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The Activist Effect

Neil Wilson highlights how activist investors can be a force for good, and picks out UK companies that are likely to be in their sights
The Activist Effect

A shareholder spring is one of those regular investing tropes that get wheeled out each year like ‘sell in May and go away’, the ‘Santa rally’, and how you can never get hold of your broker when the Test Match is on.

It’s usually mentioned around the peak of the season for annual meetings. An annual appraisal of companies and their management, annual meetings are the chance for shareholders to voice their opinions and even vote down decisions. Usually nothing much occurs – there’s the odd minor revolt over executive pay, but it rarely amounts to much.

But now we are in the midst of a developing trend in European and UK equities that goes a stage further: shareholder activism. 

Like all US imports, activist investors can be good, but not always. Lately we’ve seen a lot of talk of activist investors throwing their weight around boardrooms, calling for shake-ups and even forcing companies to sell their crown jewels for a fast buck. News that an activist has built a chunky stake in a company can boost shares, but they are far from guaranteed to succeed in their aims.

Activist investors take many forms, and all are not alike. Activists can clearly have a positive role to play; they can help keep management honest and they tend to help balance sheet discipline. Of course, you also get the sharks just looking for a quick profit. It all depends. Some activists just want to leverage a few assets a bit better, or fancy a seat on the board. But some want wholesale change.

 

Activism is growing

Shareholder activism is on the march across Europe, but the UK is the single largest hunting ground for activists, according to consultancy Alvarez & Marsal (A&M). Its latest semi-annual report looking at activism in European companies identifies 150 individual targets, suggesting the practice is on the rise. The UK accounts for 35 per cent of the targets, although they made up only 25 per cent of the companies in the report.

A weaker pound, underperformance by UK equities versus US peers and rules that tend to stackthe odds in favour of shareholders are all reasons why activists are interested in UK companies. Brexit has clearly created opportunities and may well continue to do so.

A&M says: “We see Brexit as creating more opportunities for activists over the next 18 months or so. It is also clear that any further weakness in sterling will increase the attraction of UK-focused corporates to foreign buyers.”

The regulatory landscape is also key. It takes just 10 per cent of shareholders to call for an extraordinary general meeting. Compared with Europe, the UK is also more closely aligned to the US, where activism has flourished and from where many of the activists hail.

With 52 companies in the UK facing an “imminent threat of activism”, according to A&M, it’s time to look at what that could mean, and which well-known stocks might be in the firing line.

 

Good or bad?

As soon as it was known that arch activist Elliott Management had built up a 6 per cent stake in Whitbread (WTE), it seemed only a matter of time before something big happened. In a textbook example of targeted activism, within just a few months the board of the old brewer-cum-hotelier had agreed to sell its prized Costa Coffee business to Coca-Cola, in a deal worth £3.9bn. The bulk of that cash, needless to say, is being returned to shareholders. Elliott – and the other shareholders – are quids in on the deal. 

While one may accuse Elliott of stripping Whitbread of the family silver, most agree it was a good price to get, that growth was starting to plateau, and that the new owners will be in a better position to boost Costa sales going forward. The sale not only allows for bumper capital returns, but generates cash for investing in the hotel business; in particular, its nascent thrust into the vast but relatively immature German market. 

The gist of the argument goes: The hotel market in Germany is a highly attractive opportunity as: it’s) 35 per cent larger than the UK; b) the budget branded sector has just 6 per cent market share versus 24 per cent in the UK; c) the market is very fragmented; d) there is no market leader; and e) Germany is bigger and industry is spread out across the country meaning business people need to travel more. 

So you’d think that with the sale of Costa and a clear strategy to drive growth in Germany, Elliott would be happy. But you’d be wrong – the investor is keeping up the pressure, and is now reportedly pushing for Whitbread to offload parts of its large property portfolio. The optics of that approach are less encouraging – similarities with private equity style asset-stripping spring to mind. 

To be fair to Elliott, the New York hedge fund established by Paul Singer, it’s also said to be calling on the company to boost its board with people with experience in European hotels. 

And where one succeeds, another fails. Barclays (BARC) has just seen off Edward Bramson, the activist who built up a sizeable stake in the bank on borrowed money. He wants Barclays to exit investment banking. 

Despite failing to gain a board seat, there is a risk of destabilisation still. For now, Jes Staley is in charge, but if he can’t hit targets – the bank’s return on tangible equity (ROTE) number being the key – then there will be pressure to come on the chief executive. Mr Bramson was sent packing and garnered the support of just 6 per cent of other shareholders, but he is not going away entirely. If Mr Staley cannot achieve his ROTE target, expect the activist to find more supporters.

But when you borrow the money to gain your stake – Mr Bramson is on the hook to Bank of America to the tune of $1.4bn (£1.07bn) – one’s motivation is questionable. When you also hedge that stake, other investors would be right in wondering just what his ‘stake’ in Barclays is really worth. Moreover, the strategy proposed is not entirely watertight – investment banking may not be what it used to be, but someone has to do it. With Deutsche Bank beating a retreat, there’s only really Barclays left to counter the US banks.

 

Targets?

As Malcolm McKenzie from A&M points out, all sectors are potentially attractive to activists, although he notes that conglomerates are particularly “on notice” as calls for break-ups remain “a key activist tactic”. 

Associated British Foods (ABF) faces repeated calls to spin off Primark, its high-growth fashion arm that seems completely at odds with staples such as tea and sugar. Primark sits rather uneasily within the ABF group, rather like Costa started to do within Whitbread. However, the Weston family’s grip on the company would appear to make any approach by an activist unlikely to succeed – for now. The research from A&M suggests that activist focus on family-dominated corporates is increasing, pointing to the approach made to Pernod Ricard by our old friend Elliott. They say this case indicates the existence of major voting blocs is likely to be less of a deterrent in future.

Kingfisher (KGF) may not exactly be a conglomerate, but it is a company that is ripe for break-up. With chief executive Veronique Laury saying au revoir in the middle of her turnaround, investors are rightly questioning whether the ‘ONE Kingfisher’  transformation plan makes any sense at all, or indeed if there should be one single Kingfisher. 

The joint sourcing approach was suspect from the start. Fixtures and fittings in Poland and Germany are not necessarily the same as those needed in France or the UK. Unification of the supply chain was the cornerstone of the Kingfisher turnaround strategy, but has not delivered on its promise.

There has been talk abut spinning off the high-growth Screwfix business from the mothership. But in fact a divestment of the troubled French business could also be considered. Kingfisher also has a multibillion-pound property portfolio it could look to offload. A complete break-up of the business is a possibility. An activist here could find easy pickings. The shares, which had been languishing around decade lows in January, have recovered ground this year, but investors would be right in thinking there is more value to unlock.

Dixons Carphone’s (DC.) shares have endured a torrid time. With precious little evidence that things are turning around in its core market, the company could become a target. In January, reports were surfacing that Elliott was circling, with the group taking a detailed look at Dixons Carphone’s finances.

There is certainly room for the company to unlock value for shareholders. Store closures would be a start. Management has already announced that around 100 Carphone Warehouse standalone formats will close in a bid to boost margins in the struggling mobile division. Given the circa 700-plus Carphone standalones in a total store estate of more than 1,000, there is ample opportunity to rationalise the Carphone estate further and improve profitability in mobile while still retaining a dominant market position. Dixons may also shed its Nordic and Greek arms to refocus on its core domestic business in the UK.

Just Eat (JE.), we know, is in the crosshairs of Cat Rock, which wants it to exit certain “non-core” businesses and consider a merger with Takeaway.com, in which incidentally it also owns a stake.

Cat Rock may have a point when it says some of the foreign ventures are a “distraction and an inefficient use of shareholder capital”. Investment in Latin America via its 33 per cent stake in iFood is proving especially costly. Selling this could generate as much as £650m.

For sure, Just Eat is at a big crossroads and costs are mounting without it necessarily getting the returns in terms of growth. In fact, the pace of growth is slowing, which combined with making bigger investments for future growth, is not a good place to be. 

Questions remain over the strategy and whether the company needs to merge to protect its market position, whether the next chief executive will have the expertise to drive growth in a tough and increasingly competitive sector, and where the current strategy, focused on sales growth over profits, will take the company. 

Global expansion and fighting off fierce competition is coming at a cost – Uber Eats and Deliveroo are expanding quickly in foreign markets, which are not that easy to penetrate. It is becoming difficult to manage growth and build scale without eroding margins. Heavy investment in its own delivery network may not be the right option, but management is sticking to its guns and will invest more heavily in delivery, while racing to boost market share, at the expense of profits. 

Others that could easily become activist targets include the likes of Domino’s Pizza (DOM), which has lately posted another warning on its international business. UK growth remains solid, but arguments with franchisees will weigh on growth prospects as it will impact the store rollouts in the UK and Ireland. 

There is also more competition than before, particularly from Uber Eats and Deliveroo. Nevertheless, Domino’s seems to be holding on to market share in the UK and the app is proving very sticky with customers. The case for shedding its international business to refocus on the UK makes sense from an investor point of view. Management, however, would take some persuading.

And wherever there are doubts about the dividend, combined with a weak share price performance, we may well see investor activism take hold. On that front, any of Vodafone (VOD), Centrica (CNA) or BT (BT.A) could be ripe for an approach.