June 3, 2016
This article originally appeared on Listed.
FTI Consulting explains why companies cannot afford to ignore the continued growth of shareholder activism and outlines the best way to handle an approach.
Shareholder activism is a polarising topic. For some, an activist can be a saviour, while others see them as a tormentor. But what is clear is that boards and managers cannot ignore them. Activism has grown significantly in the past five years and activist funds now have more capital than ever. Activists around the globe are taking a more diverse view on their investment targets in terms of size and sector; and Australia is far from immune to this trend.
Shareholder activism has been around for a long time in Australia, but it is only now that we are starting to see the combination of sophisticated approaches with the institution alike scale in capital.
Activism is increasingly on the agenda for Australian listed boards, either in dealing with brewing issues or planning for possible ones. An established and traditional approach has proven to work well. Companies with a genuine track record of shareholder engagement (both in terms of quality and regularity of communication) are best placed to recognise, assess and ultimately mitigate activist concerns. Effective shareholder engagement also serves as an early warning system, where shareholders feed back intelligence to the company.
More than ever, boards and management need to prepare themselves to deal with this up tick in activism; including how to manage it constructively; and how to respond strategically depending on the different forms of activism they confront.
One reason activism has increased significantly over the past few years is the growing amount of capital at funds’ disposal.
One reason activism has increased significantly over the past few years is the growing amount of capital at funds’ disposal. It is estimated that primary focus activist funds now have assets under management of $169 billion, while partially focused activist funds control $173 billion for a total of $342 billion. It is also estimated that the volume of activism has grown four fold in the past five years.
Recently, FTI Consulting and Activist Insight surveyed 24 international activist firms, which collectively have engaged in more than 1,200 activist events across more than 10 countries. The survey revealed that both the proportion of assets allocated by investors along with total amount of funds allocated to activist investing are significantly on the rise. Unsurprisingly, these activist firms are positioning themselves to take advantage of this movement; with 86 per cent of the funds we spoke to expecting to undertake capital raising over the next 12 months.
Nearly 80 per cent of investors surveyed think merger activism will rise in the coming year. Operational activism is also seen as a fruitful area for activist pursuit, with 63 per cent of investors surveyed indicating an expected increase. Activists are also finding it easier to reach settlements with management teams. More than 90 per cent of activists surveyed indicated that they found it less difficult to reach settlements with management compared to previous years.
Not only are activist funds raising more money, but they are increasingly cooperating with other financial stakeholders, such as institutional investors and other funds. Seventy per cent of those surveyed indicated that they expected an increase in future partnerships with institutional investors and funds.
Activist investors are also increasingly savvy about using the media to assist in placing pressure on boards and management teams. This further highlights the need for ongoing engagement with all market stakeholders, ensuring these relationships exist should a board or management team need to call upon them. This requires greater attentiveness by companies and the need for ongoing engagement of all market stakeholders.
The FTI Consulting survey finds that activists are increasingly finding the US market over-crowded, forcing them to widen the search for opportunities into less crowded or previously untapped markets. Outside the US, the most cited jurisdictions being targeted for investments were Canada and the UK; but Australia joined the ranks of France, Denmark, and Switzerland as a significant destination of funds.
In terms of size, 58 per cent of investors surveyed identified small-cap companies (less than $2 billion) as a market range with significant opportunity for shareholder activism. On a sectoral basis, most respondents (totalling 52 per cent) identified the energy sector as the most undervalued, 43 per cent identified industrials; and 38 per cent identified healthcare.
The best way to prepare for a potential activist is to try to view your company from their perspective. Where might an activist see a short-term yield potential? Are there any corporate governance weaknesses that need to be addressed? Are any key shareholders or stakeholders that interact with the company feeling disenfranchised or unhappy with the actions the board and management have taken?
Critical for any company is for it to know its shareholder base, both in terms of constitution and who holds the balance of power, but also in what makes particular shareholders tick and what their concerns are. If there are sound reasons why a potential activist strategy would not work – do your shareholders truly know these arguments? And how can defensive responses be incorporated into investor messaging before an activist appears?
Companies should consider surveying their investors on an annual basis as part of activism preparedness. This achieves three things: it provides the company with a current and actionable view on how its current and potential shareholders, as well as sell-side analysts, view particular areas that activists could target; it provides concrete evidence as to how vulnerable the company might be if an activist takes a position; and it is external proof that the company has an active and responsive shareholder outreach program.
One of the first considerations in the face of an activist campaign is to truly understand the type of activism being pursued. There are three basic types of activism to which companies are vulnerable: economic, corporate governance and political activism.
Economic activism is the type of activism we hear about most. It is where an investor in a company seeks a shorter term gain by promoting a yield producing action. This contrasts with corporate governance activists who have the specific goal of restructuring representation or voting practices. Political activism is different again, and usually has an investor who is philosophically opposed to aspects of the business’ activities.
In addition to understanding the activist’s objectives, some boards are better equipped to deal with these activities than others. Companies that get the balance right on engagement and transparency are traditionally best placed to prevent an action and defend themselves once activism is initiated. If it does occur, companies that have good lines of communication with their shareholders are best prepared to deal with shareholder activism. This is done by recognising early signs of concern, and having the ability to respond quickly and strategically to activist claims or demands.
Based on global experiences, there are a number of best practice principles that should guide companies faced with an activist shareholder. They include the following:
An interdisciplinary approach, with legal and investor relations closely coordinating with management and the board. This ensures that company representatives are empowered to engage in what is often a fast-moving situation; that they are equipped with responses to possible areas of attack; and that a clear and consistent tone is set.
Making a genuine attempt to assess the objectives of the activist helps to shape the response and increases the opportunity to reach a negotiated outcome in the interests of all parties. Clearly, fundamental under performance and governance are the most likely triggers to activist investors.
The international experience is that activists are now targeting higher performing companies.
Global evidence suggests that three in four activist campaigns start as collaborative, but half of those eventually turn hostile. Therefore, management needs to consider how they engage as much as whether they accept activist demands. This includes the formation of a response team; understanding the activist; understanding the activist’s proposal; and developing an appropriate response plan.
Develop and implement a shareholder outreach program tailored to each institution, based on analysis of current shareholders voting patterns, voting process, past communication with the company, and the influence of proxy advisory firms.
In determining what response you should have to an activist shareholder, boards and management should be mindful that shareholders can benefit from activism. International studies (including from Columbia Business School and the European Corporate Governance Institute) have found that activism can play a role in reversing downward trajectory in target company performance and generates shareholder returns. That can be challenging to a company whose first reaction is sometimes to resist a challenge.
The ability to see accurately and objectively the root cause for the activism, can overcome this reflex action. What is more, an engaged shareholder base will make it easier for companies to assess the motives of an activist, and therefore ensure a response that will be better for the company, its shareholders and the activist.