A key lawyer has sounded the warning on activist shareholder campaigns against ASX-listed company boards, saying US funds are starting to take a keener interest in Australian companies.

Speaking to Star Investing a week after meeting with the UBS head of global activism and partners from Kirkland Ellis, Jeremy Leibler, partner at Arnold Bloch Leibler, said he left those meetings with one conclusion:

“To the extent that it’s [shareholder activism] not here yet, it’s coming — so boards need to be ready for it,” he said.

Rumours of big US hedge funds running more shareholder activist campaigns in Australia have been rife for years now, but recent developments have made their entry more likely according to Leibler.

“We’re starting to see them go into new much more difficult jurisdictions,” he said.

“They’re going into Europe, Japan, the UK — and if they’re going to jurisdictions where the regulatory framework is not nearly as friendly to activists as Australia, we can be sure they will come here.”

A recent report from Shulte Roth & Zable [PDF] backs up previous research from Arnold Bloch Leibler [PDF], and shows the level of activist campaigns against ASX-listed boards is on the rise.

The SRZ numbers showed that there were a record number of activist engagements in 2018, with 78 companies targeted — which is 28 percent increase on the previous year.

While high-profile campaigns make headlines, Leibler noted that in the majority of cases activist campaigns end with an agreement with target boards behind closed doors — so they don’t make it to the public eye.

So how do campaigns usually play out, and what makes the Australian market ripe for activist investors?

How an activist campaign plays out

An activist investor can be a good thing or a bad thing, depending on what their aims are and your own views on their campaigns.

On the one hand, activist campaigns can be run to essentially short the stock of target companies by bagging them out and aggressively selling their position.

In other cases though, shareholder activists are given room to breathe simply because shareholders have seen the share price of a company tank — and the activists have good ideas about how the company’s management can create better value for shareholders.

In each case, there’s a rough playbook.

  • An activist will start buying up a position in the company
  • The activist will approach the board, seeing if a deal can’t be struck between the two parties
  • If it can’t, the activist shareholder will circulate a white paper detailing the ways the company’s board has failed and why they should go
  • If no deal can be made, the activist will usually call an EGM (extraordinary general meeting) to spill the board and replace them with their own recommended members

Most campaigns have the aim of spilling the board, particularly at small cap level — and Liebler said this is where ego rather than value creation runs rampant.

The ex-CEO

Leibler described a scenario where a disgruntled ex-CEO or a CEO in conflict with the board may seek to run their own campaign against the company.

“A common scenario is that you’ll have a founder and major shareholder of a listed company, who may own 5 to 15 percent of the company — and perhaps once upon a time they were CEO and they were either sacked, or there were disagreements with the board,” Leibler explained.

“The CEO will decide that they’ve got a bunch of friends on the register, and he needs to re-ignite the ‘entrepreneurial spirit’ of the company and spill the board and replace them with directors who are more aligned with their strategy.”

With a bruised ego, the chairman of the target company may dig in simply because of hurt feelings — or because they genuinely believe the minority holders are trying to usurp the board without paying a control premium.

Whether the activist campaign is from a high net-worth holder, an ex-CEO, or a hedge fund, Leibler says recent developments have made Australian companies an attractive target.

“We have such an incestuous market”

Leibler said one of the biggest factors causing a board to surrender to activists with minimum fuss is that they were worried about the perception of being forcibly removed.

“We have such an incestuous market for independent non-executive directors,” Leibler explained — adding that it wasn’t so much a criticism as a fact of life.

“A non-executive board member is not going to want to risk the reputational damage which comes with being kicked off the board.”

When their next potential board appointment comes up, it’s going to be an issue and a cross against their name.

“Nobody wants to hire a director who just got kicked off a board,” said Leibler.

He thinks the large number of activist campaigns which are effectively settled out of the public eye meant activists are going to become more emboldened.

Meanwhile, other market conditions unique to Australia make it a great target market for activists.

Unique market conditions

Leibler said the ability for a shareholder to call an EGM to spill the board with just five percent of the register is a boon for activist shareholders.

“I think overseas activists find that fairly amazing…that they can call for that sort of meeting with such a small position themselves,” he said.

Jeremy Leibler
Jeremy Leibler

He also noted that the ‘two strike rule’ against remuneration reports was viewed by activist groups as a source of leverage against boards.

But Leibler said the largest factor making Australia an attractive proposition over the next few years is the large presence of superannuation funds, who take long positions in the market.

“We’re starting to see super funds like AusSuper dabble in this space — and they’re going to get involved in the space because the funds and the fund managers generally are under a lot of fee pressure,” he said.

“Investors are saying ‘why should I put money into your fund if you’re not actually doing a lot to drive value?’

READ: The case against passive investing

“They need to demonstrate to the market that they can deliver value to shareholders, and they can demonstrate that by being more actively engaged and less passive in issues to do with company administration and governance.”

It’s why Leibler thinks issues such as gender diversity are given such prominence in white papers issued by activists.

“You’ll see the first ten pages of the ‘white papers’ issued by activists focus on things like gender diversity,” he said.

“On the last page you’ll find ‘oh, by the way we want to break up the company.’

“It’s not because the activists care about gender diversity, and they should, but issues like that and other ESG considerations are longer-term considerations for longer-term holders such as super funds or index funds.”

READ: The rise and rise of ethical investing

Activists know that if they’re able to appeal to super funds and index funds, who are looking to take a more visible role in creating value, then they’re essentially half way there.

So, what’s a board to do if they know activists are going to take an increasing interest in the Australian market?

What’s a board to do?

Being the target of an activist campaign is particularly unpleasant, but there are measures you can take before and during a campaign which can dull their advances.

“You need to make sure your disclosures are up to date — what you’re telling the market is consistent with what your internal forecasts are saying,” Leibler advised.

“That’s where an activist can really pounce and create a picture of a company in disarray.”

He said constant communication with shareholders about the longer-term vision of the board and shorter-term matters were vital.

“The first time you’re speaking to your major shareholder shouldn’t be when the activist is knocking on your door,” Leibler noted.

Finally, he advised that boards not think of activists as big, bad wolves looking for a meal — but rather a source of mutual value creation.

While he warned against caving to activists’ demands immediately, there was no harm in at least hearing them out.

“Once the activist shows their hand, I think the best advice I can give companies is to engage,” Leibler said.

“Don’t dismiss them out of hand. Sometimes there’s a way forward with these things, and they can be resolved.”

 

The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Star Investing. Star Investing has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article.