It seems that barely a week goes by recently without new reports of a new activist investor position in a London-listed, often FTSE 100, firm. Activist investors have built stakes in British corporate heavyweights including GSK, Unilever, Aviva, Taylor Wimpey, Glencore and Shell, to name just some of the most notable.
Valuations often rise after the involvement of a major activist investor is announced. The market presumes that if an activist investor sees the company as an attractive proposition it must be undervalued. And that the demands made by the activist investor will unlock shareholder value that will benefit all investors.
The criticism of activist investors is that they can think too short term and demand changes that, yes, may increase a company’s value significantly now but to its long term detriment. Activist investors typically have a time frame of a few years during which they want to buy into a company failing to fulfil its perceived potential for investors, apply pressure for changes, and then sell out again at a significant profit when markets approve the changes.
The reality is both can be true. Like private equity ownership of companies, there are examples of activist investors aggressively pushing for changes that unlocked short term value at the cost of long term stability. And there are other examples of an activist investor being just what a company needed to shake it out of its torpor and return it to dynamism and growth.
Here we’ll look in a little more detail at what defines an active investor, if existing investors should generally be pleased or not when one shows up, and, if so, how to pre-empt which companies are most likely to be targeted.
What is an active investor?
An activist investor is, as the name suggests, an investor whose intention is to take an active role in determining the company’s strategy and influencing key business decisions. The approach stands in contrast to the passive approach of the vast majority of shareholders, retail and institutional, who don’t have the time, experience, resources or inclination to agitate for specific changes.
Activist investors also need to have a large enough stake in the company and a reputation for driving change that benefits shareholders for their voice to carry weight. To successfully instigate changes in strategy that were not in the board or management’s immediate plans, or even to provoke changes in leadership, activist investors have to convince other investors to support their demands.
Passive investors like index trackers with holdings in hundreds or even thousands of companies don’t have the resources to so actively involve themselves in company strategy and operations, even if they can have a voice. That means they can often be quite happy for an activist investor to arrive on the scene if there has been a feeling the company has underperformed or failed to come close to its full potential.
Activist investors are businesses trying to maximise their earnings and profits, which are realised through selling stakes in public companies at a considerable profit to the price they paid for them. There is no set time horizon for that investment and activist investors can stay around for the long haul, especially if they succeed in getting seats on the board and persuading the company to accept their demands.
But in a majority of cases, activist investors will have a shorter time horizon than long term investors and seek to make their profit over 3-5 years.
Why are London-listed companies currently so attractive to activist investors?
London-listed companies have been a favourite hunting ground for activist investors for a few years now. The main reason is that they have looked good value compared with international peers listed on other major international exchanges.
Brexit uncertainty turned international investors off UK equities and saw growth lag other markets. The strong underlying fundamentals of many London-listed companies has convinced activist investors valuations might anyway outperform international peers as the market rebalances to take account of their continued post-Brexit performance.
Source: The Times
Another factor in London’s favour, from the perspective of activist investors, is that the majority of shareholders in most public companies are passive index investors. Compared to European peers, few London-listed companies have large blocks of shares owned by management-friendly investors like family offices, which can thwart the demands made by activists.
On the contrary, passive index investors like pension funds are often receptive to activist investors willing and able to devote the resources to identifying how more value can be unlocked for shareholders. They can be easier to convince to support the activist’s agenda with their votes than other more active investors, who might have conflicting ideas and opinions.
Why do boards dislike or fear activist investors?
Boards, chief executives and even chairmen tend to have a hostile attitude to activist investors for the simple reason that they place their jobs under threat. By default, an activist investor’s involvement in a company is an implicit criticism of its management’s performance.
By acquiring a stake and making demands for change, the activist investor is saying they feel the company’s leadership has failed to optimise shareholder value. That position can either be stated aggressively alongside a list of demands. Or it can be approached from a more collaborative position in a softer style through working with management and attempting to reach consensus.
And it’s not always the case that chief executives can be seen as to blame for a company’s underperformance. It’s not unusual for activist investors to come into a company at precisely the point it has recently made changes in senior management. It can be seen as a good moment to gain influence and work with the new sheriff in town while they are still working out their strategy and may be more open to ideas.
But even in the latter case, a company’s new management would probably rather not have the added pressure and input of an activist investor breathing down their necks and likely to issue public criticism if their demands are not met.
Whether the approach is aggressive and noisy or more diplomatic and collaborative, an activist investor continually scrutinises management decisions and the quality of their execution. Regardless of how the commentary and advice are presented, does anyone with some level of faith in their ability enjoy the presence of a back seat driver?
Should other shareholders be happy about the involvement of an activist investor?
As mentioned, passive investors can see positives in the appearance of an activist investor. Even if the approach can sometimes be seen as personal and aggressive, there are occasions when companies might generally need the application of some pressure if new ideas have run dry and inefficiencies ingrained.
Shareholders asking questions of capital allocation, cost management and if they are really being handed their fair share of profits is never a bad thing and shows stock markets are working. There has been concern the growing influence of passive capital has meant the management of the largest public companies is not always under the same level of pressure to attract demand for their stock as was once the case – simply being part of a major index generates huge self-fulfilling demand.
Activists can help turn talk into action and prevent failings from being swept under the carpet.
But, ultimately, does the presence of activist investors genuinely improve shareholder returns? The American consultancy Alvarez and Marsal conducted research in 2021 that showed the share price of companies subject to activist campaigns over the three years to February 2020 outperformed the market by 3.6%.
Of course, activist investors are not universally right in their presumptions of what is needed to improve a company. Other investors should not just blindly support proposals for change put forward by an activist investor. Last year shareholders in the energy company SSE pushed back against some demands made by the especially feared activist Elliott, describing calculations they were made against as “back of a fag packet”.
How to spot probably activist investor targets
The fact that the share price of companies often leaps on news an activist investor has appeared on the scene means investors can be keen to try to spot upcoming targets. A strategy of only investing in a company in the belief it is likely to attract activist investors who will help turn its performance around would be inadvisable. There are obviously no guarantees that activist investors will buy into the company or that they will succeed in driving management to unlock greater shareholder value.
But some of the questions to ask about a company that might offer clues it could attract either an activist investor or a potential acquisition bid to push up its valuation are:
- Is the business really suited to life as a public company?
- Does it have a poor track record of shareholder returns?
- Does it have any undervalued divisions that can be sold?
- Are there poor-performing divisions?
- Is it time for the whole business to sell up?
- Does it have a new chair willing to make more dramatic moves?
- Does it have an efficient balance sheet?
- Are its shareholders likely to welcome change?
There is a high likelihood London will continue to be a favoured destination for activist investors over the next couple of years with the management teams of plenty of potential targets still to experience the often unwelcome tap on the shoulder.
