How To Make Peace With The Shareholder Activist Movement
Shareholder activists have been portrayed as modern-day pirates, forcing loyal board members and management to walk the plank while they plunder vulnerable companies. It’s time to dispel that myth, starting with the primary differentiator. The rogues of yore took treasures that didn’t belong to them; today’s activist investors want to enhance the value of an asset they already own for mutual financial benefit.
If you sit on a board or report to one, you may find this perspective challenging. I, too, spent years serving on boards — Unilever, General Mills, The St. Paul Companies and Apple among them. In addition, I have been a C-suite executive for Northwest Airlines, General Mills and Unilever. I also advised management and directors as a consultant with firms like Bain & Company and my own enterprise, The LEK Partnership. While I don’t agree with all activists’ actions, in general, I view this phenomenon as the continuation of a positive trend. My journey, in many respects, reflects a sea change in the corporate mindset, which is approaching the tipping point between resistance and acceptance.
In the United States, for many years, there has been mounting concern for the interests of the true owners of a corporation — the shareholders — and a diminished focus on the security and legacy of company and its agents. And, if you consider the notion of a shareholder activist, it makes sense that someone with a stake in your business should have a voice.
From a macro perspective, as a capitalist, I want to see the U.S. economy progress. For that to happen, our resources must be used productively and efficiently. I believe shareholder activism helps improve the economy through the free market.
While change feels uncomfortable, it can produce positive results. Just as the appearance of minorities and women on boards was once opposed, we are now entering a new era with more activists taking seats at the table. It is vital to prepare for and embrace this development. Let’s take a look at why this is happening, the advantages it delivers, why your company may become a target and ways to respond before the perceived sword of “Blackbeard” scratches at your boardroom door.
Roots of Activism
Shareholder activists are defined as investors with an equity stake in a publicly traded company who use that leverage to influence or demand strategy and/or management changes to enhance its value. If we consider history and jump across the pond, we would see the roots of today’s U.S. activist movement first flourished in Great Britain. Investors there have long been vocal, sparking robust dialog with companies about compensation, deployment of capital and more.
American tradition has been different. Shareholders dissatisfied with management simply “got out,” selling their shares. However, this process does not fuel the economy. In addition, if a shareholder’s hunches were correct, there was no mechanism in place to redirect the company. Management was allowed to continue negative practices, other investors followed suit and the stock price dropped. Generally, value didn’t instantly plummet; it drifted down. This gentle slide promoted complacency, unless a buyer was sitting in the wings prepared to purchase the entire company. For large corporations, it was unlikely that anyone would have such resources, and even medium-sized or small companies were somewhat immune from this outcome. But today’s activists don’t need a lot of financial firepower — they just need an equity stake and the gumption to make their views known.
The Rubber Stamp Stops Here
As a result, activism changes boardroom dynamics and expectations, enabling shareholders to exercise their ownership rights. We should never forget that management operates as an agent of shareholders and the board of directors is constituted to act on their behalf. Activists believe if a board only adopts strategies recommended by management, or has not sufficiently monitored decisions to ensure optimal performance, investors should voice their opinions directly to the board. If they are unable to persuade directors to adopt their point of view, they should present their perspectives to other shareholders. Because these intercessors can act at any time, business now operates differently.
If you look at activists’ motivation in its most naked form, their mission is to make money. This is a desirable outcome in our capitalist society. Profitable businesses benefit shareholders, the company itself, the organization’s employees, the communities in which they operate and their affiliated industries. Collectively, this process stimulates the economy. It’s what we call “the free market.”
Activist investors are constantly surveying the landscape to identify companies that are not employing optimal strategies. Because they don’t possess inside knowledge, management missteps must be observable externally — and be reflected in the price of stock. In addition, activists must have an alternative strategy that they believe will have a positive impact on the company’s financial performance.
For this to affect the greater economy, to some degree, the concept of “herd immunity” is at work. On a farm, if a significant number of cattle are vaccinated, the unimmunized few won’t catch an illness because the herd at large is protected. The exploits of activist investors operate in a similar fashion. By forcing a handful of companies to do the “right” thing, awareness spreads throughout boardrooms, building protective shields of preventive behavior. The entire system benefits.
Crossing into a New World
My own adventure into the realm of shareholder activism is punctuated by one very public event with ConAgra Foods Inc. In 2015, I teamed up with Jana Partners, which specializes in event-driven investing. They approached me about an opportunity that truly captured my attention. Two years prior, in 2013, ConAgra had completed its acquisition of Ralcorp Holdings Inc., a leading supplier of private label packaged food in North America. Over the next 19 months after the deal closed, “ConAgra shares slipped 0.3 percent, while every other food-products company in the S&P 500 advanced at least 10 percent,” according to data compiled by Bloomberg. The Ralcorp purchase was clearly a misstep and Jana wanted to do something about it.
The investment firm and I discussed their thesis about what ConAgra had done wrong, what the board should do to redirect the company and the potential value of stock if they acted on the recommended strategy. If a proxy fight ensued, Jana asked if I would put myself up as a board member, along with two other candidates, including Jana Managing Partner Barry Rosenstein. This signaled a new trajectory for my life. I gave the proposition considerable thought, knowing that I might become persona non grata within conventional business circles. Ultimately, I found this new approach compelling because of the opportunity to create value for all shareholders who stayed with us — myself included. I agreed to move forward.
Our first step was to join forces and purchase enough outstanding shares to qualify for a 13D (a form required by the SEC when a person or group acquires beneficial ownership of more than 5 percent of a voting class of a company’s equity securities registered under Section 12 of the Securities Exchange Act of 1934). By the time we announced our status, the group owned 7 percent of the corporation’s s hares, providing enough leverage to get a seat at the table. Due to a peculiar set of circumstances, resolution was reached at lightening speed — within three weeks of our announcement. ConAgra had already hired a new CEO. Unlike many companies, it benefited from an independent non-executive board chairman. The company acknowledged that our proposals were sound, and the CEO quickly and publicly revealed the intention to sell their private label business, a key element of our program. Ultimately, they removed two board members, and we helped to add three who were compatible with the leadership. Barry and I were not among them, freeing us to ungroup so we could buy and sell shares without the restrictions imposed on board members.
The share price today is up substantially — $40.48 as of 2/22/17, a 25 percent increase over a year ago and a __ percent increase from when we first filed our 13D. There are many other instances when activists positively influenced the destiny of an organization. For example, I would say the combination of Dow Chemical Company and DuPont looks as if it will create value. Only time will tell, but this merger required massive change that would have been difficult to accomplish absent the influence of activism on both sides.
Critics: They Have Some Points
So far in this article, my premise has been that activists possess ideas that will improve a company’s performance. Sometimes they do; sometimes they don’t. Critics generally fall into two camps. The first is what I call “corporate culture” people who don’t believe that shareholders know what’s in the best interest of the company. They feel management’s job is to act on behalf of investors, who should keep their noses out of the process. This faction is not interested in direct feedback and operates with the sentiment that if shareholders don’t like it, they should sell their stock. This mindset is a throwback to the 1950s and not appropriate in today’s environment.
The second group of skeptics, whose perspective I believe is more credible, suggest activists focus on short-term financial performance and do not necessarily take the best long-term course of action to manage assets. Sometimes, this may be true. Advocates for change may propose selling off pieces of a business or dropping research and development, which creates immediate improvement in share price, but diminishes long-term value. This is where leaders with outstanding communication skills can influence shareholders with persuasive arguments to marshal support for their position. In fact, proactive actions should be taken long before activists set their sights on a company.
There are plenty of corporations with discrepancies between their current stock price and current financial earnings, yet shareholders believe a tremendous future lies ahead. Tesla is one such example. CEO Elon Musk has done an impressive job articulating how his strategy will result in long-term value. Because his passion has effectively built a bridge between Tesla management’s intentions and shareholders’ minds, it would be difficult for an activist to make a case for a better short-term use of assets. That just wouldn’t happen. Time will tell whether today’s shareholders of Tesla are making a wise investment. If you look back a decade at Amazon, you’ll see an example of when it has worked.
Similarly, the letter to shareholders in AT&T’s 2014 Annual Report from Chairman, CEO and President Randall Stevenson was a masterpiece. He explained to investors that they closed on the acquisition of DIRECTV, bought two companies that will provide access to wireless networks in Mexico, and succeeded in getting additional wireless airways in the U.S. through a government auction. He then asserted, combined with other major investments made during the past five years, that the pieces had been assembled to claim leadership as the top integrated communications company in the world. Stevenson summarized the strategy and told readers why it was important: “These investments are also changing AT&T into a vastly different company with unique capabilities serving new markets that will further differentiate us from our competitors. Over the past several years, we have taken several steps to position AT&T for the future, while rewarding you, our shareholders, with solid returns.” This positioning provided the framework needed for investors to support management’s long-term goals.
Changing Board Dynamics
Savvy companies should take their cues from Tesla’s Musk and AT&T’s Stevenson, and engage in proactive communication. It’s up to the board and management to explain strategies that will impact future returns along with expected results. When done effectively, shareholders become your advocates.
In addition to communicating long-term perspectives, companies can take other steps to avoid becoming activist targets. My leading recommendation is to begin thinking like them. Management and boards should constantly consider whether they are pursuing the right strategies. Among the questions to ask:
- Are we making this decision because it’s always been done this way?
- Are we defaulting to the easy route?
- Is this action based on historical practices or whims?
- Have we considered a variety of options?
- Is there a different way to structure our balance sheet?
Improving as a board member requires you to behave in a more disciplined manner and be able to articulate the “why?” behind your company’s actions. Ask tough questions and demand answers. Know if the corporation is getting the most out of its assets. Typically boards are satisfied with improved year-over-year performance, but today’s threat of activism forces you to constantly confront whether a better way to do things exists or if a set of assets is worth more together than they would be separately. When activists can take a stake in a company and assert an alternative strategy, you must look at the situation through “their eyes” at all times. If an opportunity exists to improve matters — then do it.
By taking a proactive stance and operating aggressively on behalf of shareholders, a board diminishes the chance of becoming a target of activists. However, if an activist approaches your company, the smart thing to do is to begin a dialogue to understand their proposal.
There are multiple ways to proceed. For example, you can:
- Give serious consideration to an activist’s recommendation, determine it has merit and implement their plan graciously.
- Consider changing course when an activist proposes something different from what you’re doing, but it is equally as good. It’s wise not to take pride of authorship. Make it your business to find common ground. Otherwise, be prepared for a fright — which will be a waste of shareholder resources — if you forge ahead without some compromise.
- Display confidence in your decision to “just say no” if you believe the corporation’s current strategy will yield superior results compared to an activist’s suggestion. Be prepared to state your reasons and be ready for a potential proxy fight that you may lose. In the end, do what you think is right for the company.
Extend an Olive Branch
It is natural to resist change. A dynamic exists on many boards that makes it difficult to transform. This can present challenges when trying to evolve your approach to responsibilities — or if the time comes to welcome new members foisted on the group by an activist intercession. Board members are often comfortable with each other, there is usually mutual respect and they truly believe they are all working for the common good of the company.
When choosing a new member through the traditional vetting process, boards carefully consider whether a candidate will “fit in.” They don’t have this luxury in a proxy battle and, in any case, this approach has become antiquated. For years, the process of selecting new members contributed to minorities and women being overlooked because they didn’t look like the 60-year-old white men at the table. Today, corporate America realizes that their boards should reflect the country’s profile; therefore diversity is now rightly expected..
Shareholder activists are frequently regarded as interlopers, especially when one announces, “I’m going to elect myself or other people to your board.” Current members may erect emotional walls and be concerned about compatibility.
Those same fears were likely ruminating the first instance boards appointed women or minority directors. But times have changed and now they are welcomed. Looking ahead, a similar acceptance will be extended to activist representatives because shareholders are demanding it. Boards will have to concede that future membership may be granted differently than in the past. Extending an olive branch will lead to a smooth transition.
Pirates at the Helm
I sometimes sense raised eyebrows regarding my predictions about the acceptance of shareholder activists, yet I speak with conviction based on personal experience. Much of my career was spent working alongside people who were opposed to activist intervention. I recognize it can be difficult to understand the benefits, but I’ve had a lot of practice promoting ideas that were challenging to sell. One of the most memorable occurred at Bain & Company when I worked with former presidential candidate Mitt Romney. We’d had a problem getting a client to accept a proposal. Mitt humorously dismissed my grumbling. His retort? “You think today was a tough sell? Think about being a Mormon missionary, as I was in France, trying to get people to convert to a religion in which you can’t drink, smoke or have fornicated outside of marriage. Now that, Jim, is a tough sell.”
I had concerns that explaining my ConAgra experience might also be a tough sell to other corporate boards. Turns out, it’s an appropriate culmination of my career and a return to the activist role I played on several boards in my earlier life as a consultant. If people are disdainful of the actions I took at ConAgra, they haven’t expressed it to my face. And, as evidence that times have changed, it led to my recent board assignment with European packaging company Smurfit-Kappa, which was seeking an American board member with M&A experience. They were aware of my role in the ConAgra intervention, and valued that I could sniff out problems before a challenge occurred.
In today’s world, that is exactly the role that board members should play. Activists are forcing us to become more diligent. This scenario presents an opportunity to amp up your game. The goal is to manage a company more proactively, enhance its stock performance, maximize its value and communicate the advantages of your strategy. And, if by chance you find “pirates” attempting to board your vessel, roll out the welcome mat. All in favor say, “aye, aye.”
Jim Lawrence serves as a member of the Diversified Search Corporate Board Advisory Group. He has spent much of his career at the top rungs of the corporate ladder and inside America’s boardrooms. He’s been the chief executive officer of Rothschild North America and PepsiCo Asia, Middle East, Africa; chief financial officer of Unilever and General Mills; and executive vice president of Northwest Airlines in addition to other positions. Previously, Lawrence was a partner at Bain & Company and founded his own consulting firm, The LEK Partnership. Since 1990 he has served on the board of directors for 16 publicly traded companies Lawrence holds a bachelor’s degree in economics from Yale University and a master’s degree in business administration from Harvard Business School.
This article was published in the October 2017 issue of Directors & Boards magazine. You can see it online here.