BHR: Episode 1
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What Is Activist Investing
12 OCT 2017 - Activist investing is one of the most widely talked about yet least understood concepts in global markets. WSD Capital Management’s Ertan Enginalev shares his views on the importance of activist investing while addressing the following questions:
- What are activist investors?
- Are activist investors good or bad?
- How do activist investors work?
- What do activist investors do?
- What do activist investors want?
Ertan Enginalev: “From WSD Capital Management: Welcome to Benevolent Hostility Review. I’m your host Ertan Enginalev.
With a number of major proxy contests coming to a head, activist investing is once again back in the news cycle, prompting the all too familiar question:
What is activist investing and why does it matter?
It’s an important question and one I got asked quite a lot back when I was starting out.
Mainly because I was the first activist investor in Turkey and one of only a handful of U.S. activists active outside the U.S.
But also because, back then, to most executives, activist investing was still this black box full of misconceptions that had to frequently be addressed.
In any case, back in university, there was this football player that would sometimes walk around campus in a lava lava sarong. Big, tall guy. Hard to miss. He played defense for the school team. They won a national championship.
His teammates used to call him “Dewey” but today people call him “The Rock”.
And while he’s obviously a huge movie star now, there’s an arc to his Hollywood career that he doesn’t generally talk about.
Today, most people see him as a role model for hard work and sheer determination. You know, if you put your head down and work hard, you too can make it to the end zone.
Which is true but there’s a crucial step that most people miss or at least gloss over.
Before “The Rock”, there wasn’t really anyone who had achieved his level of success by crossing over from wrestling. In fact, most wrestlers ended up being fads. Here today, gone tomorrow.
What most people don’t know is that the long-term outlook for Dwayne’s career wasn’t really all that different.
And to his credit, he understood this better than anyone.
And so he did something very few people in his position are prepared to do.
Admit he had to change and then do what needed to be done before his ascend started to stall.
Which meant firing his entire team and setting course on a path that played to his potential.
If you’ve watched any of his movies post “Tooth Fairy”, you probably know what I’m talking about.
So what does all this have to do with activist investing?
Well, most people - and by extension most companies - favor the status quo.
It’s only when the wheels start to come off, people start to react.
In most instances, that’s too little too late.
Truth is, changing strategy mid game is never easy or pain free but when you know that’s what needs to be done - that’s what you should be doing.
The longer you wait, the more painful it will be.
And it’s this “reactionary gap” that activist investors seek out to press management to make necessary changes.
And while shareholder activism and company responses have changed quite a lot since Ben Graham launched his campaign at Northern Pipe Line back in 1926, the core objective and thinking remains more or less the same. Which is to bring more rigor to target companies and engage passive institutional investors in the process.
An important aspect that fails to get the attention it deserves is that activists do not operate in a vacuum.
To successfully engage target companies, they need to persuade other investors to support their plan since activists tend to be minority shareholders, holding a small percentage of a company’s shares while the greater part is owned by pension funds, mutual funds and other types of institutional investors.
Without their vote of confidence, any activist engagement would be short-lived.
Put another way, activists do not own, control or manage the corporations in which they invest. Instead, they rely on the support of not only the target company’s shareholder base but also - in many cases - its other stakeholders, to address key issues that can range from operational underperformance to capital inefficiencies to weak corporate governance.
The reason activists are such an important intermediary in global equity markets is that pension and mutual funds tend to be ineffective monitors of corporate governance issues due to conflicts of interest and reputational risks.
Activists are unique in that they maintain more concentrated portfolios and are subject to fewer reputational and headline risks.
And while contentious campaigns tend to attract the most media attention, it should be noted that most activists prefer to approach companies privately in an effort to address issues in a more collaborative manner.
The prevailing wisdom of target companies, however, is that dealing with an activist investor is like running an election campaign. And like election campaigns, most engagements and proxy contests have a long history of demonstrating the value of negative campaigning which is a rather unfortunate strategy.
Case in point, since our firm’s inception, we’ve launched only one public campaign which is still considered to be one of the most successful campaigns of the last 20 years. Not only because the share price of the target doubled in less than a year, but because the broader market index was negative.
Nonetheless, despite the proven benefits of shareholder’s economic engagement, target companies will argue that activist investors foster short-termism by preventing management from making long-term investments needed for sustainable growth.
The reality is many activist investors advocate strategies that require substantial time to implement with durations measured in years rather than months.
There’s also the added pressure that time frames can be fickle and prone to change between an initial proposal for a change at a target company and the actual acceptance and implementation of the change by management.
The key for success is to formulate changes that do not impair long-term value creation for the sake of short-term gains.
After all, that sort of ‘hit-and-run’ approach would not be in the interest of any stakeholder, least of all institutional investors with a long-term approach and the sway to make or break a shareholder activist campaign.
I hope this addresses some of the questions and misconceptions surrounding activists and activist investing. It’s a fairly simplified and condensed overview and there are certainly a lot more intricate aspects worth analyzing in detail, some of which we have highlighted on our site for those interested in this subject.
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