By Chris Young
Back in the day, mergers and acquisitions advisers routinely viewed transactions as "in the bank" immediately upon the announcement of a deal. Indeed, deal conference calls were usually filled with congratulatory back-slapping from stock analysts as junior investment banking staffers planned elaborate closing dinners at tony steakhouses. True, regulatory concerns could occasionally scuttle a deal, but the shareholder vote (yawn) was usually a foregone conclusion.
But today, thanks to leadership provided by hedge fund activists, a shareholder vote can be very much in doubt. Consider the multibillion-dollar Novartis (NVS ) buyout of Chiron (NVS ) earlier this year. Chiron stockholder opposition to the buyer's "best and final" price resulted in hundreds of millions of dollars in incremental value received by target shareholders. Despite the common perception of hedgies as fast-money operators bent on corporate destruction, examples such as Chiron indicate ordinary investors can benefit from activists' "selfish" efforts.
How have we gotten here? A confluence of trends has conspired to alter the dynamics of dealmaking. First, high-profile M&A disasters like the AOL-Time Warner (TWX ) merger and numerous academic studies together have established a new conventional wisdom among investors that a significant percentage of deals destroy shareholder value. Even if most M&A indeed creates value, investors today will go out of their way to ensure that destructive transactions are not ratified.
SECOND, HIGH-PROFILE SCANDALS of the '90s, such as Enron, WorldCom, Tyco International, (TYC ) and the like, have made shareholders more cynical about the decision-making process of boards of directors. Investigations into conflicts inherent in investment banking's business model have left a cloud over advisers' objectivity. (Think Jack Grubman at Salomon Smith Barney.) Fairness opinions by such experts-for-hire were finally seen for what they have been all along: nothing more than insurance policies for the board.
Lastly, investors and regulators began to pay more attention to how fiduciaries were voting shares. Today, institutional shareholders who consistently defer to management (the modus operandi of the past) may be accused of abdicating their fiduciary duties.
Only a spark was needed to ignite the new "power to the shareholders" zeitgeist. Enter the hedge funds. With their growing economic clout (an estimated $1 trillion in assets under management worldwide), they've become the catalyst for the new world order of M&A and proxy fights. Unlike their more inhibited counterparts, the so-called vanilla asset managers, hedge funds are anything but wallflowers.
To be sure, left-leaning pension funds have long taken activist stands on pet peeves such as golden parachutes or the labor impact of a proposed deal. Hedge funds, however, maintain a laser focus on shareholder value. After all, fund managers get paid 20% of any shareholder value they can "help" create. For some funds, doing the "Wall Street walk," or selling shares when things go awry, is the coward's way out. Especially during periods when markets move sideways and volatility is low, activist investing potentially provides a better path to alpha. Why wait for an investment thesis to pan out when you can accelerate the process via activist pressure?
Such thinking is even spreading to an unlikely quarter: normally quiescent asset managers. These powerful constituents have long preferred to work behind the scenes if they were unhappy and sell their shares if their concerns were not remedied. But lately, "vanilla" managers have taken the first tentative steps toward activism. In the Chiron buyout, dissidents were joined by Citibank's (C ) asset management arm, proving an imprimatur of legitimacy to the activists' cause. To the extent that other traditionally passive investors follow that lead, the power of the M&A vote to rock management's world will only increase.
So, for the time being at least, it appears that boards will have to come to terms with activists looking over their shoulders on each and every proposed deal, acting as a market check more powerful than any regulatory scheme. And yes, shareholders free-riding on the activist coattails should remember to thank the hedgies for the extra return.
Views expressed in Outside Shot are solely those of contributors.
Chris Young is a Director of M&A Research at Institutional Shareholder Services