The market was stunned when a tiny activist hedge fund, Engine No. 1, that owned just 0.02% of ExxonMobil’s stock, won two seats on the company’s board. After a final proxy count, the hedge fund added another board seat, bringing their total to three. Engine No. 1 dealt this major blow to ExxonMobil by convincing other investors, including much larger institutional investors and hedge funds, that the company needed to shift away from fossil fuel and strengthen its efforts to combat climate change.
This “David versus Goliath” story highlighted not only the growing global concern about climate change – but also the significant impact even a small activist shareholder can have on a company’s board and long-term strategies. And, at a cost of millions of dollars for both sides and a damaged reputation for ExxonMobil leadership, it also shows why public companies of all sizes should be prepared for this potential event.
How We Got Here
Activist investing is not new; in fact, it dates back to 1926 when Benjamin Graham wrote a letter to Northern Pipeline laying out actions the company could take to gain more profits that could be distributed to shareholders in the form of dividends. When the company denied his request, Graham solicited votes from his fellow investors and ultimately the dividend was paid.
Activist investing grew in the 1980s, with the rise of corporate raiders whose strategy was to break up companies by winning control of the board through proxy fights. Investors like Carl Icahn and T. Boone Pickens became well known for forcing companies to increase value or pay the activists to go away.
Fast forward to today, where activist investors are primarily not individuals, but hedge funds and institutional investors such as pension funds, insurance companies and endowments seeking to pressure management for change. Recent activist targets have included Kohl’s Corporation, Walt Disney Company, Comcast, Intel and Twitter, to name just a few of the nearly 200 activist campaigns in 2020 and early 2021. While Engine No.1 won its seats on the ExxonMobil board through a proxy fight, most changes in board seats are secured through negotiated settlements that avoid costly proxy campaigns.
Should an activist investor approach a company, all eyes will be on the executive team’s response and how they manage through the situation. The stakes are high. An activist investor issue brings a multitude of variables that could impact the company’s future, stock price, confidence in management, relationships with other investors and employees, as well as the company’s reputation in the industry and with its customers and communities.
While the criteria activist investors use to identify targets varies by company, their goal is primarily to pressure the leadership team to make changes that would increase the company’s share price and benefit the activist investor.
Some of the areas activist investors look at in targeting a company include:
- Share price
- Financial performance compared to peer group
- Capital structure; preferred stock, debt
- Operational issues
- Dividend policy, stock buy-backs
- Mergers and acquisitions
- Use of cash
- Long-term growth strategy
- Corporate governance; executive compensation
- Effectiveness of leadership team
- Board composition and diversity
- Specific issues such as climate change, diversity and inclusion, product safety
Baseline Vulnerabilities Assessment
While most companies appreciate the importance of having a crisis communications plan in place, many of these plans do not address the company’s unique vulnerabilities from the perspective of an activist investor. We recommend companies undertake a third-party assessment that provides an objective look as an activist investor would see it – before the activist takes a position or reaches out. This view identifies potential weaknesses and risks which may attract an activist investor, as well as strengths that could be used to combat an activist approach. The assessment then leads to developing a list of possible activist demands, as well as company preemptive actions and responses.
Activist Communications Playbook
Many companies are caught off guard or wait until and activist investor surfaces before even starting to prepare their responses. These companies are at a distinct disadvantage in a fast-paced crisis that can significantly impact the company’s future. Being prepared with an activist communications playbook in place will provide defense narratives, processes, messaging and materials that management can immediately implement should the need arise.
Many companies test how the playbook could work through a crisis drill or tabletop exercise that simulates an approach from an activist and enables the team to see how it would work together in determining responses and actions. This exercise can then result in improvements to the playbook and the response process.
Activist Trends 2021 and Beyond
As the ExxonMobil activist campaign highlighted, some activist investors not only want to increase shareholder returns, but also want to support broader environmental, social and governance (ESG) issues.
In response to shareholder activism, some issuers are adopting shareholder rights plans or “poison pills” aimed at giving management more time to respond to an activist approach.
Whatever the coming year will bring, it’s clear that shareholder activism will continue to be a force in the markets and in the direction of numerous public companies. And to borrow a line from Benjamin Franklin, when it comes to defending a company against an activist attack, “An ounce of prevention is worth a pound of cure.”