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CEOs can no longer do nothing – activist investors won’t let them; Chief executives owe it to shareholders to take bold action to ensure growth

CEOs can no longer do nothing – activist investors won’t let them

Chief executives owe it to shareholders to take bold action to ensure growth

When billionaire investor Carl Icahn started agitating for Apple to return cash to shareholders, the tech giant started to listen Photo: Bloomberg News

By Katherine Rushton

8:55PM BST 18 Jun 2014

One of the most clichéd questions I will admit to asking a chief executive is what keeps them awake at night. They never answer truthfully of course – at least not on the record – but privately they dissemble.

Twenty-odd years ago, the truthful response would have been the threat of a hostile takeover. It was an era of corporate raiding, after all.

Businesses would routinely knock out the competition by buying it outright, leaving their management teams high and dry. Or billionaires would go on asset-stripping missions, as Carl Icahn did with the airline TWA, just so that they could rip them apart and flog them off for a short-term profit.

However, the downturn put paid to that, and over the past five years a new threat has emerged. “Activist shareholder” has displaced “hostile takeover” as the phrase most likely to strike fear into a chief executive.

It has been a creeping process. Not so very long ago, public companies regarded these activists with the sort of irritation ordinarily reserved for flies. Their buzzing was annoying, but they could largely be ignored and often swatted away.

Many companies dealt with activists simply by refusing to meet them. Others were more brusque. When Dan Loeb, founder of the hedge fund Third Point, first took a stake in Yahoo! in 2011, its then-chairman, Roy Bostock, reportedly ended one of their early conversations by hanging up the phone.

One suspects that Mr Bostock would take a very different approach nowadays.

Mr Loeb’s campaign for an overhaul at the beleaguered technology company paved the way for an embarrassing parade of chief executives at Yahoo!, who each took a turn at the helm only to leave shortly afterwards, under some or other embarrassing cloud. It also precipitated a boardroom clear-out, which cost Mr Bostock his job and left Yahoo! tarnished in the process.

Its carousel only stopped turning with the arrival of Loeb’s hand-selected candidate, Marissa Mayer.

The episode was a turning point for shareholder activism. In the past, investors had tended to sit on the sidelines, requesting changes to protect their existing investments, usually as a matter of last resort. They would operate behind the scenes, homing in on individuals or individual issues that they felt were a problem, but leaving the company’s management to find a new way through.

Loeb embraced a new style of business. He bought into companies specifically to engineer shake-ups, and had no qualms about denigrating them in public. He was not content with a few firings, either. He demanded specific appointments, enormous strategy revisions, and embraced a scorched earth policy whenever something obstructed his path.

His strategy proved profitable. By the time he cashed out of Yahoo! last year, he had made $520m (£306m) from the boardroom coup. Unsurprisingly, other shareholders have adopted the same approach, changing the relationships companies have with activist investors.

Figures such as Mr Loeb and Mr Icahn, alongside Pershing Square Capital’s Bill Ackman and Elliott Management’s Paul Singer, have become the bogeymen of Wall Street. Instead of flies, companies now treat them like venomous predators. They do their best to escape attention, but if they do get into a fight, there is no way these figures can be ignored.

Sometimes activist investors are a force for good. Apple’s chief executive, Tim Cook, had openly admitted that the company had far more cash on its books than it knew what to do with, before Icahn started buying into the business in a serious way.

The iPad maker is not used to taking orders from anybody, but when this billionaire investor started agitating for the company to return cash to shareholders, Apple started to listen. In April, the company announced plans to return $130bn to its investors, marking one of the biggest shareholder windfalls in history. That may not have been the right decision for just any company, but it is for one with Apple’s cash hoard.

On other occasions, activists’ high-risk tactics are damaging. That is especially true where shareholders criticise the company publicly but do not get their own way. For example, Loeb’s campaign for Sony to split in two, separating its technology and entertainment arms, has only served to rattle shareholders and drive down the company’s share price.

Often, the damage is far more insidious. Chief executives become hesitant about making bold decisions, for fear that they will attract the attention of activists. They preserve the status quo instead of leading growth, presumably believing that it is better to reign over a smaller kingdom than to take a gamble that could cost them the whole thing.

Certainly, those companies that do put up a fight appear the poorer for it. Michael Dell succeeded in taking his eponymous computer company private, against the wishes of Mr Icahn, who was heavily invested in the company, but the business and its board appeared feeble in the process.

Meanwhile, when Loeb turned his sights on Sotheby’s, the auction house, it launched a vicious counter-attack, questioning his motives and undermining his reputation. The tactic paid off in the short term – the two sides reached a truce, whereby Sotheby’s chief executive keeps his job but Loeb and his allies have three seats on the board – but it is hard to imagine this set-up being remotely constructive in the longer term.

I hope the latest evolution of shareholder activism will change that. While Mr Icahn has been demanding buy-backs and Mr Loeb has been shaking up boards, Mr Ackman has been engaging in another landmark battle, which combines chief executives’ terrors, new and old – the activist investor and the hostile takeover

He has amassed a more than 10pc stake in Allergan, the pharmaceutical maker behind Botox, to try to force it to sell to Valeant, a Canadian rival. Allergan had already rebuffed a few unsolicited approaches from Valeant, but it may not have the option to do so much longer. On Wednesday, Mr Ackman and Valeant announced they will go hostile, taking Valeant’s latest bid, for $53bn, directly to Allergan’s shareholders.

This marked a new chapter in the era of investor activism: shareholders piling into companies to try to force them to do deals with rivals they had never even wanted to consider.

Looked at one way, notably from the chief executive’s chair, it is a combination of nightmares that could present a more serious threat to long-term shareholder value than hostile takeovers or activist investors ever managed on their own in the past.

However, I hold out hope that in the right hands, it will go the other way and jolt companies out of inertia. Chief executives may have become paralysed with fear in case their action attracts the attention of one of a handful of billionaire investors. Well, there is no room for that anymore. Now that activists are trying to force companies into unsolicited deals, inactivity is just as likely to gain their attention.

Chief executives owe it to shareholders to take bold action to ensure growth. The threat of an activist-fuelled takeover finally aligns that professional imperative with their own instinct for personal survival.

If anything keeps them awake at night, it should be the threat of doing nothing.

 

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About bambooinnovator
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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