Evolution of Activism
Shareholder activism spread to Europe from the US. Traditionally Board-level engagement with shareholders has been more distant in the US. US investors also have a greater tradition of litigating and bringing class actions against Boards that fail to act, or are perceived to have failed to act in the interest of shareholders. Borne out of this model some US investors adopted an iconoclastic approach to driving change in US Boardrooms, including through a seat at the Boardroom table, and this is now spreading in Europe.
Activists were once-stigmatised as ‘corporate raiders’, with a reputation for acting within narrow financial interests and maximising returns based on a strategy of pressure on the target Board through amassing large voting rights. From these early days, Activists have morphed and are increasingly picking up the mantle of defending shareholder value and even good governance.
There is now a broad spectrum and different types of activism. Some Activists look purely at the governance structures; others seize opportunity within an M&A transaction; others look at achieving value by streamlining the business model. The spectrum of Activist engagement ranges from hostile to constructive engagement and Georgeson sets out forms of Activist engagement from the most hostile to most constructive below:
- Shareholder Litigation
- Proxy Contest
- Director Nominations
- White Paper
- Public Letter
- Public Filing
- Private Engagement
There are many instances where Activists have helped to keep Boards on their toes and thereby driven value for all shareholders. There are also egregious examples where Activists have seized upon short-term gain, for example cutting back on important long-term investment and R&D. The Activist should not be underestimated and an Activist’s commitment to the long-term health of the company should not be taken at face value.
Board anxiety regarding activism is justified and Fidelio sees an appetite for Board learning on the subject. Fidelio Board breakfasts on the topic of activism have been well attended by FTSE and international Board Directors. These have been an opportunity to learn from Activists and advisors about the Activist approach to investing, including the often very long-term research that they have conducted before they appear on the radar screen.
At our recent “A Seat at the Table” Programme, we included for the first time a module with Cas Sydorowitz, CEO of Georgeson Corporate Advisory. An understanding of activism is now essential for public company Directors and Cas worked through a number of topical and relevant case studies where Activists have played a major and disruptive role. This played to the strengths of the “A Seat at the Table” Class of September 2018, which included senior women with extensive legal and capital markets expertise.
The Triggers of Activism
Public company Directors need to be alert to the triggers of activism if they are to fulfil their obligations to the company and its shareholders and stakeholders. Here are two key triggers that should be on the radar screen of all public company Directors:
- Valuation dip – The valuation dip is the opportunity for the Activist to engage. Typically an Activist will have been researching the company for a long period. A fall in valuation can be driven by a number of factors – internal and external. The company’s ability to weather a valuation dip and rebuff an Activist intervention is determined largely by the second trigger.
- Lack of alignment – A company is particularly vulnerable to an Activist intervention when there are inconsistencies between its communication to the market on strategy and direction, its actions and critically the composition of its Board. If a company’s equity story is predicated on agile digital transformation and no-one on the Board has relevant experience, as soon as the share price flags the door is left wide open to activism.
Germany is a market that was long considered challenging for Activist investment but recent high-profile examples have demonstrated that the same principles apply. Research here too has highlighted triggers which have created opportunity for Activists to gain a foothold in German companies:
- Operating underperformance
- Governance deficits and board remuneration
- Corporate simplification and conglomerate breakups
- M&A arbitrage (“bumpitrage”)
- Capital deployment and payout policies
So what steps can Boards be taking to strengthen their proposition, short of the original proposal by the Financial Services Chair mentioned in the introduction who argued for an Activist on the Board?
A strong valuation is obviously the best defence. The more robust the share price, the more content the shareholders and the narrower the window for Activists.
But a robust valuation clearly depends on many factors some beyond the company’s immediate control. Nonetheless there are some fundamental steps that companies should be taking to support relative valuation and if these steps are not being taken the Board should be concerned.
- A Credible Equity Story – An effective public company Board will insist that the company has a credible equity story which it is presenting to the market. In particular the opportunity to generate value must be clear and attractive and the strategy how this is to be achieved must be well articulated. The time frames and investment requirements must be realistic.
- Shareholder Engagement – The Board must be aware of what shareholders and the market is thinking. There are a range of tools from formal perception studies, conversations with investors and broker or banker feedback. Again, an effective public company Board will be paying attention to the following:
- Know your shareholder base: Ensuring that the Executive has a firm grasp and very good and immediate information about the shareholder base with a warning system which detects early signs of hostile or disruptive activity. The Board needs to understand who is on the register and why. Equally the Board needs to be alert to obvious shareholders who should be on the register but are not.
- Expectation management: Recognising that expectation management is a key part of capital market communication. This discipline appears easy in the good times but can turn quickly and the Board must ensure that the company has the skills to manage expectations in difficult times as well. If Board Members are new to capital markets and have little experience they should turn to the Company Secretary, Head of IR, Head of Corporate Affairs to provide insight and induction. If Board Members remain unclear this should be on the Board Agenda.
- Investor engagement: Ensuring that the interface with the markets is highly professional. Beyond the CEO, the Board should ensure that a skilled CFO/Finance Director is in place who understands investors and markets and, for larger companies, a very professional IR capability. The IR Director should have credibility with investors and the gravitas and experience to keep the Board appropriately informed and to speak truth to power. Fidelio is beginning to see Boards benchmarking the IR function given its importance as often the primary contact for investors and a key line of defence against activism. Boards are also increasingly expected to be visible to shareholders. This too requires careful briefing and co-ordination and benefits strongly from an experienced IR Director and Company Secretary.
3. Board Alignment – The Board and the skills matrix should be aligned to the strategy of the company; if this is not the case an immediate door is being opened up for Activists. Some practical steps that the Board can be taking to strengthen this alignment include:
- Effective communication of the equity story
- Clear articulation of the skill matrix of the experience and expertise of the Board and how this aligns with and supports the strategic goals. This analysis should be explicit on the website and in the Annual Report.
- Appointments to the Board should also follow good process. Fidelio is seeing a sharp uptick in interest in the governance of Search. A well-run Search process (i) increases the understanding of what the role and profile should look like to support the strategy; (ii) heightens the likelihood of attracting an excellent Candidate because of the professionalism and focus of the process and (iii) demonstrates clearly to shareholders the commitment to building a meritocratic and diverse Board that is clearly capable of acting in the interest of the company and the broad range of shareholders.
Public company Board Directors should be concerned about the strength of the equity story; the quality of shareholder engagement; and the calibre of the appointments process. These are not easy undertakings but should be receiving airtime on the Board Agenda. If a Director can gain comfort on all three, the risk of Activist intervention will be substantially diminished.
- the equity story lacks credibility;
- shareholder engagement is not characterised by integrity and fails to inspire confidence;
- and the Board-level appointments process is not transparent and clearly not linked to the objectives of the organisation;
the door will have been left wide open to Activists, including those with a short-term and highly disruptive agenda.
And should the Activist engage, here are five practical steps for Board Directors to follow:
- ͏Listening carefully to the Activist. There may be wisdom in the points being made, so Board Members should engage appropriately.
- Come up to speed quickly on the Activist and how he (typically, he) works.
- Making sure your advisors are aligned and can be mobilised – listen to your advisors but determine your own strategy.
- Ensuring the Board is operating effectively with good communication between Board Members combined with the ability to “meet” at short notice and respond quickly.
- The Board must own the response and speak with one voice when reaching out to key stakeholders, including engaging with major shareholders to build support, reassuring and updating employees, and ensuring a robust media strategy is in place.
Self-evidently the disciplines set out above relating to the equity story, effective shareholder engagement and alignment of Board composition become all the more important when an Activist is on board. This should be good housekeeping for a public company Board.
Activism is properly a topic of importance for Boardrooms internationally. Indeed, activism is both a cause and a symptom of disruption for leading companies across the globe.
It is possible to have an extensive debate about the impact of activism. Some interventions have been egregious but at the other end of the spectrum some Activists, in particular a distinctive European brand of activism, are evidently interested in supporting long-term value creation.
Fidelio’s argument is not about the merits or de-merits of one school of activism versus another. Activism has served to up the game of public company Board Directors.
Fidelio currently sees strong interest from public company Boards to better understand the Activist risk as a first step to mitigating that risk.
But be warned. Activists too are on the front foot. The expectation of performance for the companies they invest in remains unchanged but the increased public and regulatory focus on good governance has provided Activists with another powerful lever.
To learn more about Fidelio’s work building Boards fit for the future, and in particular our support for Boards in the context of activism, please contact firstname.lastname@example.org.