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March 8, 2019

Close to 14 percent of the 3,500 publicly-traded companies in the U.S. were targeted by activist investors in 2018, according to research by Activist Insight and the law firm Schulte Roth & Zabel. As the so-called ‘proxy season’ begins, the companies with an activist on their shareholder register, as well as those that are vulnerable to an activist approach, should be ready to explain to investors how they plan to improve returns.

Spring is traditionally the time of year when companies start sending out statements to shareholders on the issues to be discussed and voted on at the annual shareholder meeting in late summer or fall. Shareholders can vote directly or have the board vote on their behalf as their proxy (hence the name proxy season).

Current high-profile activist campaigns demonstrate the breadth of issues companies are being challenged on: eBay has agreed to add two board members and carry out a strategic review of the business after activist hedge funds Elliott and Starboard pushed for the company to sell-off divisions; casino operator Caesars is replacing three board members with nominees chosen by the activist Carl Icahn, who has recommended a sale or merger of the whole business; Starboard has also nominated five potential directors to the board of Bristol-Myers Squibb, citing underperformance and calling for the drug company to drop its proposed $74 billion merger with Celgene.

Proxy season is expanding both as the number of activist campaigns increases, and as some target companies seek to push their annual meetings later and later in the year to avoid putting an activist’s requests to the vote, says Nate Dwyer, Managing Director at Alvarez & Marsal’s (A&M) Corporate Transformation Services in San Francisco.  “Whereas previously companies could get away with severe underperformance, now there are too many activist funds to allow that happen,” he says. “Activists are doing what they’re meant to do, which means more campaigns. There’s also an increase in activists willing to go to court to get companies to stick to reasonable timeframes.”

Proactively addressing the issues that mobilize activists is the most effective way to stave off an activist approach in the first place, says Jim O’Donnell, Senior Director at A&M’s Corporate Transformation Services.

“For underperfoming companies, 85 percent of the problems will be in three to five areas. If you can get those turned around, then the management team and the board will be the ones achieving success and taking the victory lap. If an activist investor is present, then they benefit by the stock price going up because the management team has shown they can turn the company around,” O’Donnell says.

When working with companies seeking to transform their operations in this way, A&M uses a multi-factor model to identify where the company is underperforming in comparison to its peers, highlighting areas for rapid improvement. The A&M model takes into account total shareholder return, valuation, profitability, growth rates, capital deployment and risk, looking at three or four variables in each category. The model also helps management teams understand how an activist looks at the company’s weaknesses, real or perceived.

“If you’re seeing a poor return on invested capital and you’re seeing higher risk in the stock price through volatility, these factors start to light up an activist’s radar,” says O’Donnell. “These are indicators of a management team not doing well. Activists are value investors by their nature, and they are looking for opportunities to unlock value by exerting some influence inside the boardroom.”

As the number of activist funds grows and campaigns become more high-profile, boards and management teams are taking activists’ views seriously. The number of settlements made by companies on activists’ requests for board seats increased to 142 last year, up from 119 in 2017, according to the research by Activist Insight and Schulte Roth & Zabel. As well as avoiding lengthy and costly proxy fights, bringing in an outside point of view can improve the independence and rigor of the board, adds O’Donnell.

Whether a company chooses to adopt the changes proposed by an activist investor or set out its own strategy for improving returns, addressing shareholder concerns over performance is non-negotiable, says Dwyer. “Thinking this will work itself out  - that the activist will go away and lose interest - is foolish; if the company carries on underperfoming, it’s only going to strengthen the activist’s case, says Mr. Dwyer.”

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