A field guide to shareholder-friendly activism
By Richard Beales
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
The rise of shareholder activism has made it harder to distinguish between different species. Many corporate agitators say they are acting for all investors. Billionaire Carl Icahn’s online mission statement, for instance, touts “a platform from which we can unite and fight for our rights as shareholders and steer towards the goal of real corporate democracy.” Whether that’s true depends largely on the goals and methods used. Breakingviews provides a field guide to the activist animal kingdom.
START INSIDE THE SYSTEM
Leo Strine, the vocal former Delaware chancellor who is now the state’s chief justice, implies in a recent essay that the relatively robust market for corporate control, evinced by widespread successful activism, may mean that power is now fairly balanced between boardrooms and investors.
Rather than fending off uppity investors, the modern advice to boards faced with an investor challenge is to listen, at least when there are rational ideas to be discussed. Activists likewise are better off starting with efforts to engage rather than launching immediate hostilities.
Icahn, for instance, started rattling Chesapeake Energy’s cage long before the eventual departure of spendthrift Chief Executive Aubrey McClendon last year. The veteran investor targeted weak governance and dozy directors. Along with Southeastern Asset Management, he overhauled Chesapeake’s board in 2012 without in the end having to launch a proxy fight.
In another example, Dan Loeb of Third Point recently took Sotheby’s to task. A plan unveiled in January to clarify the auctioneer’s capital structure included borrowing more externally rather than within the company and distributing an initial $300 million of excess funds to shareholders. Though Loeb had gone public with a critical letter in October, the plan nonetheless incorporated his input. A proxy contest for new directors, which Loeb has now launched for three seats after Sotheby’s offered him only one, is a fallback. At least he initially took a less confrontational course.
DO THE WORK
It’s lazy to fall back on an outdated playbook, with non-specific gambits like demanding that a company borrow heavily to pay a big dividend. For a start, that smacks of short-termism. But boards and other shareholders also expect more these days.
An activist should address a target’s specific circumstances, not just point to generic metrics by which the company seems to be underperforming its peers. That’s especially the case if a constructive discussion with directors is the goal. With activism one of the most lucrative hedge fund strategies of late, there are wannabes in the business as well as the real thing.
DITCH THE DOGMA
Governance, finances and sometimes broad strategic direction seem fair game for shareholder criticism. Narrower details are more a matter of judgment, and experienced company managers have as much to add as an activist outsider, however much work he may have done.
Darden Restaurants is a case in point. Under pressure from one activist, Barington Capital, the U.S. eatery conglomerate decided in December to spin off its Red Lobster chain. So far, so good – as long as other shareholders were broadly supportive of a breakup. Starboard Value, holding 5.5 percent of Darden, then set about trying to persuade shareholders that the company should consider a different sort of split. With management already moving in roughly the desired direction, that seems counterproductive.
Insisting on a specific result sometimes seems to owe as much to an investor’s ego as to the company’s best interests. Bill Ackman of Pershing Square, a generally well-regarded fund manager, arguably strayed into that territory. After getting himself onto J.C. Penney’s board, he pushed the struggling retailer’s other directors hard to hire ex-Apple retail chief Ron Johnson as CEO in 2011. The decision turned out to be disastrous.
Some of the most successful activists recognize they don’t have a monopoly on good ideas and are prepared to compromise. Insiders and even targets admire investor Nelson Peltz in this context. So much so, General Electric invited him in to address its top managers and Martin Lipton, the Wachtell, Lipton, Rosen & Katz lawyer known for defending boards, named him as an activist he actually liked. It’s perhaps no coincidence that Peltz and his Trian investment fund also have a lower media profile than the likes of Icahn or Loeb.
AVOID SPECIAL DEALING
Companies may want to get rid of activists even after they have claimed board seats. For instance, Yahoo spent $1.2 billion last year buying back most of a stake owned by Loeb. After that, the hedge fund boss took himself and two fellow nominees off the company’s board, along with any expertise they might have lent on behalf of other shareholders. That was his prerogative, but the buyback, in which other owners were given no chance to participate, plainly separated Loeb’s financial interest from that of other shareholders.
One big risk to this practice emerged recently. ADT, the home security group, bought back about $450 million of stock from Corvex Management in November at roughly $44 a share and Corvex’s Keith Meister stepped down from the board. The company’s next earnings report in January disappointed investors, and the stock plunged to around $30. The proximity of the stock buyback to the weak quarterly results didn’t look good, and the company is already in at least one law firm’s crosshairs.
Another undesirable idea is for an activist to nominate directors whom it then pays, separately from other board members, if its own specific goals are achieved. That could reward, say, borrowing heavily, a strategy that could easily alienate long-term investors.
Of course, no uppity investor is required to act for the greater good. If that’s the pitch, though, which in many cases it is, then other owners need to keep their eyes peeled for the right sort of aggressive investment creatures.