Executives take note: activists are sometimes right; McKinsey’s consultants suggest the best strategy is to listen

March 23, 2014 3:13 pm

Executives take note: activists are sometimes right

By John Authers

McKinsey’s consultants suggest the best strategy is to listen

Executives need to beware of activist investors. They are better armed than ever before, and they are coming after ever bigger targets. As this year’s proxy season in the US comes into view, with annual meetings and board elections on the agenda, heads of big corporations should no longer assume that they are safe.

Not only that but some of the raiders’ ideas actually make sense. No longer barbarians intent on forcing money out of the company through grotesque financial engineering, the current generation of raiders tend to have done their homework. Like business school students diligently working on a case study, they have good ideas to suggest. So it behoves managements to listen to them, rather than move straight into confrontation.

That at least is the message from McKinsey. Activists are making themselves so pesky that McKinsey’s consultants are offering what amounts to a self-defence manual for managements and boards under fire.

Perhaps surprisingly, they suggest that the best strategy is to listen. And this view even has a government imprimatur. Mary Jo White, recently installed as the head of the Securities and Exchange Commission in the US, said in December that there was “widespread acceptance of many of the policy changes that so-called ‘activists’ are seeking to effect”.

Meanwhile, an effort is on by large shareholders and corporate lawyers to draft a new shareholder-director exchange protocol (known as SDX) to ease dialogue between investors and activists before everybody spends wasteful amounts of money fighting a proxy battle.

The main reason to listen, and perhaps for the changed attitudes towards activists in general, is that activists’ ideas do add value – at least according to McKinsey data. Media attention is dominated by the most dramatic successes and failures. But after analysing 400 activist campaigns in the US, out of 1,400 launched in the past decade, McKinsey found that the median campaign was launched at a company on a downward trajectory, and succeeded in improving it. Excess shareholder returns, compared to sector peers, tended to persist for at least 36 months.

Looking at companies’ total shareholder returns relative to their industry average, activist targets had on average declined by 13 per cent in the two years before the campaign started. They then recovered by 5 per cent over the next 12 months, and maintained these gains for two years.

These gains may be because activists tend to have better information, and even internal support, before their involvement is even triggered. According to Activist Investor Insight, a London-based newsletter that covers the industry, US activists are increasingly “invited by longstanding shareholders who are unhappy with the direction in which management is taking the company”. Some activists even report that they have been approached by employees anxious to confront weaknesses that board and management do not recognise.

McKinsey also found that campaigns that were “settled”, with management doing enough to assuage activists’ concerns, produced the best returns. The fact that management “wins” – still the single most likely outcome – ended with the poorest result for shareholders is another argument for engaging with activists, rather than moving straight to an all-out fight.

Why were activists able to unleash some value? Evidently, with a few exceptions, they are no longer about crude “greenmail” as they were in the 1980s. Instead, McKinsey found that today’s activists tend to look at operating issues and performance metrics. They are more patient than they used to be, and also more willing to work with management.

Executives of big companies should also be aware that size is no longer a defence. US-based companies targeted by activists last year had an average market value of $10bn, according to McKinsey. In 2009, the average size was less than $2bn. This is not just because market values have risen with the revival of the stock market

Larger companies – recent targets have even included Apple and Procter & Gamble – are in focus because the activists have more money than ever before. Activist-style hedge funds have about $75bn in assets under management. Combined with the leverage that is still easily available, this allows them to aim at the biggest targets. Operating on such a scale means that picking on smaller targets will barely affect their returns.

All of this might sound unsettling for managers, but there are at least some hints from all of this activity that corporate governance, and by extension the market system itself, might just be working as they are supposed to. Watch this proxy season for signs of dialogue to see if this rosy prognosis bears out.