Predators Are Good for Stocks
Carl Icahn, Bill Ackman, Nelson Peltz, and other activist investors are turning out to be a shareholder’s best friends. Stocks of companies targeted by activists from 2009 through 2013 gained 48 percent on average as of the end of last year, according to data compiled by Bloomberg. That beat the Standard & Poor’s 500-stock index 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,” says 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.”
Activists take stakes in companies they deem undervalued and push for changes such as higher dividends, share buybacks, cost cuts, management shake-ups, and sometimes the breakup of companies. A look at 81 U.S. targets of activism from January 2009 to the end of last year shows that in the six-month periods before the activists stepped in, these stocks had been trailing the S&P 500 by about 8 percentage points on average.
Last year activists targeted 369 companies, up 12 percent from the year before, according to Hedge Fund Solutions. Among the companies they challenged were Apple, Microsoft, and PepsiCo. The increase was fueled by an almost tripling of money flowing to the activist hedge funds from investors over the past five years, to $93 billion at the end of 2013.
Martin Lipton, a founding partner of corporate defense law firm Wachtell, Lipton, Rosen & Katz, says the studies showing benefits for shareholders are misguided because they don’t consider how an activist’s campaign might push a company to take short-term steps that sacrifice longer-term objectives. As an example, he mentions stock buybacks, which can result in more debt or less spending on research and development. “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,” he says.
Icahn and David Batchelder, co-founder of Relational Investors, say their internal data show that stocks of companies they targeted continued to outperform the S&P 500 many years after they sold their stakes. “Marty Lipton is completely wrong. He’s been wrong for 30 years,” Icahn says, “and it proves the short-termism argument wrong.”
A study published last year by Columbia’s Jiang, along with professors from Harvard Law School and Duke University’s Fuqua School of Business, supports Icahn’s argument. After analyzing about 2,000 activist campaigns from 1994 to 2007, Jiang’s team found that the target companies’ valuations, including return on assets, improved in the five-year period following the interventions. Three years after the activists exited their stakes, shareholders still had positive returns. Activists “are a bit more disciplined and a bit more patient than the perception,” says Chris Ruggeri, mergers-and-acquisitions services leader at Deloitte Financial Advisory Services.
Among the biggest beneficiaries of recent activism were shareholders of Fortune Brands, who doubled their money after Ackman’s Pershing Square Capital Management pushed to break up the company. Ackman’s campaign, started in October 2010, led Fortune to sell its golf unit, then split into two publicly traded companies: Beam, a bourbon producer, and Fortune Brands Home & Security, which makes door locks and kitchen cabinets. Beam announced in January that it’s being acquired by Suntory Holdings for about $16 billion.
Although he abandoned his call for PepsiCo to merge with Mondelēz International, Peltz is still trying to get PepsiCo Chief Executive Officer Indra Nooyi to separate the soda and snacks businesses. She has repeatedly rejected the request, describing the moves as “financial engineering.” Peltz, whose fund owns 0.8 percent of PepsiCo, says he remains committed, even as the company’s stock underperforms the broader market. “You’ve got to earn the right to be a conglomerate,” Peltz says. “The individual businesses need revenue growth similar to or better than their standalone competitors, and their margins better be best in class.”
Some activist campaigns have hurt stockholders. After Ackman’s investment in J.C. Penney, the stock lost 71.1 percent through December, as the company switched strategies and sales plummeted. Corvex Management’s Keith Meister and billionaire investor George Soros urged ADT, the largest provider of home security systems, to repurchase stock with borrowed money in late 2012. ADT ended up buying back shares held by Corvex in November, and two months later the stock plunged because of disappointing earnings. Shareholders have lost about 30 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 for research at Gimme Credit in Chicago. “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 says. Illinois Tool Works, Ingersoll Rand, and Timken are among machinery companies that saw their stock prices rise while their credit ratings fell or were considered for a downgrade after activists 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. Chris Davis, who heads the activist investor practice group at law firm Kleinberg, Kaplan, Wolff & Cohen, says management should keep an open mind. “If you are a public corporation and you get approached by an activist,” he says, “and your advisers are telling you to light the torches, grab the pitchforks, and man the perimeter, it’s time to get new advisers.”