As M&A business cools, banks warm to activist investors

As M&A business cools, banks warm to activist investors

Fri, Jan 24 2014

By Jessica Toonkel, Olivia Oran and Soyoung Kim

NEW YORK (Reuters) – Corporate raiders, long scorned by Wall Street, are gaining new credibility as activist investors, to the point that some investment banks are eager to bestow on them a new title: valued customer.

Big Wall Street banks like Goldman Sachs (GS.N: Quote, Profile, Research, Stock Buzz) and Morgan Stanley (MS.N: Quote, Profile, Research, Stock Buzz) are still content to defend corporate America against investors like Carl Icahn and Dan Loeb, who take large stakes in companies with the hopes of effecting such changes as spinning off a division, cutting costs or ousting management.

Protecting the corporate castle is profitable work, part of nearly $70 billion in corporate fees generated by investment banks annually, and big banks fear upsetting their best clients.

Smaller investment banks, though, see a new source of revenue: Working with investors on one corporate campaign could help them win future assignments from another company, which may seek defensive services from banks familiar with the inner workings of activists.

Getting involved in a merger-and-acquisition transaction is also opportune if the target company ultimately pursues a sale of itself under investor pressure.

That’s a potentially attractive proposition for an industry still grappling with slow dealmaking activity in the wake of the financial crisis. U.S. M&A fees last year were still down 27 percent from 2007, at $15.9 billion, according to data from Thomson Reuters and Freedman & Co.

“I keep getting calls from people who want to be in this space. Bankers are trying to figure out ‘how can I charge for working with activists?'” said Steve Wolosky at Olshan Frome Wolosky LLP, a top lawyer for activist investors such as Starboard Value LP.

“Everyone is expecting the big banks to start doing this … the answer as to when is ‘follow the money,'” said a banker at a large firm that has discussed working with activists.

“It’s not that different from what happened with the private equity firms in the 1980s. No one wanted to work with the ‘barbarians’ until they realized it was very lucrative,” he added, asking not to be named because he was not authorized to speak with the media.

Boutique banks including Houlihan Lokey, Moelis & Co and Blackstone Group LP’s (BX.N: Quote, Profile,Research, Stock Buzz) advisory group have worked with investors such as Barington Capital, Starboard and Pershing Square Capital on their activist campaigns.

Evercore Partners Inc (EVR.N: Quote, Profile, Research, Stock Buzz) and Jefferies LLC are also keeping a close eye on the trend, several bankers said.

Activist investors have become more respectable in recent years after a series of campaigns that brought about changes seen as instrumental to companies’ success.

Loeb, for instance, made a handsome profit for himself and his investors from his two-year crusade to increase Yahoo Inc’s (YHOO.O: Quote, Profile, Research, Stock Buzz) value. The shares, which were around $13 before got involved, now trade near $40. He was also instrumental in naming former Google Inc (GOOG.O: Quote, Profile, Research, Stock Buzz) executive Marissa Mayer as Yahoo’s chief executive officer.

On Wednesday alone, Icahn urged e-commerce giant eBay (EBAY.O: Quote, Profile, Research, Stock Buzz) to spin off its PayPal arm and renewed an attack on Apple Inc (AAPL.O: Quote, Profile, Research, Stock Buzz) to return cash to shareholders. Loeb revealed a major stake in Dow Chemical Co (DOW.N: Quote,Profile, Research, Stock Buzz) and urged the largest U.S. chemical maker to spin off its petrochemical unit.

The number of activist campaigns against U.S. corporations has increased 20 percent over the last few years, according to FactSet Shark Watch, from 198 in 2010 to 236 last year.

While large activist firms mostly have the team and reputation to take on a fight without outside aid, other activists hire Wall Street advisors to render campaigns more believable, to perform financial analysis and sometimes to find potential buyers for the target company.

ADDING HEFT

For smaller or new activist investors, enlisting a bank helps to “show they are serious because they are paying the bank a significant fee to do the work and use their name,” said Gregg Feinstein, head of the M&A group at Houlihan Lokey.

Houlihan, which also defends companies against activist campaigns, represented its first activist publicly in 2011 when it assisted Orange Capital in its campaign against Australian REIT Charter Hall Office Management.

Orange succeeded in its push, which included the sale of its U.S. portfolio. Houlihan is now helping Barington Capital to persuade Darden Restaurants Inc (DRI.N: Quote, Profile, Research, Stock Buzz) to break up into two separate companies and to spin off its real estate.

Moelis advised Starboard Value during the hedge fund’s push for Smithfield Foods Inc to break itself up rather than sell to Shanghui International Holdings Ltd.

Blackstone will work with corporate clients as well as activists, including Pershing Square, the hedge fund founded by William Ackman. The bank helped Ackman when the billionaire invested in Canadian Pacific Railway Ltd (CP.TO: Quote, Profile, Research, Stock Buzz).

Some bankers work with activists because they are attracted by the opportunities to build relationships with investors, who often manage to secure board seats at major corporations.

“Many banks use the activist product as a means toward securing future mandates from a corporate client, including takeover defense or ultimately the sale of the company,” said Tom Stoddard, a senior managing director at Blackstone.

Banks working with activists generally charge a flat fee, a percentage of the gains the activist receives if the campaign is successful, and an additional fee if the activist publicly discloses the bank’s name, according to several people familiar with these arrangements.

The flat fees can range anywhere from $250,000 to $1 million, and the percentage of investor gains bankers earn can be anywhere from one to 5 percent, these sources said, asking not to be named because the information is not public.

It is hard to generalize fees because often caps and credits are associated with these structures, one of the sources added.

Banks fending off a high-profile attack can make from a few hundred thousand dollars to $2 million in monthly flat fees, on top of a success fee as high as $7 million to $8 million, according to one industry banker.

“People are willing to pay higher fees if you fight people like Carl Icahn than if you are fighting a new kid on the block,” the banker said.

Such fees are only a tiny fraction of what Wall Street banks generate from deals ranging from capital market transactions to mergers and acquisitions.

Computer maker Dell Inc’s $25 billion buyout by founder Michael Dell last year, for example, created $458 million worth of investment banking fees in 2013, according to Thomson Reuters data.

That reliance on corporations for revenue explains why it’s still rare that banks work with activists.

But as investors become more common in the boardroom and the amount of money activists make grows, more banks may change their view, said Lyle Ayes, managing director and head of shareholder activism practice at New York-based Evercore

(EVR.N: Quote, Profile, Research, Stock Buzz).

When Evercore brought on Ayes early last year, one of his first mandates was to help decide if the firm should represent activists.

In the end, Evercore decided against the idea. “It’s too close to home for too many of our important clients.” Still, he added: “Evercore asked the question before I arrived, they asked when I arrived and I suspect they will ask it again.”