The new face of activism

Oct 1, 2005

Now that they’ve reached the trillion-dollar tipping point, hedge funds are taking a more active role with management. 

Last summer, UK hedge fund Laxey Partners succeeded in ousting three board members of Private Equity Investor, a publicly listed investment company. The fund installed its director and fund manager, Colin Kingsnorth, and two more of its own nominees, culminating in a public battle over stewardship of the company. 

Laxey Partners’ corporate coup d’état is just one more example of a trend that is gaining visibility and momentum: increased activism among hedge funds. Helping perpetuate this growing activism is the mood among the public and regulators combined with post-Enron regulatory changes, which – for now, at least – favor shareholders. 

Not all campaigns are successful, and most hedge funds would probably not call themselves ‘activists’. But whether alone or, as is often the case, acting with other hedge funds that may take the activist lead, hedge funds can represent a formidable challenge for corporate managers. There are certainly quite a few more of them to contend with; the size of the hedge fund population has swelled thanks to the large payouts many managers are taking home. 

‘There are not many examples of anyone surviving one of these horde-like attacks,’ says investment banker Gary Lutin of Lutin & Co. ‘You have something like 8,000 hedge funds operating today, because people are pouring money into anything that makes noise as a hedge fund manager.’

As Lutin points out, few firms that have experienced these high-profile battles have prevailed unscathed. Time Warner is already sitting down with veteran corporate raider turned activist Carl Icahn after he publicly criticized the company’s share performance and increased his ownership stake. And Wendy’s recently announced plans to spin off its Tim Hortons doughnut chain following pressure from hedge fund Pershing Square. 

On the defensive

The problem companies face is that not all hedge funds share the same motives. And even if the motives are in the long-term interests of shareholders, it doesn’t mean the recommendations are the right ones.  ‘Hedge fund activism is making many companies more defensive,’ notes Lutin. ‘Some of the large funds are diversifying into areas without adequate knowledge, such as value and activist investing. And some of the activists are really doing it primarily to promote their funds, so they just like to scream. That gives the entire sector a horde-like appearance that can send corporate managers into a panic.’ 

Even hedge fund managers admit some of their peers are motivated more by the desire to drive short-term activity in a stock. Others may be primarily driven by self-publicity, especially in the US where hedge funds are not allowed to advertise. 

‘Advertising is a part of it but it is also ego,’ says one hedge fund manager who requested anonymity. ‘It’s really case by case in terms of whether or not the campaigns are harmful. Another important point is that there are some activists who make a lot of noise and then tend to disappear or don’t follow up when new management comes in. That’s less effective, as management figures out over time that these activists won’t stick around.’ 

In some countries, notably Germany, hedge funds have taken a drubbing from politicians questioning their motives and the secrecy under which they operate. 

In March UK hedge fund TCI and Atticus Capital, a fund with operations in both the US and the UK, and several other Deutsche Börse investors knocked down a proposal by then CEO Werner Seifert to acquire the London Stock Exchange (LSE). Not only was the proposal withdrawn, but Seifert was also forced out. The funds are now under investigation by BaFin, the German regulator, on suspicion that they acted in concert. 

‘This activism is for the best when it is good advice – there is good and bad advice, and even hedge funds can do stupid things,’ says Arne Vaagen, a partner at Stockholm-based hedge fund Futuris Asset Management. 

Vaagen has not been involved with activism and says it is not common for hedge funds to be activists in the Scandinavian market. He has, however, noticed more funds, especially those in the UK, becoming more active, and that is affecting IR among Scandinavian issuers. ‘Hedge funds are growing up and companies are accepting it,’ says Vaagen. ‘In response, companies are opening up in how they deal with the funds.’ 

In sync

In the case of Laxey Partners, the experience has been a good one, according to Peter Dicks, chairman of the board at Private Equity Investor. ‘Almost anyone can call himself a hedge fund operator,’ says Dicks. ‘You have to look at what they’re trying to do in each specific case. The fact is, in most cases, if companies are performing poorly or not as well as some might think they should be, they’re targets for hedge funds. That’s not a lot different from when I started in this business years ago. It’s just a different way of handling things. In our case, we had an extremely positive relationship with our activist shareholder and it worked out perfectly well.’ 

Dicks characterizes the relationship between Laxey Partners and his company as ‘long term’. That wasn’t evident from the start but Kingsnorth, who now sits on the investment company’s board, has been extremely supportive, says Dicks. 

‘Everyone is very happy with the arrangement,’ he adds. ‘It has helped us to understand other shareholders’ viewpoints, and that is a very good thing. I genuinely think other institutional shareholders would say that, by and large, it’s been a good outcome.’ 

Greg Bylinsky, managing director of New York-based hedge fund Lime Capital Management, doesn’t consider himself an activist but he was one of the leaders in a shareholder effort to push Farmer Brothers, a California coffee distributor, to either sell itself or become a private company. More recently he has seen an increase in the number of requests he receives from other funds to participate in their activism. 

Bylinsky believes most funds, including Lime Capital, would rather be in a cooperative relationship with management. ‘Activism is effective when boards take their fiduciary duty much more seriously,’ he says. ‘Where activists remind management of their fiduciary duty, they can be much more effective.’ 

Still wary

Few companies choose to go on the record criticizing hedge funds, though they are often wary of their motives. Given the amount of money these funds are controlling globally – $1.06 tn as of June 2005, according to Reuters – they are a truly powerful group. Some funds, in search of better returns, have even taken on the role of private investment firms, taking outright control of companies. 

‘Obviously your antennae go up when hedge funds are involved,’ says David Sternblitz, VP and treasurer at US specialty retailer Zale Corporation. ‘We look at each hedge fund a little more closely before we accept a meeting but we really treat everyone equally, and some of our longest holders have been hedge funds.’ 

As a ‘value’ firm, most of Zale’s top shareholders are value investors, and – inevitably – some of them are hedge funds. Sternblitz says the company strives to maintain open and direct communication with those funds in the stock. But communication can be difficult, especially in the US with Reg FD restrictions. Hedge fund managers are often savvy, well-informed investors who are anxious for any morsel of information their peers are not privy to. They place a premium on face-to-face private meetings. 

‘The frequency of requests for meetings has definitely increased,’ observes Sternblitz. ‘It’s part of the job to determine who requires management’s time. I need to talk to those people on the front end and spend ten or 15 minutes asking questions, trying to get as much of a feel as possible for who they are. The type of questions they’re asking can help you decipher their motives or whether they’re short term-oriented. But it has to come through direct communication, as there isn’t much public information available on these hedge fund investors.’ 

‘This new activism is definitely changing how corporations view hedge funds,’ adds Lutin. ‘As with any new trend in its infancy, you get both good and bad aspects. But it also means you have a vital marketplace and people are experimenting with a range of issues. The dotcom bubble witnessed people investing in sock puppets but those sock puppet ads stimulated interest in the internet, which was a great thing from a macroeconomic perspective. If the hedge fund rush ultimately stimulates interest in responsible corporate governance, that too will be a good thing.’ 

Surviving the pirates

One activist hedge fund that has been in the news quite a bit is Pirate Capital, a Connecticut-based fund that has participated in several high-profile battles. One would think finding your company in the fund’s publicly disclosed shareholder list would be cause for panic. But for Timothy Thorp, VP of IR at Duluth, Minnesota-based Allete, panic hasn’t set in. 

‘They haven’t really been any different from most other institutions,’ says Thorp. ‘Of course, hedge funds tend to be more aggressive and, in many instances, a lot more short term-oriented. Last year, after we did a spin-off, we had a lot of hedge fund activity. But we don’t treat them differently from others. Having said that, we tend to have a more proactive bias with them. You don’t like to surprise any investor, least of all one that tends to be more active.’

As for the hedge funds’ tendency to be more demanding when it comes to one-on-one meetings, Thorp says the only thing he can do is be prepared. ‘Some of the funds will ask questions that will further their interests,’ he explains. ‘You just have to be aware of their interests and stay on your toes. The fact is we are consistent with our communication, because if you start catering to them differently or communicating differently, that’s a slippery slope.’

By Ian Sax
  

© copyright 2005 Cross Border Ltd