19 Mar 2015

Shareholder activism: what’s behind all the noise?

by Karen Evans-Cullen, Rod Halstead

Apart from maintaining and developing their shareholder relations functions, Australian companies need to plan for the possibility of an activist attack.

How worried should Australian boards be about shareholder activism?

We’re not talking here about dreadlocked tree-huggers or retail shareholders with a social conscience. They have only nuisance value.

Rather we are talking about the uber-capitalists: cashed-up hedge funds who combine legal manoeuvring with less conventional tactics in an attempt to change a company’s board or business direction.

We have previously explored both the legal tactics of activists and the possibility that they may expand their activities to Australia. Recent developments have shown that that possibility may be becoming a reality: within the last 12 months, Antares Energy, Karoon Gas and Molopo Energy were all targeted by activists.

Personal attacks

Antares and Karoon both faced the traditional tactic of attempts to change their boards. Molopo was quite different: Keybridge Capital wanted to engineer a return of capital by going over the heads of Molopo directors and putting it to a vote of Molopo shareholders. That tactic foundered in the Supreme Court of New South Wales. However, the novelty of the attack, combined with some of the tactics employed against Karoon, show that Australian companies can no longer be quarantined from US-style activism.

In a letter to Karoon shareholders, Pegasus CP One raised the usual concerns about the direction of Karoon’s business. However, Pegasus also took a swipe at Karoon CEO Robert Hosking, claiming to have concerns about the involvement of members of the Hosking family in the management of the company.

Personal attacks like this are still rare in Australia. However, they are almost becoming par for the course in the USA. Perhaps the most egregious example was the resignation of Yahoo CEO Scott Thompson after activist fund Third Point published the results of its investigation into whether he really had, as he claimed, a degree in computer science.

Another high-point (or, depending upon your viewpoint, nadir) of this tactic occurred last year when Pershing Square’s Bill Ackman delivered a three-hour presentation on Herbalife, describing its CEO as a “predator” and the company itself as a “criminal enterprise”.

This type of attack is not, of course, simply aimed at point-scoring. Third Point leveraged the gaps in Mr Thompson’s CV to question the competence of the board committee which vetted him before his appointment. It ended up securing three seats on Yahoo’s board. An attack on Dow Chemical yielded two board seats.

The “white paper”

A less contentious weapon in the activists’ armoury is the “white paper”. In Australia, a “white paper” is an official government policy document; in the world of shareholder activists, it’s a paper which details all or some of the target company’s alleged failings. And the emphasis is on “detail”: some can run to hundreds of pages, and can cover topics such as the company’s financials, corporate governance, strategy and/or competitiveness.

Unlike a government white paper, activists’ white papers are released selectively, depending upon the activist’s strategy and objectives. It can, for example, be sent to the target board to kick start negotiations or as a statement of the terms of surrender that the activist will accept. Other recipients can include the media, sell-side analysts and institutional investors.

The role of institutions

Traditionally less gung-ho than hedge fund activists, institutions may find that receiving an activist’s white paper provides them with both a justification for changes to a company and someone to take the running.

This view received considerable traction recently, with the release of a report by worldwide consulting firm FTI Consulting.[1] This showed that 76% of surveyed institutions had a favourable view of shareholder activism and that 84% thought that it added value to targeted companies.

However, the same survey also showed that institutions may use hedge funds as stalking horses. Rather than the traditional activist goals of sales, separation of assets and return of cash to shareholders, institutions believed that the benefit of shareholder activism lay in the more inchoate outcomes of:

  1. providing a catalyst for change.
  2. aligning the interests of board and management with those of shareholders.
  3. forcing companies and boards to sharpen their strategic focus.

This “sup with the devil” mentality on the part of institutions is reinforced by the fact that 61% of institutions surveyed by FTI thought that hedge fund activity could also have a negative effect on companies by encouraging short-termism.

Lessons for Australian companies

So what does this all mean for Australian companies (or, at least, those which are large enough to attract the attention of activists)?

Probably the most important point to make is that the Australian legal landscape is quite different from the USA’s.

We have a long history of general meeting requisitions to consider spill motions, but stepping outside that well-trodden path is largely unknown territory. Keybridge’s novel attempt to wrest control of capital management from Molopo’s board was, as we said, rejected by the Court.

This doesn’t mean that US-style activism cannot take off in Australia, but the US experience cannot be directly translated to here. Among other things, activists will have to navigate Australia’s strict controls on building up associations of shareholders (even if, in practical terms, proving the existence of an association is often very difficult), its even stricter insider trading laws and, in the more extreme cases referred to above, laws regulating what can and can’t legally be said.

On the other hand, incumbent boards can’t assume that either traditionally conservative Australian institutions or Australian laws will always provide a bulwark against activists.

Apart from maintaining and developing their shareholder relations functions, therefore, Australian companies need to plan for the possibility of an activist attack.

This includes monitoring of the landscape in order to keep up to speed with current tactics. More immediately, it also requires the mundane slog of monitoring the share register in order to identify the entry of possible activists (and, if necessary, using the substantial holding or beneficial ownership disclosure provisions of the Corporations Act in order to investigate such activity). It would also be useful to recognise the possibility of personal attacks on the competence of the CEO and/or directors, and to have the mechanisms in place to ensure than any refutation can be prepared and published with a minimum of delay.

[1] 2015 Shareholder Activist Landscape: An Institutional Investor Perspective, FTI Consulting, January 2015

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.