Investors Picking Fights Enhance Value as Stocks Beat S&P 500Tara Lachapelle and Beth Jinks
Activists are turning out to be a shareholder’s best friend.
The often noisy investors such as Carl Icahn, Bill Ackman and Nelson Peltz -- who urge corporate heads to rethink their strategies and expedite stock-boosting changes -- generated a 48 percent average gain for shareholders of the companies they’ve preyed on in the last five calendar years, according to an analysis of 81 companies by Bloomberg News. That beat the Standard & Poor’s 500 Index, the benchmark gauge for U.S. stocks, by about 17 percentage points.
“Some people argue that the activist hedge funds benefit at the expense of the other shareholders, but that doesn’t happen,” said Wei Jiang, a Columbia Business School professor whose own study reached similar conclusions. “It’s not like they pump and dump and the rest of the shareholders suffer.”
Bloomberg News analyzed returns of U.S. targeted companies amid a wave of activist campaigns that has reignited debate about whether they are good for long-term shareholders. Last year, 369 companies were targeted, up 12 percent from the year before, according to Hedge Fund Solutions, affecting corporations as big as Microsoft Corp., PepsiCo Inc. and Apple Inc. The increase was fueled by an almost tripling of money flowing to the activist hedge funds over the past five years, to $93 billion at the end of 2013.
Activists take stakes in companies they deem undervalued and push for changes such as increasing dividends and share buybacks, cutting costs, shaking up management teams and boards or breaking up companies. In some cases they’re able to work out a truce with executives, and other times they turn to proxy fights to try to get their way.
Bloomberg News’s data looked at U.S. targets of activism since January 2009, measuring the stock price change from the day before the activist’s position was made public through Dec. 31, 2013. The companies had to have pre-activist market capitalizations of $1 billion or more.
In the six-month periods before the activists stepped in, these stocks had been trailing the S&P by about 8 percentage points on average, data compiled by Bloomberg show.
Winners for shareholders include Jana Partners LLC’s effort to break up McGraw-Hill Cos., Starboard Value LP’s activism at Office Depot Inc. and Elliott Management Corp.’s at Brocade Communications Systems Inc. Daniel Loeb’s Third Point LLC made money for investors in targets including Yahoo! Inc., while Ralph Whitworth’s Relational Investors LLC fueled stock gains at Illinois Tool Works Inc. Corvex Management LP successfully pushed for the sale of AboveNet Inc., handing investors a better gain than the broader stock market.
Among campaigns that lost some shareholders money were Icahn’s efforts at Nuance Communications Inc. and Ackman’s involvement with J.C. Penney Co.
The findings were embraced by activists including Icahn and Relational co-founder David Batchelder, who said in interviews their internal fund data showed targets continued to outperform the S&P 500 years after exiting the investments.
Such results, said Icahn, 78, may undermine arguments long-held by activist critics, foremost among them Martin Lipton, a founding partner of corporate defense law firm Wachtell, Lipton Rosen & Katz in New York and pioneer of raider repellents including the poison pill.
“It shows Marty Lipton is completely wrong, he’s been wrong for 30 years,” Icahn, billionaire manager of Icahn Enterprises LP, said in a telephone interview. “And it proves the short-termism argument wrong.”
Lipton, 82, said that studies showing benefits for shareholders are misguided and don’t consider how an activist’s campaign might push a company to take short-term steps that sacrifice longer-term objectives. He cited as an example a stock buyback that may result in more debt or less spending on research and development, hurting its prospects.
“The proper conclusion is that the kind of activism we’re talking about -- the kinds of things that Carl Icahn and Bill Ackman do -- does not lead to improvement in corporations over the long term,” Lipton said in a telephone interview.
A study published last year by Columbia’s Jiang, along with professors from Harvard Law School and Duke University’s Fuqua School of Business, disputes the contention that activism damages companies.
After analyzing about 2,000 activist campaigns launched by hedge funds from 1994 to 2007, Jiang’s team found that the target companies’ valuation and return on assets improved in the five-year period following the interventions. That means they were earning higher profits on less investment. Three years after the activists exited their stakes, shareholders still had positive returns.
The studies are showing that activists “are a bit more disciplined and a bit more patient than the perception,” said Chris Ruggeri, M&A services leader at Deloitte Financial Advisory Services LLP.
That perception stems from their lineage back to the so-called corporate raiders of the 1980s, who were seen as “barbarians climbing up the walls of the fort and to be deflected at all costs,” Ruggeri said.
While corporate raiders, including Icahn, were known for launching hostile bids to take control of companies, activists take smaller stakes, agitating for changes that will boost shareholder value.
One of the biggest winners of recent activism were shareholders of Fortune Brands Inc. Their money doubled after Ackman, who runs New York-based Pershing Square Capital Management LP, pushed to break up the company starting in October 2010.
Ackman’s campaign at Fortune led the company to sell its golf unit and split the rest into two publicly traded companies, Beam Inc., a bourbon producer, and Fortune Brands Home & Security Inc., a manufacturer of kitchen cabinets and door locks. Beam announced in January that it’s being acquired by Suntory Holdings Ltd. for about $16 billion, meaning that the reward to shareholders will be even larger.
Some activists including Trian Fund Management LP, Relational and ValueAct Holdings LP are more patient investors, often committing to years of corporate turnarounds.
“When we show up with strategic initiatives and a CEO rejects our ideas, we say ‘we’d rather be rich than right, convince us why we are wrong,’” said Edward Garden, Trian’s chief investment officer who co-founded the firm with Peltz and Peter May.
For more than a year Peltz, 71, has been trying to get PepsiCo CEO Indra Nooyi to separate the soda and snacks businesses after abandoning calls that it merge with Mondelez International Inc. She has repeatedly rejected the request, describing the moves as “financial engineering.” Peltz, whose fund owns 0.8 percent of PepsiCo, said on March 14 he remains committed to the change, even as the company’s stock underperforms the broader market.
“You’ve got to earn the right to be a conglomerate,” Peltz said in an interview. “The individual businesses need revenue growth similar to or better than their standalone competitors, and their margins better be best in class.”
The effectiveness of activism in recent years has emboldened usually passive institutional shareholders to increasingly back corporate changes. At Microsoft, ValueAct’s Mason Morfit and Jeffrey Ubben quietly garnered enough fund manager backing last year to gain a board seat and a say in the selection of a new CEO -- with a less than 1 percent stake. Microsoft shares have climbed 35 percent since ValueAct first disclosed its stake last April.
Some activist campaigns have hurt stockholders. Ackman’s Pershing Square exited its stake as J.C. Penney’s largest investor in August, after an effort to remake the retailer caused sales to plummet amid public spats and management reversals.
Over the course of Ackman’s three-year investment in J.C. Penney, the stock lost 58 percent, erasing about $4.6 billion in market value. Just weeks after Ackman quit the board and sold his stake, the troubled retailer issued stock that further diluted shareholders.
At ADT Corp., Corvex Management’s Keith Meister and billionaire investor George Soros urged the largest provider of home security to repurchase stock with borrowed money in late 2012. ADT ended up buying back shares specifically held by Corvex last November, and two months later the stock plunged because of disappointing earnings. Shareholders have lost 33 percent since Meister was paid to go away.
Activists can also be detrimental to bondholders. Their campaigns often involve returning cash to shareholders by increasing a company’s debt, according to Carol Levenson, director of research at Gimme Credit LLC in Chicago.
“Credit quality suffers, spreads widen, cash that could have been used in productive ways for all stakeholders is siphoned off to one group of stakeholders, and the financial risk profile of the company weakens,” she said.
Illinois Tool Works, Timken Co. and SPX Corp. are among those that, while their stocks increased, had their credit ratings lowered or were considered for a downgrade after Relational’s Whitworth or Trian’s Peltz agitated for changes, according to a study by Joel Levington, an analyst for Bloomberg Industries.
Still, Jiang of Columbia found that activism may not make companies more vulnerable to financial distress. The rate of bankruptcies during the economic downturn of 2008 and 2009 wasn’t higher for targets of activism than other companies, her study showed.
“If you are a public corporation and you get approached by an activist, and your advisers are telling you to light the torches, grab the pitchforks and man the perimeter, it’s time to get new advisers,” said Chris Davis, who heads the activist investor practice group at law firm Kleinberg Kaplan Wolff & Cohen in New York.