“Activism” and “event-driven trading” go together like a sunny day and an ice-cold Medalla. In every type of event-driven setup something is happening at a company that could change the fundamentals, the corporate structure, the shareholder base, etc. With activism, an investor (usually a hedge fund) has taken it upon themselves to force an event or influence the outcome of an ongoing event. Activism can be an event-driven setup in its own right but often it’s a catalyst to kick off a chain of events or change the flavor of an existing setup. For the investors initiating the activism this can be extremely valuable, but it can also be valuable for the other investors who are along for the ride.
That’s why we love to track activism at KEDM.
What is Shareholder Activism?
Put simply, “activism” in investing is a when an investor takes an outsized position in a public equity to gain a degree of control or influence over how the business is run. An activist engagement could range from simply sharing ideas with the management, to refreshing the entire board and firing the management and installing new leadership. They can be friendly or hostile. Hands off or incredibly hands on. Either way, there is a hard catalyst and incentivized shareholders to initiate change – a ripe combination for value creation..
Activism yields outsized returns if done right, and if you are as much a fan of the Oracle of Omaha as we are, you’d realize that this type of investing is similar to what he used to refer to as “control situations” in his early partnership years. We especially like one of his plays. In Sanborn Map, Buffett bought a major stake in the publisher of detailed maps of all US cities and towns. Due to falling earnings power because of an alternative mapping method gaining traction, investors had turned pessimistic, and the company’s shares lost significant value. However, Sanborn Map had an oversized investment portfolio made up of public securities apart from the operating business, which was not being valued appropriately by the market. The fact that management did not own shares ensured that the board would do nothing towards improving shareholder returns, even though the company was trading at a negative enterprise value. Buffett explains:
“Let me give you some idea of the extreme divergence of these two factors. In 1938 when the Dow-Jones Industrial Average was in the $100-$120 range, Sanborn sold at $110 per share. In 1958 with the Average in the $550 area, Sanborn sold at $45 per share. Yet during that same period the value of the Sanborn investment portfolio increased from about $20 per share to $65 per share.”
Seems like a layup!
Uncle Warren took a significant position in the company, and through the kicking and screaming of the Board of Directors, he used the liquidity in the investment portfolio to tender for most of the shares outstanding, causing the discount to fair value to close and shares to appreciate significantly. Had Buffett not gotten involved actively, Sanborn shareholders would never been rewarded for investing in the company. If interested, read more about Sanborn Map here.
Regulatory Filings and the Activist Letter
Buffett’s “control situation” differs from most modern activist situations as he had taken control of the company. If you own the majority of the voting shares or a “controlling stake” the fight with management and the board is fairly easy. Today activist investors are able to exert their influence with increasingly small stakes. In the 20th century controlling stakes or large double digit percentage stakes were common. Today investors regularly engage in activist campaigns with mid-single digit ownership percentages. That means lobbying other shareholders or getting a loud enough voice to effect change.
When an activist is targeting a company, it will accumulate shares then file a 13D and typically send a terse public letter to the board. This letter will contain the “ask”, and the board will usually respond with a denial rebuttal or initial defenses such as a poison pill. In a lot of cases, the engagement will continue back and forth, and eventually the activist and the board will settle without going into a full-blown proxy fight. This settlement will usually result in one or multiple board seats for the activist, in exchange for a standstill agreement which means that the activist cannot make further share purchases. These agreements are sometimes called “cooperation agreements”, where the activist agrees to cooperate with the current management, supporting them in the next annual meeting.
Hostile Boards and Activist Counter Tactics
If the amiable style does not work, one way the activists can get a board is seat is a through AGMs (Annual General Meetings, held once a year). Each year, Board seats will be up for vote and if the activist’ candidate can secure enough votes, a seat will be awarded. This will require the activist to put forth their own candidate, file proxy materials and solicit the votes of fellow shareholders. The much more painful way is going through an EGM (Extraordinary General Meeting). In certain situations, if the AGM is too far out in future (usually held in March-July) or if there is a time sensitive corporate action in the making (M&A, sale, spin etc.), a shareholder can compel the company to call for an EGM. While the rules to call an EGM are complex and varies by company/jurisdiction, rule of thumb is the activist will need at least 10% ownership. So, if there is something time sensitive, it’s important to pay attention to which type of activist campaign you are dealing with.
Now, the readers of this monitor will not be going out and running their own activist campaigns, and while we won’t turn this into a master class on How to be the next Carl Icahn, it is worth mentioning a couple tricks that the companies use to screw activist investors.
When threatened by an activist shareholder, the most known defense is the “poison pill”, which is when a company issues large amounts of new shares with the goal of diluting the activist shareholder’s ownership. Now, since these actions are taken by the same Boards that want you to use a paper straw wrapped in a plastic package, they don’t call it “poison pill” anymore, you will see it named “shareholder rights plan”. Companies also use super majority amendments, anti-takeover devices, or golden parachutes in their battle against activists. We won’t go too deep into these individually as you likely won’t be going activist yourself but each of these seeks to make it harder for the activist to get more control or potentially disadvantageous to do so.
Top Activist Funds
Playing a 13D activist event is simply riding on the coattails of large investors enacting their own catalyst. If you filter through the pikers and understand the funds that create real value, or simply believe in the activist’s vision, it is a source rich in alpha. To that extent, it is important to keep track of all the activist campaign going on globally (which we do at with our 13D Monitor) but it is also valuable to know the top players in the space a bit more intimately. The heavy weights are, Elliott Investment Management (Paul Singer), Carl Icahn, Third Point (Dan Loeb), Starboard Value and Value Act. While this is not an exhaustive list, we need to add some honorable mentions such as Jana Partners, Engaged Capital, Greenlight (David Einhorn) and Eminence Capital. Before we finish the list, its worth mentioning our all-time favorite US small cap activist Carlo Cannell of Cannell Capital who is always a worthy and entertaining read.
Bottomline, activists agitate for change. And with corporate change, comes stock price change. Track these changes at KEDM…