Shareholder Activist
What is a Shareholder Activist?
Shareholder activist or shareholder activism is a straightforward financial concept. You are not alone if, after reading the phrase “shareholder activist,” you thought about active shareholders. Before defining why shareholders are active, let’s explain who they are.
Understanding who is a shareholder is fundamental to comprehending the logic of shareholder activism. A shareholder is an owner of a company’s shares. Walmart is a public company whose shares are traded daily on the financial market.
So, you can buy Walmart’s shares at any moment you want. Once you exchange your money against these shares, you become an owner of Walmart to the extent of the size of your stake within a company.
Why does it matter so much? The shares you possess now entitle you to the right to vote and make decisions regarding the company. Imagine you have an 85% stake in Walmart.
You are a majority shareholder and can set the direction of the company’s policies, financial, strategic, and other decisions. Nobody can amend what you do due to your majority ownership.
You are the one and unique captain of the boat. It sounds simple, but is it true in practice?
In reality, things are more complicated. Let’s now imagine that the remaining 15% of Walmart's shares belong to a hedge fund and retail investors, with a proportion of 10% and 5%, respectively. The hedge fund is unsatisfied with the management team and how the company is managed.
Yet, their stake is only 10%, but it is sufficient to become a board of directors member and exert pressure on the management. The goal is to make the management initiate changes seen as beneficial for the company by the hedge fund.
As you may guess, the hedge fund has become a shareholder activist.
- A shareholder is an owner of a company's shares. He has the right to vote and make decisions regarding the company.
- Shareholder activism occurs when an investor acquires a stake within a company to influence its policies.
- Activism has a controversial reputation in the finance world. It is often criticized due to its short-term value-extracting goals.
- Long-term shareholder activism can, nevertheless, bring improvements and generate value for all participants.
- Hedge funds perform better as activists than mutual and pension funds.
Who Is A Shareholder Activist?
A Shareholder activist, also known as stakeholder activism, is when an investor acquires a sizable stake within a company to influence its decisions and actions. This stake can range from 1% to 10%. Stakeholder activism is a controversial type of engaged stewardship.
Investors have stewardship responsibilities. Since they can directly influence a company, they are best positioned to improve long-run value, share benefits with society, and make a company work toward diversity, climate change, etc.
Poor stewardship leading to corporate failures is blamed by society. The controversy of stakeholder activism is dualistic. Some experts consider it the worst thing ever, while others extol its virtues.
“Shareholder activists … are more like terrorists who manage through fear and strip the company of its underlying crucial assets … extracting cash out of everything that would otherwise generate long-term value’’ - Peter Georegscu, Romanian-American business executive, author, and the Chairman Emeritus of Young & Rubicam.
Hillary Clinton once called it the “tyranny of short-termism”. Bernie Sanders and Elizabeth Warren favored the bill to limit activist hedge funds. Eric Cantor called short-termism a problem for the private sector, politics, and governments.
When they mention the term “short-termism”, they refer to reproachable short-term actions oriented to extract value from companies and exclusively benefit investors seeking quick gains at the cost of other parties.
For instance, instead of building a factory in a community to create jobs and liven up its economy, a company decides to spend money on dividend distribution for shareholders.
But is everything so cloudy, as people above say? Another stream of opinions perceives shareholder activism as valuable and creating opportunities for everyone.
“The value add of an activist … is that we can help prevent the next Kodak from disappearing, where tens of thousands of jobs are lost, by waking up a complacent company to the competitive threats it faces and the inefficiency that has crept into their business because of complacency’’ - Bill Ackman, activist investor, founder and CEO of Pershing Square Capital Management (hedge fund).
The recession of Kodak started in 1975 when the first-ever handheld digital camera was invented. The bosses at Kodak didn't feel that all photography would eventually become digital by 2010. It would also mean spending a lot of money to transform the business. After such a critical strategic decision, in 2013, the company emerged from bankruptcy.
Shareholder Activist Example
Let’s analyze in-depth one example of activism.
In 2008-2011 the well-known company Adobe was hitting a downturn. Adobe’s problems:
- Low sales of Creative Suite
- Lay-off of 2,000 employees between 2008-2011
- Incompatibility of Adobe’s products with new rising stars - Iphone, Ipad, and other mobile devices
- Preference for HTML5 rather than for Adobe from Steve Jobs
Adobe's share price plummeted from $42.17 (17th of November 2007) to $28.2 (16th of December 2011). Thus, the shareholder activist ValueAct Capital purchased a 5% stake in the company in late 2011. It will increase to 6.3% by December 2022.
ValueAct aims to redress the issues within the company. ValueAct partnered with Kelly Barlow, who became its representative on the Board of Directors at Adobe on the 5th of December 2012.
The founder of ValueAct Capital, Jeffrey W. Ubben, said:
“I don’t need the quick hit. … You can’t just keep throwing stuff at the wall; you need to get in there, get the information and work on a long-term plan that is going to be sustainable.”
As a result, the engaged position of ValueAct convinced Adobe to move away from Flash and focus on HTML5 technology. They also switched to the subscription revenue model instead of one-off purchases. Adobe started to develop new and more performant mobile applications as well.
And this paid off, and Adobe’s share price started to react positively to changes. ValueAct Capital liquidated its position in June 2016 at a price per share between $92.6-$92.9. Adobe had an incredible upward expansion thanks to the intervention of the shareholder activist.
The company almost doubled the number of employees, from 10,000 to 20,000. Revenue went up from $ 4.2 billion in 2011 to $ 7.3 billion in 2017. So, the campaign of ValueCapital was focused on long-term value creation, which was achieved.
Let’s go through another example of activism between Engine No.1 and ExxonMobil:
1. In December 2020, Engine No.1 purchased a 0.02% stake in ExxonMobil worth $40 million. Engine No.1 was only the 184th largest shareholder but successfully imposed drastic changes within the company.
2. Engine No.1 pointed out that the company faced "existential risks" due to its denial of environmental changes. The ROCE (return on capital employed) was gradually deteriorating and would continue so because of the exclusive focus on fossil fuel energy.
3. Engine No.1 addressed a letter to the board of directors giving a poignant reflection on the reality of the company:
“No company in the history of oil and gas has been more influential than Exxon Mobil Corporation (“ExxonMobil” or the “Company”), which is home to many of the industry’s most talented managers, operators, scientists, engineers, safety professionals, and other employees.
It is clear, however, that the industry and the world it operates in are changing and that ExxonMobil must change as well. While the entire industry has faced steep declines, ExxonMobil stands apart.”
4. The strategy of Engine No.1 was to convince the largest shareholders (BlackRock, Vanguard, and State Capital) to support their initiative. The activist had time before the next AGM (annual general meeting) on 26 May 2021.
5. Engine No.1 proposed to reform the company in the direction of sustainability and appoint four new independent directors with experience in the energy sector.
6. Between 12-17 April, proxy advisors (ISS, Glass Lewis) backed at least three proposed directors. Several institutional investors declared their support for at least one of the proposals. On May 25, BlackRock supported the campaign as well.
7. After the AGM took place, three new independent directors were officially elected. In January 2022, ExxonMobil announced the goal to cut its greenhouse gas emissions and become net zero by 2050. Even if ExxonMobil opposed these changes initially, they were finally broken and had to abide by the shareholders’ newly voted initiatives.
Shareholder Activist - Is It Always A Win-Win Game?
As a general rule, the evidence shows that hedge fund activism is beneficial for all participants:
- Stock price significantly increases without long-term reversal. It keeps growing after the activist’s exit for several years.
- Increase in ROA (Return on Asset)
- Increase in labor productivity
- Better IT investments
- Sell-off of unused or inefficiently used plants
- Higher CEO turnover (ousting of bad and less experienced CEOs, hiring of more competent CEOs)
- The high turnover rate among directors at the executive level (better credentials, more technology, and industry-based skills)
When we refer to stakeholder activism, we mean long-term value creation-oriented investors like ValueAct Capital. In literature, shareholder activism is often associated with opportunistic and speculative short-term investors whose investing spans 1-3 years. Long-term activists, as opposed to short-term, have a more extended holding period.
Additionally, stakeholder activism is, in a sense, a tool to improve companies' sustainability. Activists can try to address environmental or social issues detected within companies. They can request specific changes or raise companies’ awareness about sustainability-related elements.
For example, in 2006, Greenpeace launched an online petition to pressure Apple and coerce the company to stop using toxic chemicals in its products.
Apple was reluctant to Greenpeace's demand in the beginning. Nonetheless, Greenpeace gathered thousands of online signatures, and Apple became more pressurized.
All in all, in April 2007, Steve Jobs released a document indicating Apple’s intentions to abolish toxins and make products greener, as well as better their recycling and manufacturing processes.
Hedge funds are not the only ones that invest in companies and act as shareholder activists. Pension and mutual funds are also playing this role. Despite that, hedge funds are more successful in their campaigns.
Hedge funds can allow themselves to hold fewer assets and can only actively focus on a few stocks. Pension and mutual funds are risks reluctant. They diversify their portfolios and have multi-asset strategies.
When a stock constitutes only 3% of a portfolio, they don’t have any incentive to devote many resources to it. They also have a redemption risk making them focus more on short-term performance to attract fund flows.
Mutual and pension funds will likely avoid investing if gains can only be retrieved in the long run.
Also, relative performance benchmarks are paramount for mutual and pension funds. They seek to outperform their peers and need to invest in higher return-generating assets than their competitors. Therefore, they will not invest in a stock that has interested some of their rivals.
Look at ValueAct Capital’s performance at the exit of its investment. Generating such a high return would be impossible in the short term. By contrast, mutual and pension funds are remunerated through management fees.
It means that the higher their assets under management (AUM), the higher their compensation. To attract significant inflows, they need to demonstrate short-term performance. It convinces investors that their investment strategies are foolproof.
Researched and authored by Illia Shliapuhin | Linkedin
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