Still Waters Run Deep - U.S. Activism in the First Half of 2019
The first half of 2019 reflected a slight slowdown in activity from 2018’s record-setting pace. Nevertheless, corporations must stay ready for challenges from dissident investors.
If there is anything to be learned from the activity during the first half of 2019, it’s that activism as an investment strategy continues to evolve. While public fights declined, anecdotal evidence suggests more challenges are being settled privately. Additionally, corporations can no longer rely only on strong share performance, as activists are increasingly focusing on corporate governance gaps to gain investor support for changes on the board. Finally, traditional long-only shareholders are beginning to adopt activist tactics to publicly voice disagreements with corporate strategies.
All these issues highlight how activism is adapting to the current market. In light of the associated strategic, operational and reputational risks, activism remains a serious threat at the board level.
Here’s a closer look at what’s churning beneath the seemingly placid surface.
Public Fights Down but Private Settlements Up
According to data from Activist Insight, 350 U.S.-listed companies were publicly subjected to activist demands in the first half of 2019, down 7.6 percent from last year’s record pace. Still, 1H19 remains the second-highest first-half total in the last six years. This activity correlates with the growth in asset managers’ employing an activist strategy. Activist Insight reported that 81 funds ran their first activism campaigns from 2017 through 1H19 against U.S.-based companies. (Note: These data points only refer to campaigns that have become public.)
Given the growth in activism as an investment strategy, it appears that more participants are seeking resolutions outside of the public eye. Large- and middle-capitalization companies are increasingly willing to settle with activists in private, rather than risk a public proxy fight and all the distractions that come with it. Furthermore, first-time activists are often also willing to settle early to avoid public scrutiny. As a result, any settlement short of a board appointment is not tracked and never disclosed. All of this indicates that activity might be higher than the data suggests.
TSR Alone Isn’t Enough Anymore — Governance Matters
As index funds continue to grow, new risks for boards have emerged beyond insufficient total shareholder return (TSR). The three largest index funds – Vanguard, BlackRock, and State Street – collectively owned approximately 20 percent of the S&P 500 at the end of 1H19. Because many of these passive funds have stringent corporate governance policies, activists have found opportunities to target companies with perceived insufficient oversight — despite strong financial performance.
Consider Voce Capital’s campaign against specialty insurer Argo Group1 earlier this year. Argo shares had outperformed peers over the previous one-, three- and five-year periods. Furthermore, the company was improving its operational execution, on track to reach financial targets, and the share price outperformance indicated the market’s belief in management’s ability to continue executing.
Yet, despite the lack of substance in the dissident’s complaints, Voce was able to find an audience for its key initial issue: that oversight at the board level was insufficient to the point of allowing management to misuse company assets. Voce argued that despite strong outperformance, investors weren’t seeing the full potential earnings power because of lackluster corporate governance.
Argo ultimately prevailed in the proxy vote after it factually demonstrated that Voce’s accusations were based on unsubstantiated speculation. Nevertheless, the fact that Argo’s board was still required to face difficult questions from both governance-focused investors and influential proxy advisors despite TSR outperformance and improving fundamentals highlights the widening set of issues that must be addressed in an activist situation.
Don’t Forget the E and S in ESG
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Governance matters aren’t the only issues that companies must address as social and environmental activists continue to pursue their agendas.
Institutional Shareholder Services (ISS) reports that total environmental and social proposals have outnumbered governance proposals for the third consecutive year when looking at January–May meetings for companies in the Russell 3000. Further, when looking at support for E&S proposals, ISS found that 48 percent of proposals received support higher than 30 percent of votes. Five years ago, only 30 percent of proposals received investor support above that threshold.
All of this highlights the importance that investors are beginning to place on such matters. While some stakeholders are certainly more concerned with change than returns, fundamental investors are beginning to price in the risk resulting from shortfalls in environmental and social standards. Additionally, as ESG-focused investors like index funds continue to grow their ownership of U.S. companies, support for E&S proposals is expected to rise.
Given the direction of support, companies now appear more willing to negotiate E&S demands. Withdrawn E&S proposals have risen to 48 percent for 2019 (through May), versus 37 percent in 2011, reflecting companies’ increased engagement and settlement on these issues. Given this climate, it is crucial for boards to recognize that shareholders understand the risks ahead and work to either address the issues or correct the misperceptions.
Is Everybody an Activist These Days?
Boards can no longer only think of activism-focused funds as potential agitators. Recently, there have been examples of long-term long-only shareholders — those who have historically addressed concerns regarding strategy in private — adopting more aggressive tactics. This includes public expressions of dissatisfaction with management actions.
Take Wellington Management, which issued a press release disclosing its opposition2 to Bristol Meyers’ proposed acquisition of Celgene. Starboard, which joined Wellington in criticizing the deal3 was rumored to have been encouraged by other long-term shareholders to wage a public campaign. ISS’ decision to support management, despite opposition from key shareholders, was likely the deciding factor that swayed the vote in management’s favor. And Wellington isn’t alone. T. Rowe Price4, Neuberger Berman5, and M&G Investments6 have each expressed opposition to strategy employed by one of their respective investment companies this year.
There are three primary reasons for this shift in strategy:
- Activism is no longer plagued by the same negative perception it had in the early 2000s, when funds mainly advocated the breakup or sale of companies.
- Today’s activists portray themselves as engaged long-term shareholders willing to invest both capital and time to help underperforming companies improve their operations and unlock shareholder value, which aligns with traditional long-only institutional investors.
- Considering the challenges faced by traditional long-only strategies, it probably doesn’t hurt to be viewed as a willing agitator, able to advocate for change to unlock value and generate returns.
Thus, while publicly disclosed campaigns declined in 1H19, in reality, activism is alive and well. Agitators are adopting new strategies, launching shadowed campaigns and encouraging unlikely investors to incorporate similar tactics. It’s crucial for boards to be prepared.
1. Disclosure: Argo Group hired FTI Consulting to help defend against Voce Capital.
2. Wellington Management Does Not Support Bristol-Myers Squibb’s Acquisition of Celgene Corporation. (2019). [online] Available at: https://www.businesswire.com/news/home/20190227005970/en/Wellington-Management-Support-Bristol-Myers-Squibb%E2%80%99s-Acquisition-Celgegne [Accessed August 22.2019].
3. Starboard Believes the Proposed Merger with Celgene is ill-Advised and Not in the Best Interests of Bristol-Myers Stockholders. (2019). [online] Available at: https://shareholdersforbristol.com/ [Accessed August 22.2019].
4. T. Rowe Price Supports Rice Group Nominees In EQT Contest. (2019). [online] Available at: https://troweprice.gcs-web.com/news-releases/news-release-details/t-rowe-price-supports-rice-group-nominees-eqt-contest [Accessed August 22.2019].
5. Neuberger Berman Files Proxy Statement Seeking to Replace Three Verint Directors. (2019). [online] Available at: https://www.nb.com/pages/public/global/insights/neuberger-berman-files-proxy-statement-seeking-to-replace-three-verint-directors.aspx [Accessed August 22.2019].
6. BusinessWire. February 27, 2019. M&G Investments Sends Letter to Methanex Shareholders. [online] Available at: https://www.businesswire.com/news/home/20190227005970/en/Wellington-Management-Support-Bristol-Myers-Squibb%E2%80%99s-Acquisition-Celgene [Accessed August 22.2019].