Activist Strategies

The goal of activist investing is typically to purchase a stake in a company (often 10% or less) and then influence certain aspects of the company's operations in order to increase shareholder value (could also be ESG motivations but commonly done for profit).

The Rise of Shareholder Activism

Activist investing has been around since the 1970s but has really taken off post-2008 financial crisis. Hedge funds often enjoy advantages in the form of less scrutiny and regulation when taking on activist campaigns. The top hedge fund activist investors currently have billions of dollars in Assets Under Management (AUM), with activist campaigns having increased approximately 5x between 2004 and 2015.

Typical Target Companies

Like a house flipper seeking a property to renovate, activist investors target companies that have not reached their full potential. If a company is already operating at its best, there's little room for improvement and limited profit potential. Hence, activist investors seek firms with one or more of these characteristics:

• Slow growth.
• Negative share price trend.
• Weak corporate governance.

These characteristics suggest the potential for improvement and profit. Additionally, they indicate that shareholders might not be content with the current situation and may be open to changes activist investors propose. This enables these investors to influence company management without resorting to extreme measures such as proxy contests.

Typical Activist Investing Process/Timeline

Activist investors work to bring about changes in a company. At any point after the third step in this process, an agreement might be reached. This indicates successful influence on the company, resulting in the implementation of new policies and procedures, which ideally boosts the value of shares.

1. Identifying opportunities.
2. Acquiring an initial stake in the target company.
3. Announcing proposed changes.
   • Potential agreement
4. Threatening proxy contest
   • Potential agreement
5. Launching proxy contest
   • Potential agreement
6. Negotiating settlement
   • Potential agreement
7. Conducting shareholder vote

Tactics Activists Use

Dissemination of Intended Changes

Activist investors' tactics involve letting their desires and intentions be known in one form or another. This may be accomplished via:

• Obtaining representation on the company's board.
• Writing open letters to the company's management.
• Proposing modifications during annual meetings.
• Launching media campaigns.
• Using legal actions.

Typical Intended Changes

• Reorganizing capital structure (through share buybacks or increased dividends).
• Reducing executive compensation.
• Aligning management compensation with company performance.
• Breaking up inefficient conglomerates.
• Implementing cost-saving initiatives.
• Bringing workforce-related changes.

Defenses Used Against Takeovers

• Multi-class share structures: These involve adding multiple classes of shares to give more voting power to managers or founders.
• Poison pill provisions: These provisions deter potential takeover attempts. They might kick in during a takeover, allowing existing shareholders to buy more shares at a discount, which reduces the per-share value.
• Staggered board: This prevents swift activist influence on the board, spreading representation over time or seats.

Impact of Activist Investors on Company Performance

There is a common belief that companies subjected to activist campaigns generally enhance their efficiency and performance. Yet, this enhancement often results in increased debt. While some investors view this higher debt positively, others, particularly existing debt holders, may see it negatively. 

Question

Which of the following characteristics is least likely to be associated with typical target firms for activist investment strategies?

1. Slow growth.
2. Negative share price trend.
3. Strong corporate governance.

Solution

The correct answer is C.

Activist investment strategies typically target firms where they believe there is potential for change or improvement. These strategies often involve pushing for changes in the company's management, operations, or strategic direction to unlock shareholder value. Activists may not be attracted to firms with strong corporate governance, as such firms are already well-governed and may have less room for the types of changes activists typically advocate for. Therefore, strong corporate governance is less likely to be associated with typical target firms for activist investment strategies.

A is incorrect. Activists may indeed target firms with slow growth because they see potential for performance improvement. Slow-growing companies may have underutilized assets or operations that activists believe can be optimized. So, slow growth is a characteristic that is often associated with firms targeted by activist investors.

B is incorrect. Firms with a negative share price trend may be attractive to activist investors because they believe that they can influence changes to reverse this trend and increase shareholder value. Activists often look for underperforming companies that they believe can be turned around.

Reading 25: Active Equity Investing: Strategies

Los 25 (e) Analyze activist strategies, including their rationale and associated processes