that institutions will be on management's side in fights against activist investors.
The article notes that "nearly 30 percent of U.S. companies with a market capitalization of more than $1 billion have been targeted [by activists] this year, according to SharkRepellent.net, up from 20 percent in 2012." One difference adding to companies' vulnerability is the increase in alliances that have sprung up between activists and institutions. One commentator cited in the article confirms that "'[t]here is real change in how activists are perceived by the investing public,'…. In the past, if an institutional investor didn't like a company's performance or its management team, it ‘voted with its feet' and sold the shares. But now many investors are ‘more open to outsider influence….They're willing to concede that a company could be made better through activism, so they are sticking around and voting for changes….As much as management may feel they are being attacked, their shareholders will not necessarily share that view.'" In fact, the article notes, institutions may be more willing to speak candidly with an activist about a company than with that company's management.
These alliances then allow activist investors, who may hold only a small block of shares, to leverage the support they receive from institutional investors to effect change at target companies. As the WSJ reports, http://blogs.wsj.com/moneybeat/2013/08/19/activist-investors-a-roar-or-a-bark/ "activists punch above their weight. They control just over $84 billion in assets,…, a drop in the bucket when compared with the trillions of dollars managed by passive funds." According to SharkRepellent.net quoted in CFO.com, there is "‘an increased willingness by mainstream mutual funds and other institutional investors to side with activists, which is absolutely essential [for a hedge fund] to effect changes with a small ownership stake, as they often do when targeting larger companies.'"
What accounts for this trend? The CFO.com article suggests that the "goals of activists often align with investors: returning excess balance-sheet cash to shareholders, selling underperforming or noncore business units or even ousting an ineffective board of directors. [According to one commentator,] ‘activist investors have a ‘good track record' of creating value, at least in the nominal sense…' The stock [often] goes up so they can show very straightforward returns; they're not necessarily creating long-term value, but they have credibility in helping shareholders realize near-term value….'" In addition, the author contends that "[a]ctivist investors can also give ‘voice' and muscle to shareholder concerns and dig deeper into the financials to find ways to unlock value. " Commentators noted that most institutions, which dominate share ownership, are ordinarily relatively passive with regard to corporate strategy and operations. Activists, on the other hand, focus on a few companies, develop alternative strategies that they believe will increase value and try to persuade companies to adopt them. The WSJ article attributes the trend to a convergence of ideal conditions: "With interest rates so low and stocks at record highs, pension funds are desperate for ways to beat the market; companies are sitting on record piles of cash earning measly returns; and since the financial crisis, boards and executives have to be more responsive to outsiders."
Of course, while activists believe they serve a valuable function by holding management accountable, the new alliances between activist shareholders and institutional investors have been viewed in many corners as entirely unhealthy. Marty Lipton has written that "'[a]n increasing number of institutional investors now invest money with the activist hedge funds or have portfolio managers whose own compensation is based on short-term metrics, and they increasingly align themselves with the proposals advanced by hedge fund activists," he wrote. "In this environment, companies can face significant difficulty in effectively managing for the long term, considering the interests of employees and other constituencies, and recruiting top director and executive talent.'"
In CFO.com, the author suggests that they best way to defend against activist approaches viewed as hostile is to keep open lines of communication with shareholders and, importantly, to try to make those communications substantive. Companies should analyze their own vulnerabilities – such as poor performance, "excessive" cash, entrenched management, corporate governance problems -- and weigh those as part of their own strategic planning. According to one commentator, "'[f]or the most part, the criticisms that emanate from a shareholder attack should… rarely [be] a surprise….There should be [board] discussion about giving back cash to shareholders, for example. Whether [the board] decides to do it or not, the rationale is going to be as valid in the broader investment community as it is in the boardroom. Good companies are having those discussions, and when an activist shows up they have already considered the argument and rejected it…." This view was echoed in the WSJ, which quoted an adviser as recommending that "boards and executives should be ready before [activists]. come knocking. ‘It's the old Boy Scout's motto: ‘Be prepared,'….Your defense is performance and preparation—understanding where your weaknesses are and how an activist might come at you…."