SHAREHOLDER ACTIVISM: BEWARE THE BARBARIANS AT THE GATE

By Shaun Read

Recent events involving the shareholder activists raises the prospect that more and more South African companies will soon be facing a brand of shareholder activism more akin to that practised in the US and UK financial markets.

Unlike the media appointed individual “shareholder activists” in South Africa, shareholder activists in the US and UK are fund managers and wealthy individuals, holding significant stakes in companies, who are seeking to influence the way in which those companies are run, usually for their own gain. As Time magazine points out, these shareholder activists, led by fund manager kingpins such as Dan Loeb, Carl Icahn and Bill Ackman, are by and large the re-branded corporate raiders of the 80's, of which Icahn is perhaps the most long-standing (remember TWA). What motivates a shareholder activist today are the same issues which motivated the corporate raiders of the 80's; namely: underperforming boards, idle assets sitting on balance sheets and/or the accumulation of non-core assets that are perceived to be worth more if sold off than retained. What has changed is that shareholder activist are no longer seek out the weak and vulnerable, but are targeting some of the best performing companies, Icahn’s recent demands for the board of Apple to return cash to shareholders, being a case in point.

The re-birth of the shareholder activist has been prompted by the events that followed the 2007/2008 global financial crisis, which has caused many companies, like Apple, to batten down the hatches and has resulted in them accumulating enormous cash reserves. Moody's reports that US firms were sitting on US$1,6 trillion of cash at the end of 2013. To provide some perspective, that is 10 times more cash than the South African Government's entire expenditure budget for 2014/2015. In addition, pre- 2008 double digit growth in earnings has given way to low growth expectations. Whilst shareholders were largely passive during the high growth/ high return period leading up to the global financial crisis, shareholder intervention in the running of companies is now more widespread. According to FactSet Research Systems, in the last five years activists have initiated campaigns at over 20% of the industrial companies in the S&P 500.

As a result, shareholder activism has increased significantly in the US and other parts of the world, with a view to unlocking trapped wealth or forcing boards to adopt the strategies of the shareholder activist. Typically the actions of these new shareholder activists consist of seeking board appointments, proxy wars, threats of litigation or proposing resolutions to declare dividends or sell assets. The success rate of these activists is somewhat mixed. Failures, such as the turnaround strategy that Bill Ackman imposed on J C Penny, have demonstrated that fund managers are not always good at directing operational management.

In South Africa, many companies on the JSE are in the same position as those in the United States. Recently Grant Thornton reported that South African companies were sitting on "excessive" cash piles. Yet South Africa has not, to date, seen much in the way of the US style of shareholder activism. Part of the reason for this is the perhaps the incestuous nature of the South African investor community. Many of the fund managers, whose counterparts in the US are at the forefront of shareholder activism, are cowed into silence by the fact that much of the money they manage comes from other shareholders of companies that may well be ripe for a dose of shareholder activism.

Inevitably, the question arises as to whether the actions of a shareholder activist are good for the long term sustainability of a company or merely achieve short term profits for themselves. Faced with an activist shareholder, the first reaction of many boards is to resist and to paint the activist goals as being bad for the company. However, as pointed out in a recent article in the Harvard Business Review, often the emergence of a shareholder activist in the ranks of a company's shareholder base can serve as a wake-up call for a hitherto complacent board. The demands of shareholder activists can usefully point directors to areas of a company's finances or operations that need attention or which may unlock value. Although Apple will deny any connection between Icahn's demands and subsequent actions of the Apple board, Apple announced plans to return US$100 million to its shareholders by 2015, more than double originally planned. In addition, Apple recently announced it was using some of its cash reserves to acquire Dr Dre's Beats Electronics for US$ 3 billion, most of it in cash, the single biggest acquisition by Apple in its 38 year history.

Given the downturn in the South African economy, South African companies can no longer operate under the illusion that shareholder activism will be limited to justifying the their executive's remuneration at the next AGM. Faced with diminishing returns, fund managers will be examining companies more closely and calling for them to unlock value, either through changes in strategy, demand for board seats, sales of non-core assets and/or returns of unused cash sitting on balance sheets.

In order for companies to insulate themselves from the attentions of shareholder activists, boards of these companies should ensure they have a coherent strategy, that short term goals are achieved and that the board itself is unified and not easily divided and conquered. Companies should also have on hand a range of advisors, fully briefed, to ensure that responses to the attentions of a shareholder activist are swift and coherent.