Boardroom battles

That could all change now that Britain has voted to leave the EU. Leading this argument is the depreciation of the pound against other major currencies – shareholders in iPhone chip designer Arm (ARM) were among the first beneficiaries of prized British assets becoming much cheaper to foreign investors. Should the Bank of England’s warning of economic instability ring true, expect new chancellor Philip Hammond to cut corporation tax in a desperate attempt to protect several UK companies from a tide of uncertainty. While such an environment won’t likely appeal to domestically-focused equity investors, bargain-hunting activists will be thrilled.

The perfect hunting ground

Shareholder Value Management wasted little time getting in on the action. Just days after the referendum the German outfit snagged a 7 per cent stake in John Menzies (MNZS), joining fellow activist Lakestreet Capital Partners in calling for the logistics group to demerge its newspaper and magazine distribution operation from its airport baggage and cargo handling business.

The Menzies family and their main ally, Dundee-based publisher DC Thomson, have yet to be persuaded, although a growing base of dissidents could soon force their hand. The fact that activists managed to oust interim chairman Dermot Jenkins, who was criticised for his close connections to the Menzies, suggests they’re on the right path to engineering change. The resignations of the chief executive and chief financial officer earlier in the year should also work in their favour.

Elliott Management has similarly been busy buying up stakes since the Brexit vote. Through its UK offshoot, the US hedge fund revealed positions in brewer SABMiller (SAB) and discount chain Poundland (PLND), both of which are in the process of being bought. Elliott has a history of squeezing out higher offers in agreed bids, having also taken a small stake in Premier Farnell (PFL) on the same day the electronics distributor agreed to sell-up to Dätwyler of Switzerland. Sometimes it spots takeover trends ahead of time, hence why its latest decision to take a 5 per cent interest in Meggitt (MGGT) sent shares in the aircraft parts maker surging.

Those familiar with Elliott will be aware that it tends to get the job done in a brutal fashion. Aside from forcing Argentina to default on its debts, the vehicle run by Paul Singer is more recently known on these shores for forcing a landmark victory against Alliance Trust (ATST). The UK’s biggest closed-end fund spent £3m on a failed campaign to defend itself against Elliott’s request to install three non-executive directors to the investment trust’s board. After a stand-off over pay and performance that culminated in the departure of the chairman and chief executive, it eventually scared the board into awarding it two precious board seats.

Harrowing tales

As these are the types of stories that make the headlines, investors can be forgiven for believing that activists are bullies armed with calculators obsessed only with short-term personal gain. The fact that executives across the companies we invest in rarely have positive words to say about them certainly feeds this stereotype – Stock Spirit's (STCK) recent comment that Western Gate is comparable to Donald Trump was splattered all over news outlets.

The encounter between the troubled vodka distiller and Portuguese tycoon Luis Amaral has been tainted by allegations of a conflict in interest. Western Gate has already been influential in pushing out chief executive Chris Health, blocking M&A activity in favour of a special dividend and gaining two non-executive director positions. Yet its frontman, Mr Amaral, also happens to be chief executive of the group’s largest customer, Eurocash.

Other examples include the vicious spat between Sherborne and private equity group Electra (ELTA), where publicity-shy New York activist Edward Bramson fought his way into the chief executive position. If you think that’s crazy, spare a thought for Petroceltic’s impoverished shareholders. Following a stuttering performance and two-year war between the oil explorer’s boss Brian O’Cathain and WorldView Capital, the Russian hedge fund eventually succeeded in buying Petroceltic outright for just 3p a share. This deal, which represented an 83 per cent discount to the previous trading session’s closing price, has been lambasted – analysts claim that WorldView snapped up roughly $1bn (£0.76bn) worth of assets for a fraction of the price.

Those familiar with how activist campaigns are conducted across the pond may not be surprised by these tales of bullying and shaming targets into submission. There, lengthy and costly battles over corporate strategy and governance appear to be a regular occurrence, particularly as most have no qualms about using the media to pressure targets.

Dan Loeb’s treatment of Sotheby (US:BID) chief executive William Ruprecht stands out as a classic example. After becoming the auction house’s largest shareholder, Mr Loeb, who has a fierce reputation for publicly humiliating chief executives, penned a letter that later appeared in the press pleading for Mr Ruprecht’s resignation. In it, he attacked the now former Sotheby boss’s lack of leadership and tendency to spend hundreds of thousands on luxury lunches. Mr Ruprecht responded by labelling him “scum”.

Activists deliver better returns on capital invested

On the face of it, negative publicity and multi-million-dollar litigation processes aren’t the best way to revitalise Sotheby’s fortunes. That said, it’s still too early to judge if these skirmishes will power the auction house to regain its crown from arch-rival Christie’s in the fine art market. Until then, investors can take comfort from recent research compiled by S&P Global Market Intelligence.

Between 2004 and 2015, the financial information and analytics specialist discovered that S&P 1500 companies displaying the highest combined degrees of activist ownership posted higher returns on invested capital and outperformed the broad stock market by “significant margins”. This revelation led it to conclude a “definite link” between the corporate efficiency measures encouraged by activists and share price outperformance for up to five years in the future.

Half a decade of success undermines the popular criticism that activists enforce quick fixes, such as cost-cutting, asset stripping or debt-funded share buybacks, to create short-term spikes in the valuations of target companies. Based on its findings, S&P Market Global Market Intelligence argues that stereotypes of the hit-and-run activist should perhaps be revisited.

“Activists often maintain positions in their target companies for many years after their holdings have subsequently slipped below the standard of significance established for this large data format investigation,” says the report. “In many cases, this can be interpreted as maintaining a smaller, less significant but still sizeable position in the company after the larger position successfully enacted the desired operational changes when the activist wielded maximum influence.”

In it for the long haul

Europe’s biggest activist hedge fund, Cevian Capital, is one of several names claiming to fit this profile. Rather than write sharp-tongued letters to chief executives, the Swedish investor aims to effect change by working with management and other influential parties in a low-profile fashion. But that’s just one point of view of the company. In its home country, co-founder Christer Gardell is known as a media whore and the “butcher” – a tag he earned from plotting to cut businesses, such as robotics industrial supplier ABB (VTX:ABBN) and carmaker Volvo (STO: VOLV-B) into pieces*.

What isn’t up for question is Cevian’s stellar track record of creating shareholder value on these shores. In addition to lobbying for the split of industrial materials conglomerate Cookson, and later reaping the benefits from the takeover of the sexier half of its spun-off creation Alent, Cevian was also largely responsible for Old Mutual's (OML) successful disposal of its Swedish life insurance operation Skandia.

Its other project, RSA Insurance (RSA) is similarly starting to profit from selling off non-core assets. While Zurich’s decision to withdraw its generous takeover offer remains a sore point, the Swedish outfit’s assisting of chief Steven Hester in his mandate to overhaul the insurer is at least starting to pay off.

Like Cevian, US activist hedge fund ValueAct comes with a reputation for masterminding positive change without making too much noise. Its successful and relatively tranquil spell at computer giant Microsoft (US:MSFT) further boosted its credentials, and explain why investors welcomed with open-arms its stake-building at Rolls-Royce (RR.).

Mirroring its strategy at Microsoft, ValueAct’s decision to take an 11 per cent position in the venerable engine maker was motivated by a series of sentiment damaging profit warnings and the arrival of a new chief executive. Various private meetings with the management team then ensued, until it finally achieved its goal of winning a seat on the board.

Rolls’ chairman conceded that this choice had been made after a “thorough vetting”, and in return for a promise that the activist investor will refrain from publicly lobbying for a break-up of the group’s aero business. Under the terms of the deal, ValueAct is also restricted from taking its stake either above 12.5 per cent or below 7.5 per cent.

The UK is a tougher nut to crack

Unlike in the US, where agreements of this ilk are common, Rolls' pact with ValueAct is believed to be the first of its kind on these shores. This revelation once again suggests that inviting activists onto boards is still a relatively new phenomenon in the Square Mile. Last year, just eight UK companies surrendered seats to these investors, versus 184 in the US.

One of the chief reasons behind this gulf in clout is different laws. Shareholders here are required to disclose holdings exceeding 3 per cent, rather than the more generous 5 per cent afforded to investors across the pond. Owning a smaller stake puts the activist under even greater pressure to win over mainstream shareholders, which is necessary if it’s to put forward a credible call for a special meeting.

Gaining allies isn’t as easy, either. Corporate culture here is more sedate than in the litigation-heavy United States, meaning that activist tactics of drumming up support through media briefings generally don’t attract as many sympathisers. The fact that institutional investors are more active in behind-the-door discussions with company bosses than their North American peers also makes them less inclined to call on outsiders for help.

These observations help to explain why nearly half of the battles on these shores ended in failure since the start of the decade. For example, while Sherborne may be best regarded as the hedge fund that had its way with Electra, many forget that it previously bought shares in the private equity group’s direct rival 3i (III), only to withdraw without comment.

Other abortive campaigns include Sandell Asset Management’s attempt to get FirstGroup (FGP) to sell its trans-American bus service and US school bus division, and National Express's (NEX) blocking of Elliott Advisors’ request for three board seats. The coach, bus and train operator stood firm against demands to sell or break-up the business, in a chain of events that ultimately prompted the hedge fund to dump its 17 per cent stake at a loss.

Crossing cultural boundaries

Elliott’s later dealings with Alliance Trust suggest that it subsequently learnt its lesson. There it tailored its campaign to be more UK friendly, employing a slightly gentler, less public tone built around scrutinising the company, rather than calling specifically for the chief executive’s head. After several years of constructing relationships with the main shareholders in this way, Elliott was granted its wish.

Still, not everyone is willing to cater to the cultural differences of a British audience, as recent media coverage of GlaxoSmithKline (GSK), John Menzies, Speedy Hire (SDY) and Stock Spirits appears to indicate. A sudden surge in American-style, finger-pointing aggression has led some to assume that British bosses will ultimately be forced to follow their US counterparts in striking deals, recognising that a failure to abide could result in further embarrassing confrontations.

Hilary Eastman, director of investor engagement at professional services network PwC, thinks otherwise. “It’s true that many US activist investors have begun to focus on UK companies as possible targets for current and future campaigns…and the fact that some UK activist investors are beginning to adopt the tactics more often seen in the US,” she says. “But to have a successful campaign, any style used needs to fit the culture and regulatory environment of the country in which they are engaging.”

“The differences in culture and the US litigation-heavy approach won’t (and probably shouldn’t) be adopted in the UK any time soon. In the UK, the recent launch of the Investor Forum and the Stewardship Code have encouraged investors to actively engage with the companies in which they own shares and build a better dialogue.

“This is part of a drive to encourage both companies and investors to take a longer view in decision making. Although adhering to the code, or joining the forum, is voluntary for institutional investors, early signs indicate that many are doing so.”

Can you profit from activism?

Activist voices can often be used as a positive force to wake-up underperforming executives and drive positive change in companies. Whether this is achieved by spinning off subsidiaries, using cash to buy back stock, or selling up to another public company, evidence shows that these opportunists often wield their influence to create long-term value.

But what sounds good in theory doesn’t always work in reality, as several of the less fruitful campaigns tend to suggest. Examples include taking up too much of management’s resources, triggering volatile price swings when unloading large blocks of shares and holding much different time horizons to the average buy-and-hold investor. Plus, let’s not forget that some don’t even make it that far, due to their inability to adapt to different cultures and lack of basic people skills.

For these reasons it’s not advisable to buy blindly into any business that has a significant activist presence on its share register. Do your homework on each individual hedge fund’s background to better establish whether it holds a successful track record, both at home and abroad.

Another important thing to consider is how the activist’s ethos match the company’s underlying situation. For example, a buyback may be a good option if the target is sitting on a lot of cash, but much less so if it’s saddled with debt.

*19 August 2016: The original version of this article stated that Cevian was also angling to dismantle security group G4S (GFS). However, Cevian reduced its holding in the company below 5 per cent in November 2014 and is no longer listed as a shareholder of the company. This statement has been removed.