Tue., Jan. 6, 2015

The Mainstreaming of Shareholder Activism

By Michael Fox

In October 2014, a full slate of nominees won shareholder support in its proxy contest to replace the entire board of directors at Darden Restaurants, best known as the owner of Olive Garden.  The victory followed a high profile campaign over the prior months led by Starboard Value, an activist hedge fund that made national media headlines, from CNBC to The Washington Post to Gawker Media.  Attacking management’s strategy and the board’s oversight, while outlining a plan to increase earnings upwards of $300 million, Starboard was able to secure the endorsement of proxy advisors Institutional Shareholder Services (ISS) and Glass Lewis, and ultimately the vote of a majority of shareholders to oust all 12 directors — an extraordinary and rare outcome.

The replacement of Darden’s full board of directors is an extreme example of what can go wrong when shareholder activism is left unchecked or underestimated. But it is also an example of how much the face of shareholder activism has changed and how companies and their communications teams need to evolve in turn.

Once derided as corporate raiders, green mailers or simply hedge funds with exclusively short-term interests, the perception of activist investors among traditional institutions has started to change significantly — activism has gone mainstream.

Shareholder activism has become an asset class unto itself, with activist funds amassing more than $100 billion in combined assets under management, up from $32 billion in 2008. According to McKinsey, activists launched an average of 240 campaigns a year for the past three years, compared to less than half that number a decade ago and the number of occasions where activists have nominated a full slate of board members has more than doubled in the past two years.

Historically, many of those campaigns called for one-time capital allocation moves like a stock buy-back or special dividend, or the sale of certain assets or the whole company.  But now, activists are becoming much more sophisticated and genuinely focused on broader corporate strategy and practices they believe will make the company more valuable.  Activists are taking their message directly to shareholders through extensive presentations or holding conference calls. They are nominating more highly-qualified director candidates and using sophisticated PR campaigns — including websites, videos, social media and building relationships with the financial media — to garner support for their campaigns and catalyze shareholders behind their point of view. 

As a result, traditional institutional investors are increasingly sympathetic to and openly, or covertly, supporting activist campaigns.  Proxy firms — like ISS and Glass Lewis, who leant their full support to Starboard in the Darden contest — have also been very supportive of activist positions, siding with activists a majority of the time.

In this new environment of heightened and enhanced activism, no public company, large or small, is safe from an activist investor’s scrutiny, nor immune to the negative PR from a well-publicized campaign. As with other areas of crisis management, effectively preparing for a potential activist attack requires a thorough risk assessment, contingency planning and a sound communications strategy. 

As communications professionals, we can’t wait for our clients to become the target of shareholder activism before we act. Our job is to help management see the businesses through the lens of an activist investor and pinpoint vulnerabilities before an activist comes calling. In a study of 500 of the latest 13-D filings, ICR identified ten categorical similarities across the companies that were targets of shareholder activism. In fact, after analyzing these categorical similarities, it is possible to predict with a high degree of accuracy a company’s future vulnerability to an activist. Some of the key areas every public company should regularly analyze to gauge vulnerability to activist investor engagement include: 

•Stock price performance and shareholder returns compared to peer group

•Financial and business performance

•Capital allocation and structural issues

•Executive pay and corporate governance

•Shareholder perception and engagement

•Media perception and commentary

Companies that proactively evaluate these and other key variables and understand the potential campaigns that may result from areas of weakness are better able to anticipate and respond to activist investor threats.

Companies — and their communications teams — need to have a nuanced understanding of who their shareholders are, how they feel about the company and their history of activism in order to determine how and when to communicate. Analyzing the shareholder’s perspective should not be viewed as a one-off; a company’s shareholder base is constantly evolving and needs to be monitored regularly.  All companies should conduct a thorough risk assessment and report to their Board on at least an annual basis.  

Effective activist defense is not about having a response plan, it is about proactively assessing the vulnerabilities, understanding shareholders’ views, taking actions to address any deficiencies, and regularly communicating management’s vision and plan to maximize shareholder value directly with shareholders and through the media.  

When a company does engage with an activist investor, the historical inclination has been to immediately view the activist as hostile and defend the company strategy.  It used to be that activists could be fended off by being labeled as short-term investors seeking to profit at the expense of other shareholders, and most large institutional investors bought in to that narrative.

Sometimes, of course, an activist investor will make demands that clash with the Board and management’s vision for the company, but these days a defensive and aggressive response is rarely, if ever, the best approach, and can negatively affect other shareholders’ perception of the company.

Instead, each activist engagement must be treated on a case-by-case basis, and companies need to consider proposals submitted carefully and respectfully. Today’s shareholder — activist or not — is empowered, and it’s important for the Board and management to demonstrate an openness to constructive criticism and new ideas if they will benefit the company in the long run. In some cases, that may mean making changes or concessions to appease shareholders. 

A public fight with an activist investor should be the road of last resort when it is clear that there is no room for compromise. When a management team reaches the point of preparing for a proxy fight, having established a prior dialogue with shareholders will prove valuable. Companies that wait until their business is in turmoil to engage shareholders will find themselves fighting an uphill battle.  Regularly articulating the company’s current and future strategic vision to major shareholders is critical.

Rhetoric can also get extremely heated during a proxy fight, which is why the board and management need to be able to anticipate what questions will be raised, prepare messages accordingly and rapidly coordinate and respond to new developments as necessary. When anything you say can and will be used against you — and pulled out of context — having a script and sticking to it is key. It is critical to involve outside advisors with first-hand experience working in and with the investment community.

Finally, since activist investors will be rallying proxy firms and institutions to their side, companies need to leverage the support of third-party advocates to even the playing field.

The mainstreaming of activism is fundamentally changing the way companies communicate with shareholders. The old paradigm of disputing and contesting all claims at whatever cost has been displaced in favor of an engagement approach and real dialogue. However, companies need to protect themselves through regular self-assessment of their vulnerabilities and be prepared to communicate their strategic initiatives in order to come out on top of an activist engagement.

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Michael Fox is Managing Partner at ICR, and also co-heads ICR’s crisis and transaction group.

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