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Activist Investors - Friend or Foe?

By Rayna Penelova

Few things can get CEO’s hearts racing like the news that an activist investor has just purchased a stake in their company. Activist investors are a class of market participants who are quite controversial and often mentioned in the media. Recently, we received a request to explore this topic and in doing so we will present to you both the criticisms and the advantages associated with them.

Activist investors are individuals or entities who buy a substantial number of shares in a company and later put pressure on the management team to make changes such as environmental actions, changing product lines, divesting a part of the business or changing compensation structures. In most cases, those changes are aimed at unlocking shareholder value and increasing the stock price of the company in question. As we can see from the graphics below (provided by Activist Insight online,) they include campaigns across a variety of sectors and company sizes.

Activist Investros by Size                  Activist Investors by Sector

To provide further perspective, Elliot Management, the largest activist investor, conducted 24 campaigns in 2018, targeting companies in Europe, Asia, Australasia (Australia and Asian countries) and North America, while also having the ability to acquire entire companies.

Let’s start with the negative part so we can finish on a positive note:

Corporations have other stakeholders, in addition to their shareholders. A company affects its employees and the community in which it operates, in addition to the impact it has on its shareholders’ portfolios. Any action a company undertakes will likely impact one or more of its stakeholder groups and could, eventually, affect the company’s perception among all stakeholders. When an activist investor selects a target, it often pressures the company to undertake uncomfortable or unpopular actions. For example, if a company is pressured to close a manufacturing plant because of its level of profitability, this may generate significant negative publicity for the company and unwanted regulatory attention due to the number of jobs eliminated. In addition, its products may face diminished demand and, as a result, the share price may suffer as well.

Activist investors often have a near term goal to realize a profit on their initial investment as soon as possible. By doing so, they may hinder a company’s long-term prospects and, therefore, its future share price. The short-term benefit may derail the long-term vision for a company.   To return to our earlier example, if a company operates a plant that is marginally profitable but has the potential to produce a new innovative  product, currently in the research and development stage, then by selling the manufacturing plant the company will jeopardize its long-term success.

So who likes activist investors?

CEO’s and executives tend to get paid more for managing larger companies. Therefore, they may not be inclined to sell an unprofitable segment simply because that would diminish their own compensation. Activist investors can force a company to be more prudent with company resources and to be nimbler with changes that realize shareholder value. They can act as an added layer of oversight on CEO’s. Activist investors essentially act as a check and a balance on management. They can be an effective tool to fight complacency within management teams and boards of directors who are often not incentivized or who are afraid to confront the CEO.

Of course, the real question is: What is the track record of these controversial activists?

When it comes to return, over the past five years activist investors have been performing in line with the S&P 500. However, they have increased their assets under management by 1400% between the 2003-2004 and 2016 periods, according to the World Economic Forum.  This allowed activist investors to target 922 companies in 2018, compared to 607 in 2013, an increase of 51.9%, according to Activist Insight. You can find more on the topic on:  https://www.weforum.org/agenda/2018/09/activist-investors-more-powerful-than-ever-wider-economy/.

It turns out that, as in most things, there are two sides to this coin and activist investors can play both a negative and a positive role in our economy. They usually focus on the short term and can sometimes be detrimental to the long-term health of a company and they tend to disregard other stakeholders which can lead to other problems. On the other hand, they are a unique and rare check on CEOs, voicing concerns with management when few others have the ability to do so.

All data was sourced from:

https://www.weforum.org/agenda/2018/09/activist-investors-more-powerful-than-ever-wider-economy/

and:

https://www.activistinsight.com/resources/reports/

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