There was a time when management of a publicly traded company could follow any strategy it felt would best create shareholder value, but activist investors have changed the game. As Barry Rosenstein, founder of mega-hedge fund Jana Partners, said at the SALT conference in Las Vegas this month, CEOs used to ignore complaints from big investors but today they’ll interrupt their golf games to take a call or hold in-person meetings immediately when issues come up. What started as a fringe trend has grown bigger than anyone expected – and the impact on dealmaking moving forward will be huge. There have been multiple cases when investors’ campaigns have led to a divestiture of a business unit or even a sale of the entire company, and no one can afford to ignore it anymore.
The impact of activists has been so impressive that management now must respond as soon as an activist investor becomes involved in a company. Oftentimes the activists are hedge funds with serious buying power, and when they take a stake in stock, sometimes upwards of 5% of outstanding shares, they clearly carry a lot of weight with their recommendations and voting power. The intention of activists varies according to the situation – usually focusing on large strategic changes like naming new board members and changing corporate structurse – but one alarming trend is the forcing of sales, deals, and privatization.
When an activist investor first announces involvement in a stock, there are often immediate impacts on the company. Depending on the market’s view of the recommendation, the stock could experience sharp fluctuations based on the anticipated response from the company. With this anticipation comes the company’s need to openly address the activists’ involvement and decide on a future strategy. Depending on the recommendations and company response, the initial impact of activists can get quite messy.
Management often performs a “strategic review” following activist involvement, and this can lead to surprising results, especially if it uncovers value or merit in the investor’s case. The targeted business can flip from being fully committed to its strategy one day to listening to the investors and seeking new forms of adding value the next. Leaders of public companies do not get to where they are by being pushovers, but somehow in recent years, activist investors have had enough sway to make even leaders of huge multinational companies question themselves.
Kick Starting Deals
The extreme impact activists have on kick starting deals can be seen in the events that unfolded around Darden Restaurants. Darden, owners of Olive Garden and Red Lobster, were approached in 2013 by multiple activist investors with recommendations for realigning its corporate structure to “unlock value.” The pressure caused Darden to sell its Red Lobster brand for $2.1 billion, which was widely seen as a sharp discount. In response to the ill-advised divestiture, Starboard Value succeeded in replacing the entire 12-person board of directors at Darden. This made it clear that Darden’s board made a strategic error in ignoring the investor’s claims, and shareholders responded by fully siding with Starboard and removing any possibility that the board could make any other disagreeable decisions.
Or take a pair of deals forced by Elliott Management in 2014. Compuware agreed to a buyout of $2.5 billion from private equity firm Thoma Bravo in September of that year. Two months later Thoma Bravo, along with the private equity portion of the Ontario Teachers’ Pension Plan, also purchased Riverbed Technology for $3.6 billion. Both companies put up a strong fight against the investors; Compuware lasted over two years before selling.
There are numerous other examples which have played out almost exactly the same way, hammering home the point that management must have a clear and well-conceived strategic vision. It’s not always companies who are experiencing declining revenues or profits that are targeted – oftentimes the companies who are most influenced by activists are the ones that fail to meet the expectations relayed to investors. Riverbed’s resistance to Elliot lost its gusto once it produced disappointing financial results based on internal and external expectations.
For good or for bad, some do believe the increasing involvement of activists is holding management to a higher level. Compuware had a board made up of multiple local businessmen who did not seem to have the right level of technology experience. The shareholders of Darden proved they believed the board did not have the company’s best interest in mind. Long gone is the day when an organization’s board of directors can be made up of friends and relatives of the founders. Now, investors expect diversified boards that bring the experience and commitment to deliver the most value to shareholders. If a company does not recognize this, they will always run the risk of encouraging an activist to become involved.
CHANGE OF TIDE
While the companies above defied requests from activist investors, now the tide is changing and management teams are deciding to listen. In a recent report, JP Morgan recommended new strategies for dealing with activist shareholders, including listening to shareholders no matter the size of ownership, making changes if consistent with creating long-term value, and objectively assessing the merits of recommendations. This marks a clear change from the previous approach where activists were labeled “corporate raiders” and seen as hostile parties. This kind of cooperation gives investors the respect they’ve demanded. It also suggests activist investors will take this growing power and continue to spur dealmaking well into the future.