What makes for a good activist idea?

Title says it all. Can anyone share thoughts on coming up with activist ideas, or just going long names that you think an activist may potentially get involved in? Thanks

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Comments (8)

Most Helpful
Oct 12, 2021 - 3:54am

Just having my coffee so might be a little less articulate than what I'd hope. Before anything, you need to separate between the types of activists. You have your Icahns who are essentially greenmailers (maybe less so in recent years), your Cevians/ ValueActs, who have a friendly approach with management and implicitly a longer term horizon and lastly you have the likes of Elliott or Starboard, which are longer term than greenmailers and far less friendly than the Cevians of the world. 

The difference in nuance between the three types is important when you craft the thesis, particularly when considering investment horizon, catalyst, tactics, but the underpinnings of the target are almost always the same. You're looking for a lagging stock price, substantial cash balance, little to no debt, a vulnerable management team and an attackable governance structure. Taking them one by one:

Lagging stock price

This is essentially a proxy for a smoking gun. Perhaps the most important element of an activist thesis is understand why the company has lagged peers (could be capital structure, could be operational underperformance, governance matters, generally a combination) and based on what you believe you can drive in terms of change, come up with a "real" (well, in your view) valuation to understand upside.

Low net debt

This goes back to the '80s and LBO boom (Michael Jensen's agency theory for fellow nerds) but the general idea is that a general reason for lagging stock prices is improper allocation of capital. If mgmt. doesn't do a proper job at that and if the capital structure allows for it, then the target should return capital to shareholders via buybacks and/ or dividend recaps. Elliott has recently started looking for instance into tech firms with huge cash balances (F5 Networks for instance) that are highly cash generative, huge cash balances and little to no debt. What does management do with all that cash? They'll tell you they keep it for option value via M&A, to which you can say "bull isht, return cash to shareholders".

Vulnerable management team & governance

To enact a buyback as above or start getting the stock to move via operational enhancements, you need a vulnerable management - what I mean by that is they have generated tepid results at best while being allowed to ride the optionality that comes with a low stake in the company, free stock compensation and substantial base salaries (which also feeds into a weak governance framework). At the end of the day, you have to map out how incentives work within the org - can management just do whatever and barely be accountable to the board? Are compensation committees made by buddies of the management team? Then you have a ball game. Then the governance aspect comes even more into play as you understand how you can change management and get on the board. This is often your thesis catalyst - the time to the next GSA where directors are elected is the time to present your case and make the noise, with the GSA itself as an inflection point wherein if successful you got "control" over the target.

This is obviously an oversimplification, as these situations are very different between each other. That said, there's a lot of material out there that dives into activist theses ("Dear Chairman" by Jeff Gramm is pretty neat) and just observing some of these plays unfold in real life is going to be much more revealing than an answer from WSO. Hope that helps.

  • Intern in IB-M&A
Oct 12, 2021 - 9:07am

Thanks, really appreciate it!! Beyond those attributes u mentioned, would it also make sense to find a company with assets it can spin-off to unlock shareholder value, or maybe the potential for a takeout (where the activist would see that potential and then push the company to pursue it)? How exactly would you go about finding/analyzing these situations?

Oct 12, 2021 - 9:24am

Yeah, absolutely. This feeds the second item on low net debt, or is one of the ways to drive it (generate cash and return it to shareholders) + some arbitrage on valuation of parts being higher than the whole. The crux there is you need to be careful about how you estimate the value of the potential asset sales (i.e. cost and eventually EBITDA attribution between the core and the sold asset if a division of the target) so it's more information dependent than the rest of the items I mentioned (which can be found in a 10-k easily). It's essentially what Cevian did with TK when they sold the elevator division, take a look at the situation if you haven't already. Elliott did something similar at eBay when they got them to sell Stubhub (letter here: https://www.businesswire.com/news/home/20190122005513/en/Elliott-Manage…). But again, it's very situation specific.

Oct 13, 2021 - 4:29pm

In 2021, when the market has so much data, it seems implausible that activists could generate consistent alpha by simply finding companies with stupid management teams and prodding them to do stuff with their capital structure or dividend/buyback policies. Seems like something the market should easily spot and price in beforehand. 

I completely agree that this is a common rationale for activists. I'm just skeptical that its a smart one. 

Oct 14, 2021 - 3:49am

What I'd argue is that identifying a "stupid" management team is getting more nuanced. By stupid I also define teams that strive to ossify crooked incentive structures and low risk comp for themselves. Nongaap investing has a substack going over the "dark arts of corporate governance" - pretty cool array of situations whereby you could rig audit and comp committees in your favor (as management) with little to no consequence. That's a solid opportunity set for anyone willing to dig through the reams of docs.

Moreover, anecdotally, the market didn't stop Elliott from doing whatever it wanted at Twitter (including not just getting on the board but a buyback and a nifty little investment in a preferred instrument in spite the lack of need for cash) - true, it may be size that allowed them to do that. But the laziness behind price discovery these days tells me both typical activism and greenmailing are far from dead.  

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Oct 12, 2021 - 10:26am

Biggest issues are (i) being big enough to be able to buy a large enough chunk of the free-float to be able to get a board seat or influence management, and (ii) finding management teams that will even listen to you. In a lot of countries there is a cozy network of board members (especially in Western European countries and Japan) who all know each other and would ever act against the CEO/management even if it was in the best interests of shareholders. See the numerous failed activist moves against European banks (both CS and Barclays of late). Activism really works best in the US, and maybe the UK, where there is greater focus on shareholder value. 

  • 2
Oct 12, 2021 - 2:57pm

1. Find company whose stock has underperformed over some cherry-picked period of time

2. Buy a meaningless portion of the shares outstanding, eg 1-2%

3. Put together a deck calling the company underlevered

4a. If company fights back, commence proxy fight and go to step 5

4b. If company submits, profit when they take on debt to buy back shares or do a special dividend

5. Replace 1-3 board members with your own candidates

6. Return to step 4b

that, my friends, is how you create value through activism

  • Associate 1 in IB-M&A
Oct 12, 2021 - 5:52pm

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