Shareholder Activism

The big trends in 2013 and what’s coming next

SCHULTE ROTH & ZABEL LLP

Schulte Roth & Zabel partners Marc Weingarten and David E. Rosewater, co-heads of the firm’s Shareholder Activism practice, on what they expect for 2014. Schulte Roth & Zabel’s Shareholder Activism practice was deeply involved in the industry in 2013, advising clients in a number of proxy contests. These are their observations from a busy year.

Rapid growth with many new entrants
By almost any measure, shareholder activism became more popular in 2013 than ever. With assets under management quickly growing and returns consistently outperforming the average hedge fund, the activist sector has seen an influx of new activist-oriented funds. As activist investors have appeared on the cover of Time magazine and filled the pages of Vanity Fair throughout the year, it is clear that investors and boards are not the only ones interested in learning more about shareholder activism.

Size is no longer a deterrent
A shareholder activist targeting a large-cap company with deep pockets used to be a one-off event that would dominate headlines for months. A few years ago, almost no one would have predicted that giants such as Apple, Procter & Gamble and Hess would become attractive targets for activists. Over the past year, however, such activist activity has become the norm rather than the exception. Today, almost one-third of shareholder activism takes place in companies with market capitalisations of more than $2 billion. While activists have long recognised that a greater variety of strategic alternatives are likely available for large companies, the persistent targeting of such companies has only been made possible by the influx of capital into activist funds over the past few years and the ever-increasing willingness of passive investors and institutional shareholders to side with the concerns of activists.

More majority slates
Activist campaigns seeking a majority of seats on a board have historically been, and continue to be, difficult to win. Incumbent boards have long argued that such campaigns are ploys by activists to gain control of the company without paying shareholders a control premium. This argument, however, appears to be losing ground with shareholders, as majority board campaigns in 2013 have garnered significant shareholder support in contests such as the ones between TPG-Axon and SandRidge Energy, or Clinton Group and Stillwater Mining Company.

Activists incentivise nominees
In proxy contests involving Hess and Agrium in 2013, activist shareholders offered their nominee slates compensation arrangements with payouts tied to the targeted company’s performance, launching an intense debate over the propriety of such arrangements. A number of boards have since adopted by-laws that purport to prohibit nominee compensation. In November, ISS entered the fray and recommended that shareholders withhold votes from directors at Provident Financial Holdings after the company adopted a by-law prohibiting such arrangements.

What lies ahead in 2014
Given the consistently high returns for the activist sector, one could expect the flow of capital into activist funds to continue to grow. More asset managers are likely to dip their toes into activism as portfolio managers who are value investors can unlock additional shareholder value – and increase returns – by serving as catalysts for their investment theses. Ultimately, it seems likely that 2013 will prove to be more akin to “the end of the beginning” of the first phase of an invigorated age of shareholder activism rather than just the peak of a brief trend.

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2013 IN REVIEW
While much activism is practiced out of the public eye, Activist Insight has observed an increase in public actions, whereby activists play a clear role in changing the strategy or governance of companies they have invested in. Public actions were launched at 237 companies in 2013, compared to 218 in 2012. As well as this measure of growth, there are also signs that activist campaigns are becoming more forensic, with an average of two actions per campaign in 2013, compared to 1.6 in 2012.

Activists maintained a relatively high level of success in 2013, achieving their objectives in 59% of resolved cases – a figure that rises to 78% when partially satisfied objectives are included. With 36% of campaigns ongoing – some 83 decisions waiting to be made at companies around the world – 2014 is already looking busy.

The year of the proxy battle
Increasing numbers of activists set out to prove themselves by winning proxy battles in 2013, with 67 activists seeking board representation, compared to 58 last year. In contrast to 2012, when only a third of efforts to gain board representation saw activists threaten a proxy contest, 46% of campaigns saw activists threaten or fight a proxy contest in 2013.

Asking companies politely may be the safer approach for activists, however, with negotiated board seats accounting for around 86% of all successful outcomes. ValueAct, which notably gained a board seat at Microsoft in the past year, is said to request references from companies it has targeted. Activists regularly say that expensive and time-consuming proxy battles are a “last resort,” and the evidence suggests this might be true. Of the campaigns tracked by Activist Insight, only 11 proxy fights went to a vote and saw the activist win, but 21 proxy contests were called off with a settlement – often one favourable to the activist.

Larger and better established activists mostly had less need for proxy contests in 2013, with Bulldog Investor’s Phil Goldstein telling Activist Insight it had become easier to gain board representation without a fight. Meanwhile, Carl Icahn added directors to the boards of six companies this year without a proxy fight. JANA Partners surprised observers by going all the way to a vote for the first time in its history, and though it failed to gain board seats at Canadian fertiliser giant, Agrium, sources said it was satisfied with the changes the company was forced to make to win over institutional shareholders.

Regional splits
US companies continued to account for 71% of all companies publicly targeted by activists in 2013, while European companies rose from 14% of the total to 19%. Canada, described as a ‘promised land’ foractivism, was consistent at around 6%. While the much anticipated growth in Japan has yet to be statistically significant, the optimism for activism outside of the US is growing.

Two high-profile campaigns
How-to and how-not-to-be an activist became the question every columnist sought to answer when referencing Bill Ackman’s abortive campaign at JC Penney. The Pershing Square CEO left the board after differences emerged over pricing strategies, and long-time foe Carl Icahn wasted no time in saying that Ackman had got too involved in the company’s day-to-day business. Ackman himself said the disastrous choice of Ron Johnson as CEO of the retailer was more of a collective decision by the board than he got credit for, but the sense that activists are more suited to discussing questions of capital allocation and governance than strategy will be hard to shake off.

Carl Icahn’s campaign to prevent Michael Dell from taking the technology company he founded in the 1980s private felt like it might never end. Indeed, we might be on the 150th rescheduled special meeting by now, had Dell not changed its by-laws to allow insider owners the right to vote on the leveraged buyout. Icahn wanted his alternative proposal voted on at the same time to reduce risk for shareholders, but the Delaware Chancery Court ruled that Dell’s voting standards were permissible. Despite saying he would seek appraisal, Icahn sold out shortly afterwards, leaving a group of shareholders including T. Rowe Price wondering whether the $13.75 per share deal was good value.

Popular tactics – a cash-rich climate
Winning board seats remained the most visible objective voiced by activists in 2013, with just under 30% of all publicly disclosed activist objectives concerned with gaining access to the inner sanctum. Traditional sources of value, such as spinning off subsidiaries – the kinds of campaigns seen at Timken, Ashland and most recently at Darden Restaurants – are also consistent features of the activist playbook. However, it is in cash-exploitation that activism has surged this year, with 13% of all activist campaigns seeking larger dividends or share repurchase programmes, compared to 8% last year. It is a trend Carl Icahn exemplifies especially well, with his repeated assertion that “Apple is not a bank” and his precatory proposal for a non-binding shareholder vote on a buyback worth around $50 billion.

Indications that the current M&A climate might be unfavourable are reflected in the drop in the number of companies activists say should be sold, an objective seen publicly only 26 times in 2013, compared to 47 times in 2012. In December, Clinton Group announced that it was exploring financing options for a takeover of Wet Seal, as the company’s results continued to drag. Most experts are expecting M&A to pick up in 2014, so this change could be short-lived. Given that 20 unique activists publicly called for the sale of a company in 2013, it remains a feature of activist investing.

The kinds of activism used in 2014 will likely be influenced by economic conditions, and particularly by a flight from bonds to equities. As a result, share buybacks and M&A could be pushed further up the agenda. However, as we make clear elsewhere in this review, governance changes will also be a staple of activist objectives.

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THE ACTIVIST TOP 10
For the first time in this review, Activist Insight looks at which activists created the biggest splash in 2013. Using our bespoke data, we have given each of these well known activists a ranking for categories such as the number of new investments in 2013, the average size of these investments, and the changes sought at companies during the year.

Finally, usingour unique “Follower Returns” feature, designed to enable investors to coat-tail activist plays, we track the performance of activist-targeted stocks in 2013, providing an aggregated annualised return for each activist. These returns should be treated as a guide only – actual performance figures are likely to cover slightly different periods and include fees, while calculations of individual stock performance do not take dividends into consideration.

1.
Few can doubt that 2013 was the year of septuagenarian investor, Carl Icahn. Whether in his prolonged battle to prevent the takeover of Dell, or an enviable investment in Netflix that more than quadrupled in value, Icahn has hit all the high notes in the past year. Most notable, perhaps, was a run of campaigns that saw Icahn’s nominees added to the boards of six companies. “There are lots of good CEOs in this country,” Icahn told Activist Insight, “but the management in many companies leaves a lot to be desired. What we do is bring accountability to these underperforming CEOs when we get elected to the boards.” As well as the usual run of TV interviews, 2013 also saw the launch of The Shareholder’s Square Table website, something that may continue to be a platform in 2014.

Icahn’s ability to make multi-billion-dollar investments from his own personal fortune contributed to a trend of activism at large-cap companies in 2013, with Apple and Transocean among those feeling the heat. According to Icahn, “The model we have works so well because there’s a need for it.” With Icahn insistent that activism is anything but a fad, there is little doubt that 2014 will be an equally busy year.

2.
ValueAct Capital, led by Jeff Ubben, Mason Morfit and George Hamel Jr, was relatively quiet in 2013, but surprised many when it emerged with a board seat at Microsoft. The activist owns less than 1% of the outstanding common shares, but is believed to be influencing the choice of a new CEO. Microsoft’s strong stock performance may justify this campaign, while Allison Transmission Holdings and Valero Energy have also performed strongly since ValueAct disclosed its investments in each company. Elsewhere, the activist received a sale premium from its investment in Gardner Denver. Despite its $2.6 billion investment in Microsoft, ValueAct amassed a portfolio of mostly small investments, typically below the 5% threshold for filing a Schedule 13D Form. These might form the basis for its portfolio in 2014, and lead to a number of new campaigns.

3.
Dan Loeb’s Third Point nearly didn’t survive the financial crisis, but has since roared back to health. Taking activism to Japan with his investment in Sony was a bold step, and perhaps required more courtesy than Loeb showed in October’s public letter to Sotheby’s CEO, Bill Ruprecht. Both campaigns are pending, with Sony opting to cut costs in its Entertainments Division rather than spin off the movie-making arm, and Sotheby’s yet to announce the personnel changes requested by Loeb. Elsewhere, healthy performance in Nokia and Yahoo! stocks boosted Third Point’s “Follower Returns,” making up for its relatively quiet season pushing for major changes.

4.
Greg Taxin’s Clinton Group doesn’t often make the headlines, owing to its preference for the small-cap space. However, the Group’s $1.5 billion in assets under management is widely spread, allowing it to disclose nine new investments and clock up the second-highest number of active campaigns, where it publicly pushed for change, in 2013. Indeed, Clinton Group was deeply involved in one of the year’s most difficult proxy contests, eventually winning a majority of seats on the board of Stillwater Mining. In general, the activist is known for its mastery of company by-laws and intense focus on growth strategies. As the year ended, Clinton Group was fighting for change at Violin Memory, Xenoport and ValueVision Media, as well as considering taking Wet Seal private. After seeing investments in Inteliquent and Digital Generation soar earlier in the year, it will be hoping to carry its good form into 2014.

5.
Starboard Value LP busied itself during 2013 with campaigns at OfficeDepot, where it successfully oversaw a merger with Office Max and won board representation, and at Smithfield Foods, where it failed to prevent a takeover bid from Chinese pork-producer, Shanghui. A busy year apparently made for healthy profits, with Starboard Value’s “Follower Returns” showing healthy growth across a number of the stocks the activist invested in. Starboard Value also won board representation at DSP Group and Wausau Paper during 2013, while disclosing 10 new investments. A particularly busy final quarter saw Jeff Smith’s fund launch campaigns to overhaul Compuware, Calgon Carbon and Darden Restaurants, as well as plans for a proxy contest at TriQuint Semiconductor, so 2014 is likely to be equally eventful.

6.
Paul Singer’s Elliott Management has become one of the world’s global activists, taking advantage of protections for minority shareholders in takeover situations with several campaigns in Germany during 2013. In the US, Elliott was also busy at Emulex, striking a deal that won board seats and secured a share repurchase programme, in return for giving up its campaign to force a sale of the company, and at Hess, where controversy over the activist’s plans to pay its board nominees kick-started an industry-wide debate about anti-activist company by-laws.

The activist’s extensive assets under management allowed it to make three bets worth more than $1 billion in 2013, but its relatively concentrated activities and preference for privacy contributed to a slightly lower-than-expected ranking in our top 10.

7.
JANA Partners, the hedge fund led by Barry Rosenstein, had a successful year despite a number of tough boardroom battles, with a source telling Activist Insight that the fund was happy when companies took credit for the activist’s suggestions. That was the pattern in a number of cases, including Ashland, QEP Resources and Safeway, which all sold or hived off business divisions. A proxy contest at Agrium marked the first time that JANA had ever gone all the way to a shareholder vote, where its nominees were defeated (though the activist can point to a number of changes announced by the issuer that JANA called for initially).

One issue that forced JANA to take a public
stand was criticism of activists remunerating
board nominees. The activist says that company by-laws preventing activists from paying their nominees makes it harder to find good candidates and has made clear its intention to oppose the
new changes.

8.
There was little new action for Mario Gabelli’s GAMCO Asset Management in 2013, with relatively few new investments above the reporting threshold. However, the activist investor scored high for the number of changes it sought and achieved in 2013 and for the successful track record of those stocks. GAMCO is known for its focus on corporate governance and has tried to remove several poison pills in the past year, albeit with limited success to date.

The run-up to 2014’s proxy season suggests
next year will be equally busy, with proxy
contests likely at Sevcon and Telephone & Data Systems, and public letters recently sent to the boards of Griffin Land & Nurseries and Superior Industries International.

9.
Very little seemed to go right for Bill Ackman’s Pershing Square Capital Management in 2013, although stock price increases from several successful engagements the year before were perhaps the activist’s saving grace. Ackman’s disastrous effort to turn around JC Penney along with his public disagreement with everyone from Carl Icahn and Dan Loeb to George Soros over his Herbalife short caused the activist’s “Follower Returns” to be significantly lower than in previous years. Even so, Ackman hasn’t been hiding away. Following a $2.2 billion investment in Air Products and Chemicals, Ackman promised, “to go to the ends of the earth” to prove his detractors wrong on Herbalife. Pershing Square has also bet $435 million on the recovery of Freddie Mac and Fannie Mae, for reasons yet to be fully explained, and can still cash in its winnings from what was a successful campaign at Canadian Pacific Railway last year.

10.
Led by Phil Goldstein and Steven Samuels, Bulldog Investors has long specialised in antagonising closed-end funds. In a conversation with Activist Insight, Goldstein admitted that despite it becoming easier for the firm to secure the changes it wants because it has gained in credibility and bargaining skills, 2013 was a good time to launch proxy contests at Firsthand Technology Value Fund and Javelin Mortgage Investment. At the year’s end, Bulldog had already settled the latter fight, accepting an enhanced share repurchase programme as a compromise. Despite its investments being mostly on the small side, the breadth of Bulldog’s portfolio and frequent successes earn the activist a place in our Top 10.

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RIDING A RISING TIDE
An interview with Marc Weingarten and David E. Rosewater of Schulte Roth & Zabel LLP

Schulte Roth & Zabel has built one of the busiest and most high-profile shareholder activism practices in the legal world. Activist Insight interviews partners Marc Weingarten and David E. Rosewater on their experience of activism.

One of the themes of this review has been that, while activist investing has gathered pace over a number of years, the services industry supporting activists has, at times, lagged behind the growth in defense services. In some industries, including the legal profession, representing activists has been a stigma to be avoided, especially as it was likely to cost firms corporate clients. A couple of law firms have bucked that trend, however, with Schulte Roth & Zabel perhaps the most prominent. The firm’s Shareholder Activism practice, started by Marc Weingarten in the mid-2000s, was a natural extension of its hedge fund practice and a raft of personal contacts. Weingarten says he learned the craft working for Asher Adelman in the 1980s. “One of Adelman’s right-hand guys at the time was Barry Rosenstein [who went on to found activist hedge fund JANA Partners], and we’d worked with Icahn on occasions,” says Weingarten. “So when shareholder activism came to the fore just before the crash, I knew a lot of people and it made sense to get into this area.”

David E. Rosewater, who made partner at Schulte Roth & Zabel in 2004, started working with Weingarten around this time. Having worked on big campaigns such as CNET, CSX, Sandridge Energy and Stillwater Mining Company, he is now regularly referred to as a rising star in the activism field. However, the first few years of the practice did not see a consistent growth in activism. Says Rosewater, “Activism started to grow in 2006/7, and hasn’t necessarily grown year-on-year straight through. As with many other strategies, it was set back a bit by the crisis because it’s an illiquid strategy and when there were redemption issues it caused issues for funds that did activism. The illiquidity of it created redemption issues during the 2008 financial crisis.”

A sea-change
A couple of years later, activist activity began to increase, and money began to flow into activist funds in search of uncorrelated returns. Absent an economic rebound, activism has been attracting a growing amount of attention. As Weingarten says, “Institutional investors have so much under management they basically own the market. Activism is another avenue to create value – they already own all the stocks, so instead of shifting their money between stocks, they are now happy to support activists to create value in a stock.”

Another important change was the crackdown on insider trading. Before Regulation FD was introduced in 2000 to address selective disclosure, institutional shareholders had an advantage to be gained from currying favour with management. Now, all shareholders have the same information, and the likes of Blackrock and Vanguard are no longer tied to company boards.

The result has been a sea-change in the perception of shareholder activism. Rosewater says, “Institutional, or passive shareholders as you’ve called them, are increasingly willing to support shareholders and in some cases not-so-passively. There are cases in which institutions are willing to provide capital to an activist and there are examples of institutions seeking out an activist to act on a particular situation where the institution isn’t capable or prepared to act itself.” Does that mean institutional shareholders might approach Schulte Roth & Zabel’s Shareholder Activism practice in search of an activist with management-busting expertise? “That could happen.”

A bigger tide
Since 2010, activism has grown in volume and in the size and notoriety of its targets. Schulte Roth & Zabel’s clients range from massive, global investors like JANA Partners, Elliott Management and The Children’s Investment Fund (TCI), to smaller US players like Clinton Group and Sandell Asset Management. Weingarten and Rosewater have taken on the likes of McDonalds, Time Warner and CNET on behalf of Pershing Square Capital Management, SAC Capital and JANA Partners, respectively. This year, they have been involved in campaigns at SandRidge Energy, with its constant to-and-fro of litigation threats, and Stillwater Mining Company, where Clinton Group won four board seats and replaced both CEO and chairman.

The increasing size of activist targets presents its own problems. Proxy circulars need to be mailed to a larger shareholder base, boards tend to have more experience and larger treasuries with which to defend themselves. It is a trend that requires greater support from institutional shareholders, and wouldn’t be possible without the increasing sums they are willing to put behind activists. Defense teams have spent much of the year coming up with new tactics to fight off activists. The result is that activists increasingly engage legal counsel before even buying a stake in a company. Weingarten says that some company by-laws make it difficult to achieve anything except at an annual meeting, while companies with dual class equity splits and large insider ownership are “pretty impregnable.”

The proxy fight remains the most important weapon in an activist’s arsenal, with board seats representing the most common single demand of activist investors. In 2013, a number of consent solicitations suggested that activists might not have to wait for annual meeting season to achieve change, with Glenview Asset Management, Corvex Management and Sandell Asset Management all seeking to oust boards by petition. Rosewater says these are unlikely to be replacements for the traditional proxy fight, noting that they are occasionally useful tools but can be removed from company charters – and frequently are. “Secondly, when you’re voting at a meeting, abstentions don’t count. Someone who doesn’t show up at a meeting is irrelevant. Someone who doesn’t show up at a consent solicitation is voting against, for all practical purposes.”

In 2014, Schulte Roth & Zabel plans to expand its Shareholder Activism practice into Europe through its London office. Weingarten says the firm is looking forward to a boom in activism, noting that, “Many people have been predicting it is going to move into Europe in a more significant way than it has.” He adds that this will be a challenge, but not an entirely new departure. “The laws are not as favourable [to activists] in many ways, so it’s going to be difficult. However, as Europe comes out of recession, there’s going to be lots of value that activists can seek out. TCI, Cevian Capital, and some US activists such as Sandell Asset Management are now branching out there.”

This article was composed of extracts from the Activist Insight Activist Investing Review 2014 in association with Schulte Roth & Zabel LLP.