Do Hedge Fund Activists Have You in Their Sights?
Lampert, Randy, Shiftan, Andrew, Chief Executive (U.S.)
You pick up the phone one day and the caller says, "Hello, I'm your biggest shareholder." Now what?
Despite media coverage to the contrary, activism is not necessarily a drawn out adversarial process. The activist fund, like all investors, is interested in seeing its holding appreciate and believes that it has a plan that (in the portfolio manager's mind) is superior to management's for achieving that goal. Clearly, as an outside shareholder, the fund may not be privy to the realities that motivate management's decisions and, as a result, the whole situation may deteriorate rapidly. When this occurs, it is not uncommon to see the activist fund put forward a proposal to the target's shareholders demanding a vote on a specific action or on granting board seats to its nominees. On the whole, activist funds have had surprising success with their proposals-more than 35 percent of the campaigns we analyzed resulted in an activist winning board representation.
At its core, shareholder activism is a communications battle to win the support of the shareholder base to back a particular direction for a company. As activism has become an increasingly recognized investment strategy, other investors have begun to follow activist funds into particular situations, thereby increasing the likelihood that the fund will succeed. Accordingly, traditional takeover defenses are becoming less and less effective and are actually a boon to the activist's argument that management is entrenched and is not sufficiently focused on providing shareholders with an increasing stock price.
On average, the activist hedge funds we tracked have $1.9 billion in equity capital under management and range in size from less than $100 million to nearly $10 billion in assets under management. Most are based in the U.S. with a few prominent funds in Europe.
The Rise of Activism
Two factors have driven shareholder activism as a discrete investment strategy: an abundance of capital and the heightened scrutiny of corporate leaders and their boards of directors in the wake of recent corporate scandals. The historically impressive returns of hedge funds make them an ideal place for cash-rich institutions, like pension funds, endowments and wealthy individuals, to invest. This demand has encouraged new entrants to join the hedge fund industry from other money management operations. As a result, the number of hedge funds and the amount of capital they manage has grown tremendously since 1990. It is estimated that there are currently 8,000 hedge funds with total assets under management exceeding $1 trillion.
The activist fund's goal is to create a triggering event that will unlock shareholder value and yield stock price appreciation. This can include changing the capital structure, altering a company's M&A decisions, forcing a sale or breakup of the company, cutting costs, firing management or modifying the composition of the board. In most cases, the fund accumulates ownership in a company to obtain a foothold. After some accumulation, the fund's conversation with management will shift from investigatory questioning to proactive suggestion. If the fund finds management unreceptive to its ideas, the activist attempts to draw public attention to the company's underperformance or management's shortcomings. In an attempt to pressure management, they rally shareholders or attract other activists to the cause.
The fund sees itself as a catalyst for change, with goals as specific and diverse as the companies it targets. These can include increasing dividends, paying a special dividend, initiating a share repurchase program, optimizing the capital structure by issuing more debt or selling and breaking up the company. In other cases, the activists' goals are less well-defined and may include functional changes in management or the board, or changing board composition to include its nominees, splitting the roles of chairman and CEO or changing compensation practices. …