In the paper Activism and Empire Building, US academics Nickolay Gantchev (Southern Methodist University), Merih Sevilir (Indiana University) and Anil Shivdasani (University of North Carolina at Chapel Hill) found public companies made better choices when an activist investor was looking over management’s shoulder, and saw "substantially higher abnormal returns".
Some assertions they make may go over the top, handing hedge funds such as Elliott Management full credit for pushing companies away from bad decisions, but the detailed paper looked at company performance from 1995 to 2011 and found links between outperformance and activist investors holding stakes in companies.
The importance of this research is backed up by Lazard’s most recent activist intervention numbers – the bank said there had been a record number of interventions at $500m-plus (£392m) market capitalised companies in 2018, with 226 targeted compared with 188 in 2017, and $65bn spent on buying stakes. A record 40 companies also tried their hand at activist investing for the first time in 2018. While the US hedge funds still dominate this field, they are increasingly crossing the pond: Lazard said there were 58 European campaigns in 2018, a 12 per cent increase year on year and a 107 per cent jump on 2013.
Gantchev, Sevilir and Shivdasani say companies bring on activist investor interest themselves: “By our estimates, firms announcing a large stock-financed deal over the past three years are about 40 per cent more likely to become an activist target”, and firms whose acquisition announcements are met with a shrug by markets even more so. No connection was found between cash deals and an increased probability of activism.
The researchers do not give company examples, but looked at 242 activist hedge funds between 1995 and 2011 that took a more than 5 per cent share of a public company, topping the filing data up with SharkRepellent.net information on sub-5 per cent stakes.
Data firm Dealogic has said the proportion of all-stock deals to cash tie-ups has fallen from about 20 per cent in the early 2000s to 10 per cent in 2017. However, there are plenty of other drivers for activism, as illustrated by last year's campaigns against Premier Foods (PFD) and Whitbread (WTB) by Oasis and Elliott respectively. Oasis and fellow activist Paulson & Co decided Premier’s chief executive had to go and Elliott saw gains from Whitbread splitting its main revenue drivers, Costa and Premier Inn. The food firm’s chief executive left at the end of January and Whitbread sold Costa and handed £2.5bn back to investors from the £3.9bn coffee chain sale.
Once the interest from an activist investor is there, on average, shareholders should be pleased, the paper says. Targeted companies make fewer deals, and when they do they are smaller, cash-driven and better for returns and the share price. “Post-activism, returns for acquisition announcements are significantly higher for targets than for non-targets, and we observe a similar pattern for returns over longer intervals of one or two years,” the Activism and Empire Building authors said. The frequency of acquisitions post-activist intervention is also lower than companies that don’t get the Elliott and Co treatment.
This all sounds very positive – if you’ve bought into a company that is determined to lose your money through M&A, the arrival of an activist investor could turn things around. But, as with most things in life, not everyone agrees. Another group of US business academics say activist investors have little impact on returns. Ed deHaan from the University of Washington, David F Larcker from Stanford University and Charles McClure from Chicago University came to the opposite conclusion as the Activism authors in a working paper from December 2018: “Our results do not strongly support the hypothesis that activist interventions drive long-term benefits for the typical shareholder, nor do we find evidence of shareholder harm”. Readers will note the ‘long-term’ here.
Whitbread’s performance could be seen as a case in point. The shares climbed aggressively off the back of the Costa sale announcements in April and August last year, but have more recently begun to weaken as its remaining hotels business has reported soft trading. Premier did very well in the days after Oasis said it would not back Gavin Darby’s re-election to the board, its share price climbing 27 per cent to 47p. But gains were mostly reversed after Mr Darby survived a challenge in mid-July, and the jump when he did stand down at the end of January did not match this high.
The other side
The deHaan, Larcker and McClure working paper, called Long-term economic consequences of hedge fund activist interventions, opens with the idea previous studies focused on average company returns do not give enough weighting to how the average investor fares after activist interventions. The idea is the average investor is far more likely to hold shares in larger market capitalised companies, but the long-term positive returns largely come from small caps. Helpfully, these three researchers looked at transactions between 1994 and 2011, covering the same period as the other group.
“Similar to prior research, we find that short-term equal-weighted mean returns are significantly positive at 5.4 per cent, and the cumulative pre- to post-activism equal-weighted mean one-year and two-year returns are significantly positive at 6.8 per cent and 5.9 per cent. However, examining returns by size decile shows that the positive equal-weighted long-term returns are primarily driven by the smallest 20 per cent of targets, with an average market value of just $22 million,” the Long-term economic consequences authors said.
“Equal-weighted average returns for the larger 80 per cent of targets are initially positive but become insignificant within three months of activism and become an insignificantly negative -1.6 per cent at the end of two years.”
From the investment side, Fundsmith chief executive Terry Smith has been a high-profile critic of the activist playbook, saying it leaves long-term holders of targeted companies worse off. In his January 2018 investor letter he laid out one part of his opposition: “Leveraging up the balance sheet to buy back stock is a frequent demand of activists and is invariably described as ‘returning cash to shareholders’ and not only when it is suggested by activists... those of us who actually seek to own the company and remain shareholders see debt raised to take shareholders who wish to exit”. Smith also said activists often held stakes in companies through derivative products rather than actual share holdings, giving them a hard exit date on the stake.
The Fundsmith chief executive said companies agreeing to activist demands also raised questions, using Nestlé (SWI:NESN) as an example. “On the whole we are not impressed when a company announces new margin targets, share buybacks and acquisitions and/or disposals in response to activists or takeover approaches,” he said, the question being if these tactics were necessary, and if so, why were they not already being done.
Dan Loeb’s Third Point has made several rounds of public calls for improvement at Swiss-listed Nestlé. The company’s share price fell 2 per cent between Third Point taking the initial stake and its major intervention in mid-2018, calling for more buybacks and quicker change in what it saw as a bureaucracy-heavy management structure, as well as selling down the major stake in L’Oreal. The massive food company has kept its 23 per cent L’Oreal stake, worth around $24bn, but is selling its $10bn skincare business. In the past 12 months, Nestlé’s share price has climbed 30 per cent.
If there is a good case for activist intervention and a sensible objective, other shareholders can reap rapid rewards. But the evidence suggests a good long-term outcome is by no means a given.