Daniel Jones, Shareholder Analytics and IR
Activism was once again a hotly discussed topic at the 2018 National Investor Relations Institute (NIRI) conference in Las Vegas, and with the number of large-cap activist campaigns in 2017 reaching an all-time high, it’s easy to see why.
Based on my observations and discussion with professionals, an often neglected part of an activism defence plan is the ‘self-reflection’ phase, where a company adopts an activists’ mindset for self-analysis prior to becoming a target. In doing this, a company must understand how activists identify their targets and the steps prior to taking a fight public.
Universe formation and identifying a target
Unlike a traditional investment manager, an activist does not have a pre-defined investment mandate which means in theory every listed company falls within its investable universe. The point of commonality among most activist investors is they are fundamentally value driven and therefore focus primarily on undervalued stocks.
Many interpret this as activists looking exclusively for companies exhibiting relative underperformance compared to their peers. However, an analyst at US-based activist firm D.E. Shaw, was asked at NIRI what activists look for when starting the research process, and was adamant that absolute underperformance was the most important factor.
This means that just as relative underperformance is not the most important factor when an activist is assessing if a company is a target, relative outperformance, will not, in itself, be enough to dissuade an activist.
What was made clear at NIRI is consistent underperformance by a company – whether absolute or relative to its peers – is generally a flag to an activist for further investigation.
Identify the problems and actionable solutions
Once a potential target is identified, activists turn their attention to understanding everything they can about the company, which includes an extensive amount of non-financial quantitative and qualitative information. This might include metrics such as share register composition, regulatory structure and constraints, research and development initiatives, ESG policy and provisions, management structure, make-up of the competitive landscape – both business peers and investable peers, etc.
By doing this, activists aim to identify all factors that contribute to the underperformance they have identified. According to the CIO of activist firm ValueAct, it regularly takes months, and can sometimes take years, for activists to understand why a company is underperforming.
Once issues have been identified, activists investigate whether an actionable solution can be reached. According to D.E. Shaw, all options that make theoretical and practical sense are left on the table for as long as possible, without regard to size or complexity. These might include things such as spinning off an asset, pursuing more stringent cost-cutting measures, eliminating product lines, making a strategic transaction, opening up to new business opportunities, etc.
When an activist shareholder has identified the issues and established robust and usable solutions, it will generally approach the company to discuss its findings. A public fight is rarely the desired outcome for an activist, who would prefer a dialogue with the company. At NIRI, it was estimated that as much as 10% of US-listed companies have experienced some form of activism, although the number of public campaigns is well below this, with just over 700 globally in 2017.
If all else fails…
In instances where direct engagement does not produce a satisfactory outcome – e.g. where the activist felt they were not given an appropriate platform, or their proposals were not sufficiently refuted – they will then identify an appropriate pathway for change. Ultimately, in Australia, that often comes through the public domain in the form of a 249D notice.
It is typical that at the point a campaign goes public an activist will start to raise concerns about a target company’s performance beyond financial metrics, often related to ESG issues. The strategy of broadening the attack to include ESG issues can be a useful way to build a consensus that change is needed amongst institutional shareholders, including passive investors and large fund managers where ESG metrics are increasingly important in investment decisions.
Understanding the activist playbook is an important aspect of developing an effective defence plan. Companies which are able to adopt an activist’s pre-engagement thinking will find themselves better able to identify the potential risks or points of weakness in their company that may otherwise be exposed. By working to address these concerns proactively, companies can not only avoid a public battle with disgruntled owners, but may unlock additional shareholder value.