With the amount of activist investments on the rise during the last few years, more and more media attention is given to activist investors and the companies they target. Targets you probably heard about are Apple with Carl Icahn dining recently with Apple's CEO Tim Cook and pressing for increase of a buyback program, Daniel Loeb of Third Point pushing for corporate changes at Sotheby's and Sony, Bill Ackman and his huge position in struggling retailer J.C. Penney which did not work out so well or could even be considered a total disaster as an investment, Jana Partners position in grocery operator Safeway, and the list can be continued.
Many investors follow activists and copy them by investing in same companies. There is even a mutual fund that offers investors exposure to shareholder activism as an investment strategy. Overall, target companies certainly provide an interesting area to focus on and one where attractive investment opportunities could be found. However, it might not be so easy to replicate activists and achieve similar performance. Even though in general the interests of activists and other shareholders are aligned, the field is not without conflicts of interest.
Performance of activist investors
Tracking the performance of activist investors is difficult, but many academic studies point to outperformance. For example, IRRC Institute’s 2009 study of 120 companies – in which activist investors gained board seats during 2005 to 2008 – found that total shareholder returns were 19.1% to 16.6% higher than peers during a one-year period beginning from the proxy contest. Morgan Joseph & Co. tracked 94 campaigns over an 18-month period during 2005 to 2006, and found that excess returns for these stocks were 16% in the year following the first announcement of an activist shareholder’s involvement. Other studies also report similarly positive results.
Activists engage different types of companies, across different industries, and of various capitalization sizes: from small-cap to large and even mega-cap businesses. The majority of companies that become targets of activists are considered value stocks. For example, it is rare to see activists initiate investments in high-growth companies.
The most important role activist funds play is the promotion of shareholders’ interests. They often propose strategic, operational, and financial changes at companies. An academic study “Hedge Fund Activism, Corporate Governance, and Firm Performance” by Alon Brav, Wei Jiang, Frank Portnoy and Randall Thomas analyzed a large sample of activist campaigns between 2001 and 2006. They found that activist hedge funds attain success or partial success in two thirds of the cases.
“Hedge Fund Investor Activism and Takeovers,” an academic study by Robin Greenwood and Michael Schor in 2007, determined that firms targeted by activists are more likely to be acquired than other similar firms. An interesting observation the study makes is that although activist investors usually have rather long investment horizons, hedge funds’ objectives are to earn returns in as short a period as possible. Therefore, they are especially interested in finding merger and acquisition opportunities for the target company.
Activist investors have significant assets under management. The stakes that they acquire represent both large amounts of money and often are large portfolio positions. In such situation fund managers’ own reputation is at stake, and the level of responsibility they assume when making such investments is much higher than, for example, a mutual fund manager who manages a very diversified portfolio. Activist investors would not be able to do this if they did not conduct comprehensive research and analysis of the target company. Obviously, the resources they invest into this task are significant and are not typically available to an individual investor or even an institution.
Despite the disclosures and wide media coverage of the activist investor campaigns receive, it is important to have a sound decision making framework when following activist actions. Few aspects are important and will help make an informed decision. First, activists file the disclosures with SEC only when they reach a 5% threshold. During the period since they started accumulating shares and up to disclosure moment, the stock price often rises significantly. Once the requisite SEC documents are filed, the publicity in the market and media help move the stock price even higher. This makes the shares less attractive for investment.
Second, activist investors have different strategies and time horizons, so achieving good returns might not be as easy as just mimicking them. Third, clear understanding of the valuation thesis is important, instead of just relying on activists who “did their homework”. Fourth, pay attention to the type of an activist campaign. Campaigns which are more corporate-governance oriented may be an indication that the company is not managed well and that management might be corrupt and non-cooperative. In these types of cases, it might take a long time to fight management, gain board seats, and eventually to enact the necessary reforms. On the other hand, campaigns that call on companies to sell some non-core assets, distribute extra cash, or spin-off part of the business and focus on the performance of the main division, do not necessarily imply that management is corrupt. It is more likely that management will cooperate, and the campaign will unlock value for shareholders.
You can do well if you take activist investors and the companies they target as a starting point for research and analysis. Attractive investment opportunities could be found in this market niche. At the same time, a sober look will always help, paying attention not only to positive aspects but also to possible conflicts of interest and own merits of a specific investment opportunity.