10 May 2018
Shareholder activism: How can companies protect themselves?
By Stephen Neale and Benjamin Depiazzi
Glaucus' recent attack on Blue Sky Alternative Investments demonstrates the devastating effect an activist short seller can have on a company's share price – so what should you be doing to protect your company against activist short sellers and shareholder activists?
Unless you have been living under a rock, you would have seen media coverage of shareholder activists (many of whom are large US hedge funds) flexing their muscles in the United States and, increasingly over the last few years, in corporate Australia.
Shareholder activism is not new. There have always been shareholder activists seeking to privately influence a company's operational and strategic direction, capital management or corporate governance. What is new to Australian shores (and will be new to many Australian boards) is the US-style of shareholder activism – aggressive, sophisticated, media-savvy and very public.
That's because activists relying on such tactics have raised significant pools of money over the last few years, but it's become harder for them to find viable targets in jurisdictions where activism is a common strategy (such as the US and Europe). Activists are now looking globally for opportunities, and that's where Australia comes in.
Australia has relatively few domestic activist funds, shareholder friendly laws, a continuous disclosure regime giving access to real-time information on companies and a securities exchange with a large number of institutional relative to retail investors (so fewer shareholders need to be convinced of an activist’s thesis for change). All of these characteristics make Australia an attractive environment for activists, which means boards need to be prepared for the tactics they employ.
What drives activists to attack a company ‒ and how do they do it?
Shareholder activists often claim to be working to add value to a company and improve returns for shareholders. While critics argue that activists force companies to make decisions resulting in short-term gains at the expense of greater long-term benefits, large institutional investors and funds have come around to the view that activists may deliver benefits, and for that reason are more willing to support them and will do so over time.
While every activist attack differs in its details, there is a common play-book for this new style of shareholder activism:
- The activist identifies a target considered to be undervalued or underperforming and then acquires an initial stake in that company.
- After it acquires a stake, the activist meets privately or corresponds with the company's board to put forward its proposed changes to the company, its board or management.
- The stake in the company is increased via equity and/or derivatives, while the activist informally engages with what it hopes are like-minded shareholders sharing the same desire to change the company.
- If the company doesn't engage or accede to the activist's demands, the activist cranks up the blowtorch by launching a public campaign attacking the company. A key weapon in the activist arsenal is to release a white paper aggressively criticising the company, its board and its management and putting forward an alternative strategy or desired changes to the company.
- This white paper is often supported by a sophisticated media campaign, which together seek to make the company's existing policies, strategies or board composition seem untenable.
- Recent examples in Australia include Elliott Management paying for billboards and wrapping entire Melbourne trams with advertisements critiquing BHP; Ariadne creating a professional website to host its claims and build awareness for its campaign against Ardent Leisure; and Halom Investments (an aggrieved shareholder as opposed to a dedicated activist) creating a slick website containing video graphics and presentations to push its plan to replace directors of MMA Offshore.
- If the activist is dissatisfied with the response from the company, it may then seek to escalate its campaign by exercising rights enjoyed by shareholders under Australian securities laws – convening or requisitioning a general meeting, requesting the share register and corresponding directly with shareholders, moving spill motions, using the two strikes rule or otherwise moving to appoint or remove directors.
A special sub-set: activist short sellers
Activist short sellers such as Glaucus take a more ruthless approach – they skip the pleasantries and instead launch a surprise attack by releasing a white paper and disseminating it as widely as possible (such as for free via the internet).
The reason is simple: activist short sellers are not interested in constructive engagement. Their strategy is to inflict maximum damage to their target's share price in order to capitalise on a short position built up prior to the public release of their white paper. The effect can be devastating. On the day of release, Glaucus’ white paper on Quintis led to a 9% drop in its share price, while Glaucus' attack on Blue Sky caused its share price to drop 9.2%, with falls continuing in subsequent days.
So, what can your company do to protect itself from activists?
- Take a look in the mirror: critically identify and address any potential weaknesses and risks which may attract activists, including corporate governance issues (board composition, executive compensation or otherwise), financial performance and large differences between the internal and market valuations of your company.
- Monitor the landscape: keep up-to-date on current activist tactics in Australia and overseas and monitor investor sentiment and coverage of your company in the media or otherwise.
- Know your shareholders: regularly keep a close eye on your company's share register and shareholder base for any known activists or suspicious movements and monitor ASIC’s short position reports, investigate any suspicious shareholder activity by issuing beneficial ownership notices, and work to understand shareholders' and activists' thoughts, motivations and sentiments.
- Communicate proactively: regularly communicate with shareholders and other third parties (such as analysts and customers) to effectively convey a strong strategic and financial vision. Proactively address concerns which may be raised by shareholders, and engage with activists where the opportunity arises, particularly activists who have the support of institutional shareholders or otherwise where there is a real or perceived benefit in addressing what may, in fact, be legitimate claims.
- Prepare as you would for a hostile takeover: with the benefit of advisers (corporate, public relations, proxy and legal), prepare for action as you would a hostile takeover defence. This includes establishing a response team and communication strategy, role playing potential scenarios, undertaking a value assessment of your company, being ready to quickly respond to any assertions made by activists, and engaging with shareholders, other stakeholders and the market promptly after an attack.
- Legal defence strategies: with input from appropriate advisers, consider mounting a challenge to any associations between shareholders, the purpose of requisitioned meetings or resolutions proposed by activists, and oppose proposed board appointments where there are inadequate skill-sets or conflicts of interest. Naturally, these defences could be used in response to a shareholder activist but would be much less effective in mitigating against an activist short seller’s surprise attack.
- Don't be complacent: it goes without saying that Australian companies and their advisers should anticipate and be responsive to the changing role and methods of shareholder activism and take active steps to protect against the possibility of an activist attack, including revisiting the condition of your current response / defence manuals to ensure they are up-to-date and effective in the context of modern market trends.