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Dec 06, 2015

Activist insights from the Delaware Law Issues Update conference

Institutional investors are taking time to distinguish between an activist's good case for change at a target company and unimpressive board candidates to drive that change

Tis the season – for corporate issuers to engage with their shareholders at a comfortable distance from the crush of proxy season, that is. That includes activist investors, much as some companies would prefer to believe they are not a target.

‘The biggest mistake companies often make is a hands-off stance toward any involvement by an activist,’ a managing director at an independent investment banking advisory firm said during a panel discussion on activism at the third annual Delaware Law Issues Update conference, held in Wilmington on November 18-19. ‘They may not be fully educated or have valid ideas about company strategy, but it’s incumbent on senior management to listen to them and, if there’s something [compelling], to take that to the board to be thought through.’

She reminded attendees that effectively dealing with activists includes having a plan to get the company’s message clearly out to shareholders.

It’s well known that activists are taking more pains with their own engagement efforts toward major shareholders of the companies they are approaching with strategy proposals or requests for a seat in the boardroom, to gain support for the changes they are pushing for.

‘We spend a lot of time talking to the company and the activist to understand their dueling narratives of both the history and the future [of the company],’ said the controller at a large institutional investment firm known for its indexed funds. ‘We get as much information as we can from commentators in the industry such as sell-side analysts. We leverage to a significant degree the active portfolio managers that [our firm] hires to run actively managed funds, who will often have a stake in – or point of view on – the company we’re looking at.’

When an activist fund has nominated an alternate slate of directors to a target company’s board, the controller said his firm evaluates the qualifications of directors on both the incumbent and dissident slates to affect value and assesses what the latter might do differently if elected.

‘What’s the case for change, taking into account competing visions of the company’s future? But secondly, who are the people who are going to make that happen?’ he asked. ‘An activist can show up with a great case for change but a really crummy candidate for the board.’

Having an activist on a company’s board can boost that board’s credibility with the broader shareholder base, a partner at a well-known activist fund said. His fund was an early investor in a variety store chain, and had a seat on its board, when the company was approached by two competitors with different acquisition offers in fairly quick succession.

‘[The company] rejected the bid by [the second competitor] out of concern that regulators would look at the deal as being anti-competitive,’ he explained. The activist fund’s board member was asked to accompany the CEO to meet with shareholders to sell the initial acquisition offer to them and it helped because many shareholders had not previously understood the anti-trust analysis that had been done on the rejected bid.

The panel concluded with a cautionary tale about internal communications. ‘One thing that made Sotheby’s eager to settle with Third Point after a court battle was the expansive discovery that admitted lots of harmful emails,’ the panel’s moderator said. Among the emails were some between directors outside of the boardroom who were raising many of the same issues as the activist hedge fund, such as questioning the CEO and whether the business strategy was maximizing shareholder value.