Activist shareholders can come across as troublemakers. But, studies show companies restructured after activist campaigns tend to outperform. Aware of this trend, manufacturers have begun offering mutual funds built to capture the fruits of activist labours.
“Activists are trained bargain hunters,” says Larry Sarbit, chief investment officer at Sarbit Advisory Services, a sub-advisor to IA Clarington Investments.
Activists can come from outside or within the company. They may be welcomed or seen as a threat. They may get their way quickly, or fight a protracted battle that costs both sides millions. One thing they all have in common: they say the company isn’t performing at full potential, and they’re determined to get their plans for change implemented.
Investing when the campaign’s announced, or while it’s ongoing, is too risky, Sarbit says, because the company may repel the activists. This usually means the change that would elevate the stock doesn’t happen. “Or the activists may bail because they decide it’s not worth the effort.”
To avoid that situation, he doesn’t invest until the campaign has succeeded. “We wait for a formal announcement that the company will be restructuring its operations or is initiating a ‘strategic alternatives’ process; or, the activists are well-represented on the board.”
His entry point may seem late. “You do get a bit of a pop in the price after the battle’s won; but then there’s the hard work of changing the company,” Sarbit says. That can take as long as five years, and not everyone’s patient enough to ride out extended sideways price movements. “We’re willing to sit on things that get ignored for long periods.”
He’s mainly interested in companies worth at least 50% more than the prices they’re trading at, and generally avoids commodities businesses. He’s not keen on financials because it’s difficult to calculate the risks of a bank or P&C insurer. “There may be money to be made with them and we’ll miss it, but we’re fine with that.”
Just because an activist has won a mandate for change doesn’t mean it’ll happen; or, if it does, that it’ll translate into an outperforming stock. Even the best-managed company can face lean margins if it’s in a sector that has a flood of new competitors. The change activists want may also cost far more than expected.
Retailer Wet Seal was a lacklustre target, for instance. It’s in a highly competitive sector and made constant demands for capital. Quarterly results were one disappointment after another, and it was difficult to have any certainty on its long-term prospects, says Sarbit. “We want businesses where we have a good idea of what the future is going to look like.” Losing that clarity is a trigger for selling.
Source: FTI Consulting and Activist Insight
Another risk is the activists are wrong about the target’s potential. Some cheap companies aren’t underpriced, “they’re just lousy,” says Sarbit. So, fund managers can’t take activists’ research at face value. “Our job is to make sure that what the activists say is realistic.”
Sarbit also wants to see activists devote significant assets to campaigns, as that shows commitment. There’s no specific threshold, but it’s a warning sign if, for instance, he sees an activist put down only 2% of its portfolio.
He says his activist fund’s appropriate for clients seeking long-term capital appreciation, and pegs anticipated gains well into double digits over three to five years.
Victoria Sivrais, managing director of strategic communications at FTI Consulting in Chicago, says companies should protect themselves from activism before it takes root. To do this, managers must explain their decisions, and “be open about how those decisions are made. This can include how they involve the board of directors.” Investor conferences and earnings calls are two key avenues for such communications.
“That detail can provide a healthy level of comfort for current investors. Should an activist then come in and try to exploit an issue, managers already have a very strong relationship with the shareholder base.” Sivrais adds that transparency should be ongoing.
Dean DiSpalatro is a Toronto-based financial writer.