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CAUGHT IN THE CROSS HAIRS: What to do when activist hedge funds come calling

Activist investors are targeting more and more companies to demand actions that they insist will increase shareholder value. While underperformance relative to peers can make a company vulnerable to intervention, activists now also target highly profitable small- to mid-cap companies that are cash rich, have low debt and have stable cash flow with a low book-to-market ratio. Activists also prefer to challenge companies that do a poor job of communicating with shareholders, especially regarding growth and capital allocation strategies. Such companies may, for lack of a strategic rationale, seem to be holding on to underutilized assets or underperforming business lines. So, what do management teams and their boards do to avert or manage an activist attack?

Managing activist risk requires excellence on two dimensions:

Corporate Governance.

The primary components include:

  • Management and the Board must ensure that the company has regularly updated strategic plans that are clear and convincing, as well as a disclosure policy that is consistently applied and levels the playing field for all investors. These plans are key because, at a high level, they provide the guideposts for the messaging that the company will want to communicate to shareholders. Maintaining a strategic focus in deliberations also enables the board to consider opportunities to enhance shareholder value – such as stock repurchases, dividend payments or transactions – without being placed under undue pressure. Strong emphasis should be given to near-term value drivers and distinctive company intangibles.
  • The Board should also regularly evaluate and update the company’s corporate governance policies and practices to appropriately reflect rapidly changing regulatory trends, global risk management, and corporate social responsibility best practices, evolving board composition tenets and SEC proxy access guidelines.

Tactical Planning and Execution.

This has several important facets:

  • Establish a team of relevant outside advisors that management and the board can call on in time of need. This includes legal, investor relations/communications, proxy and financial advisors who can serve as a sounding board for management and the board and who can facilitate timely response to activists, if need be.
  • Have a contingency communications plan to address the concerns of key stakeholders – employees, customers, suppliers and others – in the event of an activist episode. Be aware that communications with any of these audiences must be consistent across all audiences.
  • Identify and be aware of events, such as the announcement of an acquisition – in fact, any use of cash, or an announcement to issue more shares – that could trigger activist initiatives.
  • Actively monitor the shareholder base. “Forewarned is forearmed.” Retain an experienced proxy firm that can help you understand the voting histories of your various shareholders, as a large holding by institutional investors could constitute a risk factor. Likewise, hire an appropriate stockwatch firm to monitor trading activity. Knowing that activist investors are taking a position in the company’s outstanding stock may enable management and the board to address issues before they become contentious.
  • Monitor shareholder perceptions of the company. Management and the board should formally take the pulse of its shareholders at least every 18 months. This will enable the company to address issues as they arise, as well as understand what (mis)perceptions may be influencing investment decisions.
  • Ensure that the company establishes enhanced communications with the investment community through an effective investor relations program. Using proactive communications, the company should seek to develop a desirable base of shareholders, including retail investors and institutional investors with longer-term investment styles. The company should strive for transparency that clarifies the company’s value proposition as an investment.
  • Because activists often use key financial and business media to launch attacks, you need to be prepared to use the media strategically, too. Good relations with key media – The Wall Street Journal and Reuters, for example – enhance your ability to get your side ofthe story out quickly and accurately.

If the company is approached by activists, management should be the first point of contact and response, after the investor relations officer. If the activists want to talk to the board, a non-executive chair or lead director should hear – in a listen-only mode – what these investors have to say. Any response should be formulated with the assistance of the full board and the advisory group and should be as fully transparent as makes sense under the circumstances.

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