The wolves of Wall Street are still around — but now they’re cloaking themselves as “activist investors.”
Gone are the days of phrases like “hostile takeovers” and “asset stripping.” Instead, agitators insist they are simply pushing to improve corporate governance and management — when in fact they actually want a fast return on their investment. Hedge funders like William Ackman of Pershing Square, James Mitarotonda of Barington Capital Group and Nelson Peltz of Trian Fund Management have become the Naughts equivalent of Henry Kravis, Carl Icahn (both still around) and Michael Milken.
And just as the go-go Eighties fueled the leveraged buyout boom, observers say the timing now is perfect for investor activism, especially in retail — just look at Abercrombie & Fitch and J.C. Penney Corp. Inc.
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“Right now activism has a strong hold because the economic factors are in their favor: available cash, low interest rates and strong feelings about corporate governance and corporate democracy,” said Ernest Brod, a managing director at Alvarez & Marsal, who heads up the firm’s business intelligence practice.
According to Kenneth T. Berliner, president at investment banking firm Peter J. Solomon Co., “The level of activism has been increasing significantly across all industries….Activism as a class of money is becoming mainstream. With activist hedge fund assets under management over $100 billion, they are no longer a little niche player in the money management community. In fact, most institutional investors have money invested with some activist somewhere.”
Berliner said any company that’s undervalued relative to its industry peers could be a target, since activists are looking for “situations where they can create immediate value.”
What constitutes value is debatable, and for every success story there’s one that didn’t end so well. And as in everything, there seems to be two approaches: the carrot or the stick.
The contrasting approaches were best seen in the battles at two specialty retailers: Abercrombie & Fitch and The Children’s Place.
Glenn Welling’s Engaged Capital, which touts a constructive approach, pushed for improved corporate practices at A&F and was ultimately successful when chief executive officer Michael Jeffries was stripped of his chairmanship in January 2014 in a nod to better corporate governance. Jeffries retired as ceo in December.
Then there was the tit-for-tat between The Children’s Place board and Barington Capital Group as well as Macellum Capital. In anticipation of a proxy fight (they later settled) each side filed investor presentations, but the retailer’s board also issued numerous press releases, pre-announced first-quarter earnings and shareholder letters repeating the same information to garner support for its own slate of board nominees.
What activist funds have discovered is that their power increases if they work in pairs. The current trend is for two or more activist hedge funds, each having smaller stakes, to join forces to push corporate boards (using public pressure) to their will.
These battles can be as dramatic and confrontational as the corporate raider days. And even when a company ups its corporate governance game and avoids a proxy fight, it may not be enough. Perry Ellis International Inc. last month, after some agitating from activist investors, provided a leadership succession plan to separate the chairman and ceo roles. George Feldenkreis holds both roles, but will step down as ceo in 2016. That quelled some of the activists’ issues, which included a withdrawal of a proposed group of board nominees after Perry Ellis added two new directors. But the activists aren’t giving up: They’re still pushing for a declassification of the existing board.
To be sure, some of the protagonists in activism have changed over time, but one thing hasn’t: They still look for undervalued companies. And it appears that agitation is just as profitable as ever.
Last year, Icahn called for the exploration of “strategic changes” at Family Dollar Stores, typically a euphemism for the sale of the company. In September, after the dollar store’s agreement to be acquired for $8.5 billion by its rival Dollar Tree Inc., Icahn was said to have made a $200 million profit after selling his stake, even though he had been pushing for a deal with another competitor, Dollar General Corp.
Then there is Ackman, a hedge fund manager of Pershing Square Capital whose fund reportedly posted a 40.2 percent gain in 2014 — earning him a whopping $1.1 billion in salary. Not shy about vocalizing his investment positions, Ackman consistently made headlines last year for his views on Herbalife and Allergan.
While those investment bets still have to play out, a black mark on Ackman’s record is his failed attempt to bring organizational change to Penney’s. That failure — the retailer lost $1.39 billion for the year ended Feb. 2, 2013; Ackman’s choice of ceo, Ron Johnson, was pushed out and succeeded by his predecessor Myron “Mike” Ullman 3rd, and Ackman is believed to have lost $475 million on his investment — is representative of what can go wrong when investor interests and management’s knowledge of an industry collide.
The key question is whether all this agitating is as good for the companies as it is for the activists’ paydays.
“Some companies need some pushing where their boards and management are insular, but I do not believe that most companies fall into this category,” said Andrew L. Sole, managing member of Esopus Creek Advisors LLC, the adviser to the hedge fund Esopus Creek Value Series Fund. “The real questions one must ask are ‘What is motivating the activist and is [his or her] agenda, one that truly benefits long-term shareholders? What are the inherent risks shareholders bear when they vote to support the financial alchemy proposed by an activist?”
Although Esopus isn’t an activist fund — it did take an activist position in Syms Corp. in 2009 — Sole isn’t exactly keen on activism. “Many of these activists simply use a rote playbook that push for stock buybacks funded by debt or by raiding the company’s available cash and this reduces the balance sheet liquidity. What if there’s a downturn? That new debt load will certainly limit a company’s options during a recession. And the activist? He will likely be long gone leaving the true long-term investors, such as pension funds and others, left holding the bag.”
Sole noted, “Activist firms gain attention when they run in and buy up a reportable stake and then send a nasty letter to the board demanding some type of ‘Rube Goldberg’ corporate re-engineering. Activism seems to be a sexy term today yet I would ask if this activity is about helping the long-term shareholders, or is it really about a strategy to elevate the activist’s profile for fund-raising purposes.”
Alvarez & Marsal’s Brod said that as activists have become more accepted, “sometimes they can be helpful to a company, and many boards have become smarter about how to react.”
Activist-turned-passive investor Robert Chapman of Chapman Capital, known for his acerbic criticisms of management in 13D filings, knows a thing or two about engaging public company boards. He doesn’t believe that corporate directors are better at working with activists for the supposed reason that they have a better understanding of their fiduciary responsibilities.
“It would be giving Corporate America far too little credit for IQ points and too much credit for integrity to ascribe higher receptivity to activists to a ‘better understanding.’ The fiduciary duties of due care, loyalty and good faith are simple, well-known and easily understood. Directors now just understand that they should fear the repercussions of shirking those duties,” Chapman said.