Originally published in MarketWatch
By Tad Kelly
In the sometimes clubby, wood-paneled world of corporate boards at publicly traded companies, a letter from an activist investor is about as welcome as a Wells notice from the SEC and not always as polite.
Occasionally demanding, sometimes threatening and in rare instances insulting — Dan Loeb once called a CEO “one of the most dangerous and incompetent executives in America” — such correspondence, along with accumulating 5% or more of a company’s shares, are some of the initial steps taken by activists in what usually becomes, at best, an awkward pas de deux and, at worst, a bloody scrum that would not be out of place on “Game of Thrones.”
One thing that seems clear to me, with activist-investor funds having $120 billion under management — up 30% from 2014 — we will see more activist moves on corporations, including some where things get ugly. As a longtime public company shareholder as well as someone who has served on a lot of boards over the years, I think we should demand better from both sides — not the usual expensive and public display of muscle flexing.
The debate about the value of activist investors recently reached Wall Street’s top cop, Securities and Exchange Commission Chairman Mary Jo White, who defended activist campaigns as often “generally a good thing,” but encouraged activists to “step away from gamesmanship and inflammatory rhetoric that can harm companies and shareholders alike.”
I couldn’t agree more.
Sure, many activist-sparked deals have resulted in increased or special dividends, spin-offs, stock buybacks, new board members or seats, shareholder-friendly changes in corporate governance and even companies being merged or sold. Sometimes these outcomes have been in the best long-term interests of shareholders and sometimes not.
However, many activist approaches to corporations devolve into costly fights among company boards, corporate executives, shareholder groups, advisory firms such as Institutional Shareholder Services and activist investors. Management gets distracted; shareholders pay considerable legal fees; victories are often Pyrrhic, complete with period details such as poison pills and white knights.
Must it always be this way? Must activism, which gets the headlines, always be hostile?
I think not.
Sometimes conflict is unavoidable, as is the case with entrenched and underperforming senior management. In fact, strong stock performance, vis-à-vis a company’s peers, is often the best defense against activist interventions. That said, a company’s stock price does not necessarily reflect the quality of its management team or the position of the company they are managing — and that goes both ways.
At large companies, even the most egregious bills from a group of the most expensive white-shoe law firms can be characterized as little more than a rounding error. Yet, the cost of management distraction of an agitating activist and the fear and uncertainty created among company employees can destroy value and, therefore, cannot be so easily dismissed.
These issues are magnified at smaller companies, those with less than $1 billion in market capitalization, where management depth is reduced and a prolonged and expensive legal battle or proxy fight can cause long-lasting damage to shareholder value. In these companies in particular, it may behoove executives, boards and activist shareholders to communicate more carefully with one another and look for alternative methods of dispute resolution.
Taking a page from the mediator’s playbook, corporate boards, their management teams and activist shareholders could benefit from a process that looks beyond hardened positions to find common interests. The focus should be less on defensiveness and more on creating mutual understanding and an expeditious, low-cost resolution.
The usual knock on activist shareholders is that they are looking for a quick payout so they can take their profit and move on, leaving behind a weaker company less well-equipped to face the future. In bigger companies, where the stock enjoys heavy trading volume — and, therefore, large shareholders can quickly exit their positions after extracting, say, a special dividend payment — this argument probably has some validity.
But consider activist shareholders in smaller public companies with limited stock liquidity. It may take those activists months or even years to accumulate a significant equity position in the stock of a company. Smaller companies can be, in the parlance of the profession, “roach motels.” (When you have a $50 million position in a $750 million company, you have successfully checked in, but you can’t easily check out.) Because activist shareholders in smaller companies cannot readily sell their ownership positions, if they want to eventually take a profit, they must work with those companies’ boards and their management teams to create lasting value.
The bottom line: CEOs and board members at public companies should not be so quick to circle the wagons when an activist turns up. Companies should hear out activists as they would any significant shareholder. After all, they could have a couple of good ideas, and management might learn something.
Activists, meanwhile, should mind their manners. The fact is that most corporate executives and the members of their boards are highly skilled, hard-working individuals who take their fiduciary responsibilities seriously.
If the two sides want to increase their chances of finding common ground — before they lawyer up and march into battle — they should use a non-confrontational framework to resolve their disagreements. There is little to lose, and, at a minimum, shareholders will see that activists and management are both looking out for them.
Tad Kelly, a certified mediator, is a co-founder and managing partner of CHB Capital Partners in Denver. He has many decades of public and private company board experience and previously worked with the investment arms of the Bass Brothers, Richard Rainwater and related entities. He can be reached at tlkelly@chbcapital.com.