Activist Investing - The Power of the Shareholder
Activist investing. Everyone’s talking about it. It seems like every other Wall Street Journal article mentions it. What’s the big hype? What is activist investing? And is it beneficial or detrimental to investors? To companies? To capitalism?
First, we need to understand that activist investing is when shareholders (either individuals or groups) push for change. Usually, the activist investor holds a large amount of shares in the target company he is attempting to change. Essentially, activists want to implement their strategy to increase the value of their shares. While their plans may be beneficial to investors and the company’s value, it usually contradicts the plans of executives. In order to succeed, activists must gain support from shareholders to persuade the board of directors and other executives to implement their changes. When met with resistance, activist investors often threaten to begin a proxy fight, which often takes the form of replacing board members who disagree with the activists’ plan (a form of hostile takeover). However, it is rare for matters to proceed that far. (For a better understanding of proxy fights and hostile takeovers, refer to my previous article.)
The concept of activist investors is not a new one, but recently, its popularity has soared, possibly due to the tremendous success of activists including Carl Icahn, Bill Ackman, Kirk Kerkorian, Eddie Lampert, and Nelson Peltz. Activism gives shareholders a voice. When activists feel the CEO or other top-level management is leading the company down the wrong path, they have the ability to intervene by rallying shareholders and using their power as the “owners” of the company.
There are many different possible reasons for shareholders to agitate the board of directors to push for change. The first reason is corporate governance, which is executed by attempting to change the company’s governing documents. An example is reforming the elections for board of directors when there is a staggered board, by making elections for each and every director an annual occurrence, as opposed to directors serving three year terms. Another possibility is to fight for the right to call special meetings (to discuss pressing matters and integrate themselves into the company’s decision-making process).
Capital change is the second type of activism. When shareholders feel as if they deserve more reward for their investment in the company, they often pressure the company to issue more/larger dividends, or engage in share buybacks, thereby increasing the value of their shares since there will be less shares in existence. Such movements redistribute assets (cash) and change the amount of equity (shares). It is essentially “balance sheet activism.”
The third reason for activism is executive compensation- an increasing problem in the business world is the distribution of wealth. While it makes sense that someone who performs better and provides more value to a company should make more money, it only makes sense if his compensation is proportionate to his contributed value. Many shareholders feel that CEO’s and other top-level executives are receiving more than their worth, so they lead activist movements to reduce executive compensation. In companies that perform poorly but executive pay is still extremely high, it can be very easy to rile up fellow shareholders and pressure the board to implement change.
The fourth motivator for activism is social policy reform. Corporate responsibility has become extremely important in the eyes of the public in recent years. Gone are the days where companies can get away with just making money and disregarding affected stakeholders. If shareholders feel as though the company is not fulfilling its requirements to the environment or society, activists will push for reform. They may want to increase the company’s spending on environmental factors, reduce the amount of harmful toxins released, create programs for those in need, etc.
M&A activism, the fifth and final major category, is what usually makes the headlines. Activists are constantly pushing for mergers and acquisitions. If stockholders see great potential in acquiring or merging with another company, even though management doesn’t, the board can be compelled to go through with it anyway. A common source of conflict is whether to spin off part of the company. One example of a company with activist investors pushing for the company to spin off part of itself is Yahoo!.
Yahoo! is perhaps best known for its internet portal, which was very popular in the late 1990’s. Recently, however, the company has been less and less profitable. Shareholders have been stirring, displeased with the current state of affairs and company trajectory. Starboard, a well-known activist group who is also a shareholder in Yahoo! (albeit a small one- they are the 26th biggest shareholder in Yahoo! with less than 1% of shares), has been making a lot of noise since the beginning of 2015. Yahoo! is a large company, with many different subdivisions and investments. Starboard’s activism falls under the fifth category described above- M&A Activism.
Originally, Starboard pressured Yahoo!’s board members and CEO to spin off their huge, 15.4% stake in Alibaba (a Chinese corporation), recently valued at about $32 billion, and focus on their core business. However, there were complications and Yahoo! was unable to spin it off tax-efficiently. Now though, Starboard has made a complete turnaround. Now they are strongly pushing for Yahoo! to spin off its core business, as they believe it’s essentially a lost cause with little potential for profitability. Instead, they should keep the few valuable things they still have and focus solely on those, including Yahoo! Finance and their stakes in Yahoo! Japan and Alibaba. The logic behind this is that Yahoo! is currently worth about $34 billion, including the approximate $42 billion share in Yahoo! Japan and Alibaba, so it seems that the core business is actually worth a negative value, around $8 billion. If the core was worth something, Yahoo! would be worth more than their stakes in Alibaba and Yahoo! Japan. Therefore, spinning it off makes the most sense for shareholders, as they would also have shares in the spinoff company. The core business can also distract management from focusing on the few key components which are actually profitable. By concentrating solely on Yahoo! Finance and their shares in Alibaba and Yahoo! Japan, tremendous value can be “unlocked.”
Yahoo! CEO Marissa Mayer opposes Starboard’s plan, as she may feel the core business is a valuable asset. Since there might be tax-related issues with spinning off the core business, Mayer may not want to absorb that loss. Additionally, she might think she can turn the core business around into a profitable operation, contrary to the belief of many Yahoo! shareholders. Clandestine meetings between the board, executives, and shareholders to determine Yahoo!’s future have recently become much more frequent. Starboard recently threatened to replace board members in a potentially ugly proxy fight if Yahoo! does not comply with their wishes. Ultimately, it seems as though the shareholders will win at least partial reform. A large, united group of shareholders can be an extremely powerful, persuasive entity. In a recent Forbes article, Eleazer Klein and Marc Weingarten, co-chairs of Schulte Roth & Zabel LLP’s Shareholder Activism Group, stated their opinions that activist investing is becoming mainstream throughout the entire world, not just the United States. To quote Mr. Weingarten, “When an activist calls, top executives will now pick up the phone. Companies have learned that you can’t just ignore activists and hope they go away.”
Generally, activism is beneficial to stockholders but detrimental to executives and the board of directors (as they are being forced to go against their plans, which can often result in less compensation and greater scrutiny). However, it is quite clear that activism is in line with capitalism- big companies are not just being run by a few powerful individuals, rather by all its shareholders. Activism gives power to the people--in the case of activist investing, it empowers anyone who owns even a small percentage of the company. The question is, does activism benefit companies in the long-run? Or do corporate raiders such as Carl Icahn make changes in order to increase the value of their shares, make money (usually by selling the shares at a higher price), and then move on, leaving the company to wither and die? This is a matter of hot debate and certainly varies depending on the case and the activist.
1. A board in which a third of members are elected each year for 3 terms.
4. Business Insider: http://uk.businessinsider.com/heres-how-much-Yahoo-is-really-worth-2015-12?r=US&IR=T
5. For a copy of the letter Starboard sent Yahoo! discussing this- http://www.prnewswire.com/news-releases/starboard-delivers-letter-to-Yahoos-chairman-ceo-and-board-of-directors-300181776.html
9. Forbes http://www.forbes.com/sites/christopherskroupa/2016/01/14/activist-investors-how-companies-should-best-engage/#2715e4857a0b330b923513e8 for a strong argument that short-term investors are more beneficial, as long-term investors are simply complacent and allow underperforming CEO’s to keep their jobs.