There are two breeds of activist investors today, according to industry watchers: Those that set their sights on making a name for themselves and the short term and long-term activist investors act in the best interest of the company and can provide a much-needed check on management.
“What I find most troubling about it is short-termism,” shared David Katz, Partner, Wachtell, Lipton, Rosen & Katz at the recent IIEF 2017 Global Shareholder Activism Conference, “where people push for things like capital reallocation, returning money to shareholders through stock buybacks, special dividends, what I would call ‘financial engineering,’ levering up the balance sheet in order to be able to do some of these things, spin off transactions, things that are intended to give a quick bump to the stock.”
Though there are some activists who are long-term shareholders, Katz argued that those are the minority of activists today. Katz also pointed out that there is a big difference between established firms and so-called “alumni” or “ankle-bitters” which try to make a lot of noise with a focus on raising more capital. Smaller companies are more vulnerable to these types of activists, as they may not have access to general counsel or the advisors that larger companies have. According to Katz, “It doesn’t matter whether or not a proxy fight is a good thing or a bad thing for the company. It matters that someone wins a proxy fight. And that is much easier to do at a smaller company.”
Jeffrey Sonnenfeld, Assistant Dean, Yale School of Management argued that governance activism has been distorted and a lack of public companies has pushed activists to target healthy corporations like PepsiCo and ADP. A recent Wall Street Journal, The CEOs Who Didn’t Deserve the Boot, showed that activism hasn’t necessarily translated into soaring performance. According to a 2015 Fortune magazine study, activist funds beat the S&P 500 index in only three of the previous eight years. Preqin’s Hedge Fund Spotlight found that 100% of the institutional investors it surveyed were disappointed with their activist hedge fund investments.
While there are certainly activist investors in it for the short term, J. B. Heaton III, founder of Conjecture LLC and J.B. Heaton, P.C., argued that there are even more poorly governed corporations which could benefit from a long-term activist investor. Heaton explained that the reason financial economists and activists press companies to give money back to shareholders through repurchases or spin offs, is that companies have a tendency to waste money later in their lives.
“For the most part, what we see out there is this bias to longevity and a bias to let the corporation grow. Why do we want a corporation that was founded for one purpose, exploited that purpose, to continue to take that money and invest it at below market returns and destroy shareholder value?”
David Klafter, Senior Counsel, Pershing Square Capital Management, gave examples of the different types of relationships they, as an activist, have with companies. Klafter explained of their process, “When we approach companies, we don’t start by thinking about how we can be a check for management. We start by combing the public markets, looking for big opportunities where either there’s a challenge or some opportunity that’s not being used by the company and we look for ways that we think the company can do better over the long-term. And then we think about the path to get there and only then do we start looking at the board, the particular governance structure, at the company and the management.”
Klafter said Pershing Square will then approach management and/or the board, usually through a “friend” in common. In his experience, management is typically “appropriately wary” at first, and the relationship can go in different directions from there.
“We were a long-term shareholder with Mondelez, where we’ve shared ideas with Irene Rosenfeld over the years and we think extremely highly of her and we’ve been activist shareholders but relatively passive. The other extreme is when we conflict with management and end up in a proxy contest or simply that we want to get some additional representation on the board. And then there’s every variation in between.”