Josh Barone
The well-paid managers of a growing list of publicly held American companies find themselves beset by activist investors.
In recent months, the targets of activist investors have included Dupont, UBS, Vitamin Shoppe, Steak ‘n’ Shake, Qualcomm …. and the list goes on.
The growing tide of activist investors creates opportunities for individual investors as well as the hedge funds and wealthy individuals who typically back activists’ demands.
But at the same time that the activists’ moves allow nimble traders to make attractive returns, their work raises some nagging questions about the fundamental fairness of the securities markets. Questions about the fairness of the markets, in turn, open the door to ill-considered and heavy-handed regulation of the markets.
While the term “activist investor” has been in common usage only since the end of the Great Recession, the concept has been around for decades.
Spotting a troubled or underperforming company, the activist investor group buys a substantial chunk of the company’s stock. The activist group uses its position as a significant owner of the company to demand that the management cut costs, improve operations, sell the company to a competitor or go private. Not uncommonly, the activist group also demands seats on the board of directors of the target company so it can keep a closer eye on things.
An activist group can do all this fairly cheaply, at least by the rarefied standards of big-time corporate finance. A stake as small as 10 percent of the target company’s stock may prove sufficient to force change, an amount that’s far less costly than the 51 percent ownership that provides full control.
All this undoubtedly sounds familiar to those who watched the unfolding of the era of the corporate raider in the 1980s. The techniques were slightly different, but the corporate targets were much the same — underperforming companies that could be broken apart and profitably sold in pieces.
Like then, today’s activist investors piously announce that they are acting in the best interest of all shareholders, small as well as large, as they unlock value that hasn’t been realized under the current strategy of the company’s managers. Of course, the shareholders that these investors care most about is themselves, but there’s nothing wrong with enlightened self-interest.
At the same time, the possibility that activists will target a publicly held company is likely to give second thoughts to executives who otherwise might pay more attention to their own needs than those of shareholders. Many publicly held companies, in fact, keep a list of activist investors and their individual tactics available for quick reference should a list of demands arrive.
At its most basic, the strategy of activist investor groups starts at the same point as any skillful investor: The search for assets whose value isn’t fully realized by the markets, either because investors aren’t paying attention or because of some failure by the company’s management. Buying undervalued assets and waiting for the market to recognize their true worth is a tried-and-true strategy as old as the financial markets themselves.
It’s been a good strategy. The London-based research firm Activist Insight took a look in 2012 at the annual net return of 40 activist-focused hedge funds since 2008. The researchers found the activists had consistently outperformed the MSCI World Index. Often, even the rumors that an activist group is looking at a company prove enough to get the stock moving, and skilled traders who look for companies likely to draw activists’ attention have done well by positioning themselves ahead of an activist’s move.
But although activist investor groups begin at the starting point as other investors looking for deep value, they are far less patient than the investors of old. Rather than wait for the invisible hand of the market to recognize the true worth of their undervalued holdings, activist investors force the issue right now. They are not buy-and-hold investors willing to spend months and years improving a company.
A key tool they use to force the issue is their access to the financial media. Broadcasters and editors know their readers thrill to the excitement of a boardroom battle, and activist investors typically get plenty of opportunities to talk up the value of their holdings.
At times, the media-driven reaction is so strong that activist investors don’t need to wait for a target company to make actual change. The price of a stock can get pumped up quickly enough that a sale will create a quick profit.
That sort of access to the media isn’t available to most individual investors. Just try calling the news director of a local television station to see if she’d be interested in doing a broadcast about the hidden value of your favorite stock.
Nor do Main Street investors have the financial wherewithal to participate in the activist-investment game at all. It’s a market opportunity that’s available only to the rich and well-connected who can put together the millions needed to buy even a 10 percent stake in most publicly held companies.
Because the two key factors in activist investing — large pools of cash and easy access to the media — are generally available only to a select few participants in the securities market, politicians are sure to keep a close eye on the practice. Nothing is more attractive to populists in Congress than taking a swing at deep-pocketed Wall Street figures who can open doors that are closed to ordinary investors. In the political realm, activist investors’ focus on corporate cost-cutting can translate into a shuttered factory in a hometown full of voters.
Unfailingly, aggressive investment approaches have brought either abuse that led to legal prosecution or political repercussions. So far, activist investing has avoided either fate. Its practitioners will need to continue their nimble dance.
Joshua Barone has been the managing member of Universal Value Advisors since its inception in 2005. Prior positions include: M&A analyst in the community bank space; insurance sales both in property and casualty, and life and health.
