New research by FTI consulting has found the UK is exposed to a high risk following an increase in investor activism outside the United States. Alongside Canada and Australia, FTI believes a strong US dollar, undervalued asset prices and increased global scrutiny of corporate governance standards has made the UK a possible target for activist investors.
What are the key findings of this latest update?
The update, which was published on 16 February 2017, confirms the long-term trend of shareholder activism growing in frequency and geographic breadth. While shareholder activism was once seen as primarily a US market feature, it is now a clearly established part of the corporate environment in many countries. For instance, the update states that 342 activism campaigns took place outside the US last year, compared to only 70 in 2010.
The research shows that, outside the US, shareholder activism is most prevalent in Australia, Canada and the UK. It attributes this primarily to changing economic factors including a strong US dollar, undervalued asset prices, together with increased scrutiny of corporate governance standards in those countries.
Interestingly, it also reports a rise in activism in Japan and China. Like activism in Europe in the recent past, Chinese activism is generally perceived to be short-term. In Japan, in contrast, driven by the 2015 changes to the Japanese corporate governance code, campaigns are more likely to look longer-term.
What does ‘shareholder activism’ mean, and what are the common goals?
In recent years the political and legal climate in many countries has facilitated greater shareholder engagement for the benefit of both companies and their stakeholders overall. In the UK, this has been encouraged by developments such as the introduction of the Stewardship Code and the requirement in the UK Corporate Governance Code for annual re-election of FTSE 350 directors. Indeed, the goal of more and better engagement between companies and their shareholders is a central theme of the Department for Business, Energy & Industrial Strategy’s green paper on corporate governance reform, which was issued on 29 November 2016 (and on which the government’s response to the consultation exercise will follow later this year). However, ‘stakeholder activism’ is usually distinguished to mean more extreme actions taken by investors with particular agendas in mind.
The goals of activist shareholders may include, seeking control of the board to change its strategy, changing members of the board to improve corporate governance, aiming to increase the share price of the company and then to sell the initial stake at a profit, requiring the company to return cash to its shareholders, seeking to have the company taken over to realise a premium to the share price, seeking to have the company effect a particular transaction (for example, the disposal of a particular division or asset which may be perceived as dilutive) to realise value, and influencing the course of a particular transaction.
From a European perspective, the update particularly focuses on activist shareholders seeking the removal of current management or board members. One such example is the recent campaign by the Children’s Investment Fund aimed at Volkswagen AG, which was directed at executive pay levels in the context of the company’s share performance.
What are the key strategies and tactics used by activist shareholders?
Activist shareholders may deploy a number of different, and often simultaneous, approaches to achieve their goals.
Hedge funds have traditionally looked to buy shares in a company to build a stake that can be voted to influence decisions at general meetings and be sold in the future at a profit if the activist’s objectives are achieved, including securing a higher price for a takeover. For example, in the high-profile case of Alliance Trust, US hedge-fund Elliot Advisors, which lobbied the company for management changes, held a stake of close to 20%.
US activists have tended to use more aggressive and high-profile publicity campaigns to exert pressure on company boards, while UK investors have been more inclined to discuss their concerns with a company’s board privately, only resorting to public announcements when those discussions break down. This is largely due to the balance of power in US companies being strongly in favour of the board and the CEO, with lower protections afforded to shareholders of US companies compared to their UK counterparts. In the last couple of years, many prominent US listed companies, such as General Motors and PayPal, have been at the receiving end of activist campaign.
Practical steps that are taken include requisitioning a general meeting to consider resolutions to effect changes—most commonly, changes to the board of directors. This can be particularly disruptive for the company concerned as it will need to call and hold a meeting and communicate its views on the proposed resolution, all of which will divert board attention away from the day-to-day running of the company and bring associated cost implications.
In planning its strategy, activists will often also request a company’s share register with a view to contacting other shareholders. This may be via traditional methods or, increasingly, through the use of social media (in particular, on Twitter) or website campaigns, to voice concerns and persuade them of the activist’s viewpoint, including potentially garnering support for any resolution at a requisitioned GM. For example, in the case of Hibu plc, following a high-profile campaign, a number of shareholders formed a shareholders’ group and requisitioned a shareholder meeting to propose the appointment of ten new directors.
In a minority of cases, activists may threaten or take legal action, such as a derivative action for breach of directors’ duties or a claim for unfair prejudice against minority shareholders. However, in most circumstances this is not an attractive route.
Finally, activists might consider entering into short selling positions, although this brings with it a risk of the shareholder activists engaging in market abuse or market manipulation (or equivalent outside of the UK) if it is combined with other forms of activism that may affect the relevant company’s share price.
What type of companies or sectors are especially vulnerable to this trend?
Each occurrence of shareholder activism will be driven by individual opportunities and issues. As such, there are no hard rules on when and where it will occur. However, looking at previous actions, and recent statements, of high-profile activist shareholders, a few factors and trends can be identified.
The make-up of the company’s share register is critical as to whether it is an attractive target for an activist. For example, companies with large family groups on their share register, and who can therefore effectively act as a shield for the board, are clearly less vulnerable.
Size is also an important factor. For many of the best known-activist shareholders, small-cap companies are often of limited interest as, given their scale, the potential upside may not justify the time and expense in mounting an activist campaign. Equally, absent a takeover scenario, larger FTSE100 companies are also usually not seen as natural targets given the costs involved in building a stake which would give the activist shareholder a platform for pushing their agenda.
Activists may see opportunities in different sectors for different reasons. For example, in a sector where market perception has recently changed, the activist may hope to benefit from the revaluation of ‘undervalued’ companies. Some have therefore argued that in 2017 and 2018 we will see more activism in the commodities space, given the end of the long bear run in that sector. Alternatively, in an out-of-favour sector, disenchanted shareholders may be open to the arguments of an activist shareholder. For the same reason, shareholders in a company being left behind, as its competitors enjoy a bull run, may welcome new ideas.
As well as the commodities space, the update also calls out the telecoms and banking sectors in Europe as being particularly vulnerable to activism in 2017.
What advice might in-house lawyers give to their boards to reduce the risk of aggressive shareholder activism?
The old adage ‘prevention is better than cure’ rings true when it comes to shareholder activism. The ease of obtaining an amicable resolution with any activist shareholder, before any issues are made public, will be enhanced if it maintains its own internal analysis of how shareholder value is being delivered and is able to provide explanations of the actions being taken, whether in the short, medium or long term. From the company’s perspective, dealing with any issues privately is far more attractive than having a public activism campaign reported and monitored by the media. For example, some companies are known to have trial runs of liaising with an activist investor, to prepare themselves for when there is a genuine shareholder concern. If a company is able to maintain a good relationship with its major shareholders (including understanding and addressing their concerns on an ongoing basis) and effectively communicate its strategy and how it is maximising value, it will be less susceptible to challenge from an activist shareholder in the first place.
Similarly, if, despite the company’s efforts, it does face a challenge from a disgruntled shareholder, it is clearly in its best interests to come to an amicable resolution privately, as opposed to receiving a general meeting requisition out of the blue, accompanied by the inevitable media flurry.
Nick O’Donnell is a partner in firm’s London office and regularly advises a number of FTSE 350 clients on corporate issues. He has over 15 years’ experience of advising on public company matters including public and private acquisitions, capital raisings, corporate governance and ongoing obligations. He has spent significant periods of time on secondment to companies and investment banks including, most recently, Goldman Sachs.
Interviewed by Kate Beaumont.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.