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With nearly $180 billion in assets under management, “activist” investment funds have become a powerful force in the capital markets. Nearly 40% of companies in the S&P 500 attracted activist attention in recent years. According to Activist Insight, 320 companies in the U.S. experienced an activist campaign in just the first half of 2017; but who, exactly, are these activists, what are they after, and what role do they collectively serve?
Activist investors are fund managers that typically buy a 1-9% stake in public companies with plans to increase the share price by actively changing the company’s strategy. Three traits generally attract these investors: low share valuation, sub-par profit margins and under-utilized assets. While some activists rely on attention-getting media splashes, the more effective ones work quietly behind the scenes with management and the board of directors to improve the company’s operations (perhaps by cutting costs or closing or selling off weaker lines of business) and capital allocation (perhaps by redirecting capital spending or repurchasing shares). Compared to yesteryear’s corporate raiders who often benefited at the expense of other shareholders, today’s activists generally seek to raise the stock price for the benefit of all shareholders.
Activists leverage their ownership by appealing to other investors, including mutual funds, pension plans, hedge funds and even index funds and ETFs. With this kind of power, no company is too large to be immune: Microsoft’s $270 billion market cap didn’t prevent Value Act from winning a board seat in 2013 and driving the removal of longtime CEO Steve Ballmer. Activists’ ability to exert dramatic change similarly can’t be ignored: in 2014, Starboard Value gained enough support to replace the entire board of directors at restaurant giant Darden—an almost unheard-of display of influence. Darden’s shares surged 50% in the months following the coup. Global food giant Nestle (market cap of $260 billion) is currently under pressure from Third Point Capital.
Not all activist campaigns are successful—and companies have become much more adept at defending themselves. This past June, noted activist Greenlight Capital, led by the colorful and respected David Einhorn, was firmly defeated in a shareholder vote on his proposal to split General Motors’ stock and replace three board members. And Bill Ackman, head of Pershing Square Capital, received a blunt rejection this week from his most recent target, ADP, when its CEO publicly called him “a spoiled brat.” It seems highly unlikely that ADP and its shareholders will pay much attention to Ackman’s demands. Even the respected and feared activist Elliott Management lost a bid in April to restructure Asian tech giant Samsung.
Similarly, not all activists are credible. Some are simply ineffective while others operate outside the bounds of even a hint of reasonable ethics. Individually, these kinds of firms tend to lose their businesses over time, but as a group they will likely always be a part of the financial markets. Investors and companies are rightfully wary of any involvement with these activists.
In the grand scheme of the financial markets, what role do activists play? Are they merely shameless predators (curiously, the respected data provider Factset labels its activist database “Shark Repellant”)? Some market participants would say “absolutely.” However, activists also help bridge the gap between public and private equity markets. Perhaps the biggest problem with public companies is the agency issue—the people who run the company are just agents who are supposed to work for shareholders. Managements, though, have strong incentives (compensation, perks, prestige) to do what is best for themselves or to do what is easiest. Private equity-backed companies generally minimize this problem by closely linking management and ownership. Activists mimic this closer linkage by unifying public shareholders in an effort to more tightly hold managements accountable.
An emerging role for activists: in an era when investors increasingly favor passive investing, which by definition does nothing to hold managements accountable, activist investors help restore the link between share prices and underlying company results.
Ironically, index fund managers are warming up to the merits of corporate activism. A recent Wall Street Journal analysis indicates their growing power: passive mutual funds and ETFs collectively own 10% of the equity in 458 members of the S&P 500. State Street Global Advisors has recently used its role as manager of its $2.4 trillion (assets) ETF business to press companies to improve the gender diversity of their boards of directors. ETF giants Blackrock and Vanguard similarly have become more actively involved in guiding the fate of public companies. Maybe the previously defenseless ETFs are transforming into sharks themselves.