Activists on the March - the Challenge to Board Composition


Activist shareholders are a feature of the global investment landscape that shows no signs of going away. The phenomenon has clear implications for Board composition and effectiveness and therefore Board Search and Evaluation. Fidelio takes up the theme in this Overture.


Shareholder activism increased again in 2018 with a record 247 campaigns initiated during the year deploying $65bn globally. And though it’s most established in the US market, in many ways activism’s spiritual home, it is also becoming a force to be reckoned with in Europe and Asia (see below).

Source: Lazard, Annual Review of Shareholder Activism - 2018


Trends in Shareholder Behaviour


Not only was 2018 a record year for activist campaigns, but the tactic is also clearly gaining ground among investors: a record 40 investors globally were “first timers”, newcomers to activism. With the continued growth of passive funds and pressure on investment returns, investors are increasingly having to justify themselves by taking a more activist stance on their portfolio holdings. This was reflected in the number of large investment firms who took a public position on activist campaigns during the year, either supporting incumbent management, or siding with the activists. The trend towards passive investing also raises serious governance concerns which are not easily addressed – it’s easy enough to envisage a dystopian future where a few large passive managers control a majority of shares in all quoted companies.


A Seat at the Table


A key activist method for exerting pressure on companies is the pursuit of a seat at the table: putting forward candidates for Board roles. Here again 2018 was a record year for this tactic, with a record 161 Board seats won at 68 companies by activist candidates globally: activist investors are increasingly putting forward not just themselves but other experienced directors for Board roles in target companies. In fact, a majority of the activist Board candidates elected in 2018 were not activist investor employees, but rather other individuals with relevant experience: the days when the activist on the Board was a solitary, perhaps eccentric, voice are long gone.


A Practical Guide In this Overture Fidelio offers a practical guide for Chairs and Board members in dealing with activism: or better still, ensuring that your company is not targeted by activists in the first place. Key areas of focus are:

  1. Performance (including Board performance),

  2. Board alignment, and

  3. High calibre IR

 

Ensure Your Business Performs


Easy to say, harder to do, but this is both the most obvious and the most powerful defence against activism. If your company:

  • Posts earnings growth at least comparable to its peers

  • Earns margins in line with sector norms

  • Has a clear strategy and an easily understandable structure

  • Enjoys a good standard of governance

its shares are unlikely to be significantly undervalued.


If, on the other hand, your company:

  • it appears to lack a compelling strategy for its business,

  • has a lacklustre earnings track record,

  • and has been unwilling to engage with its shareholders,

it’s much more likely to trade at the sort of discount that will attract activism.


While governance factors are intangible, they are vitally significant in driving valuation, and the presence of controlling shareholders, or of substantial cross-shareholdings may lead investors to conclude that the interests of other stakeholders dominate. This is the reason a number of European industrial groups tend to trade at a discount to standalone estimates of their individual asset values: conglomerates of whatever hue are prime targets for activism, though clearly the presence of major strategic shareholders can act as a deterrent.


Balance sheet factors also play a role here as they can significantly impact returns on equity, and some activists like to tackle companies with significant cash positions, or those which appear under-leveraged compared to their peers. “Balance sheet inefficiency” can be very much in the eye of the beholder – one person’s efficient balance sheet is someone else’s over-leveraged company with insufficient reserves for a downturn – but here as elsewhere, careful benchmarking and scenario analysis goes a long way, as well as clear communication and effective engagement with investors. A Board that is neglecting shareholder engagement or lacks Board Members who understand how to engage with the markets and with investors represents a risk.


Develop a Strong Strategic Rationale


In an increasingly disruptive world a strong strategic narrative is essential for all quoted companies, but it becomes critically important for those targeted by activists. Fidelio’s recent work on the 'Chair and Disruption' in which we interviewed a number of prominent Chairs in the UK and internationally about – among other issues – their strategic process, confirms that the Board has a vital role to play in strategic development.


Though strategy processes differ significantly across companies, in most cases the executive team has the job of developing the strategy with the Board providing a stringent and well-informed critique. In our view it’s vital that the Board doesn’t just rubber stamp a ready-baked strategy, but provides and appropriate level of constructive challenge: gameplaying a scenario where the company is targeted by activists could be a worthwhile Board development exercise.


Align Your Board Composition With the Strategy


Once your company’s strategy is established, it’s vitally important that the Board’s skill set is sufficiently diverse, and includes the experience and knowledge required to monitor and support effective implementation. An obvious potential deficit is in the digital skills needed in today’s fast-changing strategic environment, but at Fidelio we regularly see other skill and diversity gaps appearing. This is clearly one of the Chair’s most important challenges, to ensure that the Board’s composition is appropriate, and aligned with the needs of business success.


It’s also essential that the Board appointment process is transparent and well governed and scrutiny of this aspect of governance is increasing. Board search which is informal, opaque, and restricted to a narrow pool of candidates plays into the hands of activists: for further details on the governance of search and Fidelio’s perspective on this issue see our recent Table Talk.


Engage With Activists


Though their messages can be unwelcome, it’s entirely possible that the activist investor targeting your company may have a point. The best way to find out is for the Chair, with other Board members as appropriate, to take the time to meet with activist shareholders and to understand their point of view. Many activist investors are thoughtful, thorough professionals who take a long-term strategic view of their holdings. They are under huge pressure to perform, and will not have taken the activist route lightly or frivolously. An outside perspective on the issues facing the company can be most valuable, and constructive engagement with activist investors can provide a positive impetus for performance improvement. The Chair does need to approach activist meetings with caution, however, and ensure both scrupulous preparation and comprehensive record keeping.


Engage With All Shareholders


Though activists are likely to be the most vocal people on your shareholder register, they are rarely the largest or the most important. It’s vitally important for a Board to understand who owns the company’s shares – as well as who does not, which can often be significant. Keeping abreast of the market view of the company is a non-negotiable task for all Board members, and while it’s tempting to dismiss broker research as mere financial journalism, the better quality analyst reports – especially the critical ones - are essential reading as they provide a window on the market perspective.


The Chair, Board and Executive Management should undertake a regular, pro-active programme of shareholder engagement through investor days and smaller meetings throughout the year. This should include - but not be limited to – meetings with major shareholders ahead of the AGM to communicate remuneration and other key decisions. In this context the quality of your Investor Relations team is paramount in managing the investor and analyst interface, ensuring a controlled flow of information both to and from the market.


Activists Just Want the Shares To Go Up


In conclusion, the first reaction of companies targeted by activists is often defensive, and it can be forgotten that activists’ incentives are, or should be, well aligned with those of the Board. Though activists can cause a lot of turmoil and disruption for their investee companies, and their use of leverage and derivatives can be a cause for concern, they do want the company to succeed and to generate value for shareholders. Visions of the best way to do this – as well as the perspectives of other stakeholders - can be a legitimate source of disagreement, and the Board therefore needs to keep an open mind on alternative strategies. Activism is here to stay: Chairs and Boards have recognize its value and maintain a positive response.


Board Composition and Effectiveness


Fidelio recognises the challenge that activists present, and some of the benefits.


Boards looking to be on the front foot would do well to:

  1. Ensure agreement and clarity on strategic direction, and that is well communicated

  2. Have full confidence in a high calibre IR team/IRO that is able to speak to truth to power and is respected by investors

  3. Align Board composition with strategic direction so that each Board seat is evidently contributing to increasing valuation

 

Fidelio’s focus is building Boards fit for the future. We do this through Search, Development and Evaluation on an international basis. To find out how Fidelio can support your organisation, get in touch via info@fideliopartners.com or +44 (0)207 759 2200.