“The best defense is a good offense” is the collective view of a recently-assembled expert panel on shareholder activism.“The best defense is a good offense” is the collective view of a recently-assembled expert panel on shareholder activism.

Dealing with the New “Reluctivist” Activist

An Offseason Proxy Toolkit - Dealing with the New "Reluctivist" Activist

“The best defense is a good offense” is the collective view of a recently-assembled expert panel on shareholder activism. On July 18, Clermont Partners hosted “Activism in the Offseason,” a webinar devoted to understanding the current landscape in shareholder activism and how companies can best prepare for an activist event. Moderated by Clermont partner Beth Saunders, the webinar drew upon the experience and knowledge of three panelists:

• Richard J. Grossman, Partner, Skadden Arps, Slate, Meagher & Flom LLP;
• Geoffrey Sorbello, Elliott Management Corporation; and
• Larry Jones, Partner Strategic Value Consulting, PwC.

The panel noted that activist funds are now a bona fide asset class, with assets under management reaching in excess of $160 million in 2015. While the number of activist funds has increased, the bulk of the assets under management remains concentrated in six funds (Elliott, Icahn, Jana, ValueAct, Pershing Square and Starboard) and the panel agreed that these firms continue to drive the most successful campaigns. However, a relatively new entrant to the landscape is gathering significance the “reluctivist,” or traditional money manager who takes more of an activist role with a company, sometimes on its own and other times with one of the larger activist funds. 

While the role of the corporate governance ratings agencies continues to be important, their near-blind support of activists seems to be waning. In 2014, ISS supported dissident board slates in nearly 60 percent of the contests. In 2015, their support dropped precipitously to 20 percent, given a more critical review of the quality of dissident board slates. Still, ISS and others are supporting the board slates run by the top activist funds more often than not, since they tend to recruit more qualified candidates and may have stronger arguments for effecting change in the business.

Some of the world’s largest institutions are also beginning to scrutinize activist campaigns more closely, as recently reported by Reuters. BlackRock and Norges Bank, for example, are encouraging issuers to consult with them before engaging with an activist investor. Some activists who gain board seats, they argue, could have too short an investment horizon and thereby put at risk the long-term growth prospects of the company in line with broader calls for longer term responsible capitalism. 

All three panelists remarked that the better activist investors do significant quantitative and qualitative homework before approaching a company. It is clear the activists undertake their own perception work – formally or informally – by speaking to investors throughout their network who have had interactions with the company and trying to assess whether there is a perceived valuation and strategy disconnect. If this exists, the activists then tend to ask for board access– in part to assess the Board’s support of the strategy, and in part to assess their support for the management team. The panelists noted that engagement with an activist investor should be viewed more as an opportunity to build a better business plan than a defense of the current one. 

What companies attract activist investor attention? Jones’s PwC has built a highly predictive model in this regard. Financial factors include total shareholder return, performance relative to peers, ROIC, the frequency of missed guidance, cash on hand and balance sheet leverage. Governance is another important consideration, including board composition, management changes and executive compensation. 

As shareholder activism has captured more of the spotlight, issuers are increasingly finding that the best defense is to actively find and address the vulnerabilities in their businesses. They are asking, “What would an activist do?” Managements and their boards are more deeply scrutinizing the components of their businesses and implementing plans to address shortcomings in performance. At the same time issuers should be looking for ways to optimize their balance sheets. 

These actions should be married with effective investor communications. The panelists urged more frequent and meaningful shareholder engagement. Managements should be actively communicating their strategy for enhancing shareholder value. They need to demonstrate that they are good stewards of capital and should strive for transparency, with detailed business strategies, KPIs supporting their guidance and alignment between the board and management on priorities. At the same, they should be engaging with investors, directly and through perception audits, to gauge investors’ understanding of the company’s business strategy. Above all, companies should strive to cultivate greater management credibility, which helps to build long-term support among institutional investors.

Looking beyond shareholder activism, the panelists identified the recent trend of direct communication between board members and institutional investors. More companies are warming to the idea of enabling interaction with select board members as part of their investor outreach programs, on relevant board-level issues such as company strategy, M&A and compensation practices. While still an evolving practice, designating and training a board member to engage with investors is another investor relations tool to potentially reduce the risk of an unwanted shareholder activist event by demonstrating transparency and helping to ensure that investors clearly understand a company’s path to value creation.

Combined with the assets controlled by pension funds and other more traditional money managers who are now quicker to support an activist agenda, the panelists made it clear that companies of all sizes and performance levels are not immune from a “reluctivist” investor, activism rumblings or an all-out activism campaign.

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