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Supporting Activist Shareholders

This article is more than 6 years old.

An activist shareholder is an individual or corporate entity that uses an equity stake in another corporation to place pressure on its management whom it may feel is under achieving.

The objective is to improve shareholder value by changing the course of corporate strategy or reshaping the financial architecture through cost cutting measures such as shedding staff or shifting suppliers.

It need not be a costly exercise, as with even a small stake in the target company of say, 12 percent, one can wield sufficient influence to engineer the desired change in the mission and hence direction the company follows. The alternative is a take-over or hostile acquisition approach that can be costly and highly difficult to achieve in the current environment of rising nationalism and employment protectionism.

Who are the activists?

A popular image of an activist shareholder is found in the fictional character of Gordon Gekko played by Michael Douglas in “Wall Street”, made some 30 years ago.

In one lesser quoted line he tells a contact:

“…I’m looking for negative control, ok? No more than 30, 35 percent, just enough to block anybody else’s merger plans…”

As a supporter of the free enterprise system I have no issue with investors, individual or corporate acquiring stock to force out inefficiencies, just as the mythical Gekko did with the incompetent management at Teldar Paper.

There is nothing wrong with being a liberator of companies, even if there must be a dose of creative destruction along the way. That is what delivers improvements in products and services thereby raising living standards.

However, when an operator, such as Gekko breaks the law, as he was clearly doing throughout his career it does not serve the free enterprise system at all.

The maxim “…greed is good…” has been taken by opponents of the market to suggest anyone that believes in such raw free enterprise is wicked and self-interested. Therefore, they should be branded as an enemy of the people.

Advance 30 years; a new mythical financier, Bobby Axelrod (played by Damien Lewis in “Billions”) is willing to cross the line as he heeds the advice of a work colleague, “… when there is nothing in the rule book, look at the situation in hand, one can be sure one has no rules to break…”

Such thinking overlooks the fact that the social engineering alternative is doomed to failure as every incentive to make personal advances and accumulate private wealth is eroded. That breeds a society that relies on a benevolent state. The result is a government that gets in the way and crowds out initiative.

The current condition

Shareholder activism has increased in the years since the financial crisis as cash balances on corporate balance sheets have risen. American businesses currently have $1.9 Trillion in cash that earns next to nothing as it sits on deposit.

Each firm, perhaps each industry has an appropriate cash level, and companies ought to target holding just enough cash to cover interest, expenses and capital expenditures; plus, a little in addition for emergencies.

One worry is that a large cash balance may exist because the current management has become jaded in its strategic thinking and simply exhausted its well of ideas for new investment opportunities. Maybe it suffers from business myopia or is too short sighted and doesn't know what to do with the cash.

The activist is not content for the company management to simply sit on a pile of cash. They want the cash put to work to enhance shareholder value, not let it stagnate.

We have moved on from mere asset stripping corporate pirates. Instead the activists seek to reinvigorate the corporation developing new business strategies that will see any increase in top line expenditure be overshadowed by the growth of the bottom line in the income statement.

Live case study

In a contempory example of this activism in action consider the case of PPG Industries (PPG) from the United States and the Dutch firm AkzoNobel (Akzo).

PPG raised its proposed offer for Akzo on Monday this week by 8 percent to €26.9 Billion ($29.3 Billion). This has increased the pressure on the Dutch firm to open talks as this appears to be the wish of many Akzo shareholders including hedge fund Elliott Advisors that has a holding of 3.25 percent

Elliott Advisors have let it be known that friendly discussions now are in the best interest of all as it believes the PPG offer was worth more than the value Akzo could achieve as an independent company.

Columbia Threadneedle Investments, a top-20 investor in Akzo with a 0.77 percent stake, said in a statement Akzo's board had:

 "…no room for excuses now and must enter into proper discussions with PPG …".

PPG said its new proposal was worth €96.75 per Akzo share, comprised of €61.50 in cash, 0.357 shares of PPG common stock and dividends worth €7.78.

This is being read as the final invitation to Akzo and sensibly included a “break fee” should any agreed deal be rejected by regulators. This issue was a concern to the Akzo board when it rejected two previous proposals from PPG. At the close of the European trading session on Friday, April 28 the share price of AkzoNobel was 2.66 percent higher than at the close of business last Friday.

Activist’s angle

PPG Chief Executive Michael McGarry said:

"…I think it's important for them to do the due diligence and to sit down and listen to us, …They have run out of excuses to throw on the table to say why they shouldn't. …"

He suggested PPG believed the deal would add to its earnings from the first year and given the support from Akzo shareholders and that the US firm would submit a formal offer to the Dutch financial markets regulator by June 1.

This consideration has merit as Akzo is behind its key rival, BASF SE:

Company                     Dividend Yield             Operating Margin         EBITD Margin

Akzo Nobel NV                         2.08                                         10.70                           15.29

BASF SE                                    3.33                                          10.90                           18.36

Akzo has confirmed it has received a third, unsolicited proposal from PPG, however, throughout the week it has been non-committal in its response although it acknowledged that it was required by law to study the bid:

"…The Board of Management and Supervisory Board of Akzo Nobel will carefully review and consider this proposal, …"

Reading between the lines it is interesting that Akzo has not rejected the bid on this occasion; perhaps this is a response to the fact that PPG offered several concessions in the guise of the break fee but also on employment, pension plans, research and development spending and the location of production facilities.

These concessions, particularly on employment were to be expected as four provincial governments in the Netherlands said they opposed a takeover of AkzoNobel as they were fearful on the impact on jobs where up to 5000 positions could have been at risk.

The activist investor urged Akzo's board to enter talks with PPG, saying a hostile bid might not include the same guarantees for stakeholders such as shareholders and employees.

Activism, driven by attentive not aleatory factors

The reasons why an activist, such as PPG merits my applause is that even a reasonable association of individual shareholders will be unlikely to control enough shares for the management to pay them any attention.

The activist, in contrast, often have more influence because they can acquire large quantities of the shares and if they have an intention to replace the existing board, management may be more willing to work with them.

Therefore, it follows that the activist can receive more attention from the financial media and so their motives will receive a high level of publicity. That said, the activist does not have a perfect record on being correct on every occasion. It may be that the timing of a course of action is incorrect, but if so they will lose money on the deal.

As an example, consider, William Ackman, CEO of Pershing Square Capital, a hedge fund that invests in select companies. He was wrong about Target and J.C. Penney. That is the nature, indeed the beauty of markets, good ideas and intelligent work reaps a reward. Poorly planned considerations are rightly punished.

Of course, critics of the markets are, in my view, akin to a Pharisee from the leviathan state that will oppose any hint of a takeover, especially from a non-domestic operator by uttering their opinion with insipid bromides. They see the world through the prism of ideals, such is the flaw in the mossback’s argument.

They may claim that measures must be undertaken to protect local or national jobs. However, prioritising local employment leads to inefficiency and poorer services, not more local jobs. Such a parochial stance will simply prevent many of the best service providers in the world operating in an economy and that will obstruct the spread of best practice.

In a world of free-flowing capital where shares can be traded between any global parties, no government or union should oppose a proposal that is focused on boosting shareholder value and not asset stripping. This is especially so in the case of PPG and Akzo were the activist has given assurances about local employment security.

Stephen Pope ~ MarketMind

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