As previously published by Forbes.
Shareholder activism is expected to keep pace in 2023 as a result of capital inflows to activist funds, the potential for asymmetric upside due to continued market dislocation and the adoption of universal proxy rules in September 2022. Activist hedge funds continue to grow, having an estimated $200 billion of assets under management.
What’s Changing?
While historically targeting mid-cap companies, blue chip bellwethers are not immune as seen in the successful proxy contest against the likes of ExxonMobil, FedEx and Proctor & Gamble. The number of large-cap corporations with a valuation of over $10 billion targeted by activist investors has increased to 45% in 2021 and held at same in 2022 up from a low-to-mid 30% range from 2016-2019.
Another shift has seen activists partnering up with other investors, be it hedge funds or alternative investment fund managers, to focus on larger targets. Yet, it was the pile-on—a practice often called “swarming” or wolfpack activism—by six hedge funds in Salesforce, with a market capitalization of $150 billion in mid-January 2023 that put corporates, advisors and investors alike on notice.
Activist campaigns are also moving beyond the traditional playbook of launching campaigns focused on cost-cutting, M&A and operational improvements, with players pursuing an increased number of actions focused on ESG—in particular, governance. This is often used as a guise to push for board changes, ultimately seeking to achieve operational improvements and divestitures. Of note, globally, the number of environmental demands made publicly in 2022 increased by 81% to 292, compared with 161 throughout 2021.
From a regulatory standpoint, the environment is changing with the universal proxy rule mandating that companies list all nominees for the board of directors on a single proxy slate, including those offered by activists. However, regulatory proposals could dampen activist strategies with the SEC’s February proposal regarding 13D disclosures, and there is also debate over how the disclosure of swaps could be subject to change, a method often used by activists to gain meaningful equity positions without alerting the market.
Dissidents are also expanding their horizons, moving campaigns outside the U.S., with activity increasing in Europe in 2022, with 341 live campaigns in December 2022, up from approximately 200 in December 2019 with more activity expected in 2023.
Corporate Playbook
Activists spend months actively formulating a plan before approaching corporations, making it crucial for companies to level the playing field by bracing for the possibility of becoming targets of campaigns. No amount of preparation can inoculate a company against the prospect of an agitating investor, but proactively assessing your business vulnerabilities and defense mechanisms, lining up a team of advisors and developing communication strategies are imperative to a successful response plan.
Be Your Own Activist
Corporations need to adopt an activist mindset and regularly analyze their competitive positioning and susceptibility to an activist approach. This approach should consist of evaluating total shareholder returns, growth metrics, operational efficiency, capital allocation efficacy and capital structure. Furthermore, an in-depth review of a company’s portfolio should be performed to enhance awareness of non-core assets that dissidents may focus on for restructuring or divestment. An outline of meaningful ESG considerations and accomplishments is crucial as of late, with activists placing ESG at the forefront of several campaigns.
Engage Your Stakeholders
Even passive shareholders are activists now, making engagement with equity holders a priority. A regular cadence of engagement including investor meetings, conferences and non-deal roadshows is important to ensure the company strategy is well understood and to create a forum for management to hear investor concerns. This is particularly important with large passive investors who have increasingly supported smaller activist funds in recent contests. Beyond shareholder engagement, ensuring cohesive and effective communication between management and board members should be a consistent goal.
Modernizing Structural Defenses
Incorporation documents can be used to fend off activist investors. Certain structural defenses such as advance notice by-laws, that require shareholders to provide timely notice of their intention to submit proposals to nominate a board candidate, and dual-class voting shares can shield a board or allow them more time to evaluate options. The most common structural strategy is providing the board with sole authority to increase the number of directors or to fill newly created vacancies. While adopting a staggered board structure can limit the windows of opportunity for activist investors, this in turn can also be used as an argument to advocate for the need for new perspectives on the board.
Consult Advisors
Dealing with activists is distracting and time intensive so it is important to assemble a team of advisors who knows the company and can work to formulate a defensive plan. Financial advisors will help to develop a framework to assess vulnerabilities, and provide a fresh perspective on strategic alternatives, capital allocation and capital structure policies.
A public relations firm can devise effective plans to articulate and communicate a consistent message with stakeholders to ensure the strategy and operational plans are well understood. Proxy advisors can augment the team by providing up-to-date information on the shareholder base, project proxy contest outcomes and insight into other vulnerabilities. And lastly, experienced law firms can assist in implementing defensive counterstrategies.
Offense Is The Best Defense
Overall, the percentage of board seats won by activists through the end of May via settlements or a vote has increased to 61%, up from 47% in 2022. Management should beware that engaging with dissidents to reach a settlement can avoid disruption, but appeasing activists can create further rifts in the boardroom and double the likelihood of a CEO’s departure.
Beyond the issue of long-term success for targeted companies, there is an overarching question of weighing shareholder versus stakeholder priorities in the quest for returns. Short-term orientation of activists might not align with the investments required for long-term growth and sustainability of a company, its employees and society. Awareness, preparedness and proactive engagement are necessary steps for ensuring stakeholder interests are safeguarded.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.