Given the activist investor climate these days, it may be surprising to recognize that activists have been around for decades. The quintessential example took place back in 1985 when Carl Icahn bought Trans World Airlines, then took it private and subsequently sold off its assets. Many claimed Icahn was responsible for the demise of this iconic American company.
These days, I watch with curiosity and intermittent dismay as Corporate America chooses sides, those who appreciate and welcome the activist investor community, and the rest. Whatever side you fall on, the fact of the matter is that activist investing is here to stay. JP Morgan recently reported that “the activist asset class has ballooned to more than $112 billion in assets under management.” According to Schulte Roth & Zabel LLP, “344 companies were subjected to activist demands in 2014.”
My great interest in activism pertains primarily to the impact this trend is having on corporate boards. With increasing frequency, activists are focused on obtaining board seats, replacing CEOs, and advocating particular business strategies. On the other side, there is some feeling that activists are best dealt with by circling the wagons and warding them off. Given their significance and increasing ubiquity this is probably not the right strategy.
What do boards need to know and what can they be doing in these challenging times? Here are a few suggestions:
1.The best defense is a good offense. In the current context this means that consistent strong performance that realizes the company’s goals is the best deterrent to activist investors. Companies become targets when they are mismanaged or have a management team that is stagnant. Excessive costs and capital allocation are other hot buttons amongst activists.
2.Realize that not all activists are the same and most activist campaigns take place and are resolved behind closed doors and with zero press. In fact, activists say that less than a third of their campaigns become public knowledge (per Shulte Roth & Zabel LLP).
3.Boards of directors have a duty to continue to evolve and evaluate themselves. Directors must be independent and mindful of the fact that they are agents of shareholders and as such it is their responsibility to serve shareholders.
4.To serve shareholders, the board must know who they are and understand their views. Dialogue between boards and principal shareholders used to be frowned upon. Today it is selectively encouraged as long as it is properly framed. Legal and regulatory implications must be considered but if handled correctly (on both sides) it can be very beneficial. As an example, Tempur Sealy, the bedding company, recently created a “Stockholder Liaison” committee to handle “communication and engagement between the board and stockholders.” This came about after the company was the target of H Partners, a hedge fund.
5.Savvy boards are watching their peers and learning from them. If there has been an activist campaign at one of your competitors, perhaps you can improve as a result. Understand the thinking, the thesis and the opportunities for progress.
6.There is a belief that activists don’t intimately know the businesses they invest in and therefore their suggestions for change are whimsical or even harmful. But boards are well advised to realize that by the time an activist launches a campaign they will have done their research. Usually this means studying the company to the point of producing a white paper. Furthermore, some activists are specialized by industry.
7.There should be a rigorous and independent process for identifying new board directors. This signals that corporate governance is taken seriously.
8.Boards need to think proactively about activism. In their Spring 2014 Audit Committee Roundtable Report, KPMG reported that 50% of directors and executives said that management had not developed a plan for responding to activists. Nearly two-thirds say their company has not conducted any type of activist vulnerability assessment. In the words of Benjamin Franklin, “By failing to prepare, you are preparing to fail.”
Shareholder activism is a wake-up call to boards and management that complacency will not be tolerated. Boards must continue to improve their functioning and challenge management to do the same. The big news in activism this year was the increased size of the targets of activist campaigns. No company is immune from a foray and the pressure to continuously improve could actually be considered a positive.