It’s been more than four years since Jim Pantelidis fought off his most recent attack from an activist shareholder, but the memory still makes him angry. As the chair of Enercare Inc., defending the company became a full-time job. “It was all-consuming,” he says.
The battle became public at 9:36 a.m. on July 17, 2014, when an obscure American hedge fund known as Augustus Advisors released a blistering letter to shareholders, declaring its intention to take Enercare private. Augustus said its buyout partner had been working behind the scenes for a full year, pleading with Enercare’s board to submit to a takeover. The company had once been a promising, albeit boring, business, renting water heaters in Ontario, but its stock had floundered, down 35 per cent from its peak seven years earlier. Because Augustus controlled the single largest block of Enercare’s shares, the fund felt justified in shaking things up.
This wasn’t Pantelidis’s first tussle with activists. In 2011, New York-based Octavian Advisors had launched a public proxy contest to install four new directors on Enercare’s board and take on roughly $140-million in debt to fund a special dividend. “There was nothing short of capitulation that they would accept,” says Pantelidis. “They were trying to hijack the company.”
To bat Octavian away, Enercare spent millions of dollars on legal and public relations advice, and endured months of cross-Canada meetings with institutional investors. It worked. In April 2012, shareholders voted down the activist's proposal.
But the peace was short-lived. Augustus began managing Octavian’s stake, and just two years later, it went public with its own plan for a buyout of Enercare. There had been plenty of similar battles in the wake of the 2008 financial crisis, when activist investors stepped up their efforts to dismantle stodgy boards and toss out incompetent leaders, all in the name of shareholder profits. They’d won some early accolades in Canada after improving results at two iconic companies, Canadian Pacific Railway and Maple Leaf Foods. Yet those victories had spawned so many copycats that the crusaders were looking much less altruistic. In fact, there was a growing fear that activists were using their influence to manipulate stock prices for short-term gains.
Pantelidis outmaneuvered Augustus by acquiring a sister company to give Enercare extra heft. Soon after, its stock price eclipsed the $13.50 to $15 a share the activists had offered. With the pressure off, Enercare put together a multiyear turnaround plan that included expanding into the United States. This past August, Brookfield Infrastructure bought the company for $3.1 billion, in a friendly deal worth $29 a share – double Augustus’s bid.
Enercare may have gotten the last laugh, but the activist trend has only accelerated. In 2018, activist funds broke the record for number of campaigns in a single year – 922 globally (75 of them in Canada), according to Activist Insight, compared to just a handful in 2003. Most of their targets were small- and microcap companies. But giants like eBay, Manulife Financial, Campbell Soup and others all came under attack in the last year, with varying results.
Why the explosion? In part, it’s because passive investing has become an existential problem for asset managers. Thanks to the longest bull market on record, index investors in Canada have enjoyed average total returns of 10 per cent over the past decade and paid next to nothing in fees. Hedge funds, meanwhile, have delivered about half that, while charging much more – often 2 per cent a year, plus 20 per cent of any extraordinary profits.
With the industry under siege, activism is seen as one of the few remaining ways for fund managers to deliver alpha – returns that beat the broad market – without deploying a huge amount of capital. By acquiring, say, 10 per cent of a company and agitating for substantial changes, they can affect the share price and net a tidy profit. (Private equity firms, meanwhile, usually have to buy entire companies, for a premium, and are stuck holding the bag if their revamps go awry.) By mid-2018, the activist sector had amassed US$128-billion in assets under management.
Not long ago, the activist mission was to call out poor governance, excessive pay and outright fraud. Lately, the motivation behind many of these campaigns has grown murkier. With so much money sloshing around, sometimes it's hard to tell who's truly out to fix a company and who wants to make a quick buck. At the same time, the sector is struggling to justify itself. Over the past decade, activist funds have, at best, matched the performance of the S&P 500, according to Activist Insight. “Unless a board is absolutely incompetent,” says Pantelidis, “activists seldom, from what I've seen, come up with any new ideas.”
Do these new-age barbarians at the gate actually create value, or have they simply corrupted the market they set out to save?
Two strains of modern activist investors emerged in the mid-1980s. In one corner of the market, corporate raiders like Carl Icahn and T. Boone Pickens began to shake up stagnant companies, often by borrowing boatloads to fuel hostile takeovers. Then there were the institutional investors intent on cracking down on bad governance – which sometimes meant punishing boards for giving in to the raiders too easily. Although they could be at odds, these two strains shared a common vision: As shareholders, they were owners, and they wanted to use that power to make changes.
Over the next decade, activists took on blue-chip players like Kodak and General Motors. At IBM, CEO John Akers was booted after the company lost its way, leading to a US$5-billion loss in 1992 and 100,000 job cuts over three years. When pushing for his ouster, California’s largest pension fund circulated a 14-page indictment of the company’s governance: “IBM was once the most respected company in the world,” it said, but “now looks to the future with shareholder satisfaction and employee pride reduced to contempt and shame.”
By 1994, the activist movement had made a significant mark. Directors knew they could no longer act like monarchs; shareholders had proven they were the ones in charge, and boards had started listening to them. “All-out war is no longer needed,” John Pound, who led a shareholder research group at Harvard, told The New York Times that year.
But in the ashes of the dot-com bust, activists started rumbling once again. In 2005, Bill Ackman bought a sizable position in Wendy's International and urged the chain to spin off Tim Hortons. A year later, he pushed for changes at Canadian Tire that included spinning out its Mark's Work Wearhouse chain.
The activist renaissance picked up speed after the crash of 2008, and when it did, two campaigns put Canada close to Ground Zero.
The first was the 2010 battle at Maple Leaf Foods. In August of that year, a small but powerful Canadian fund called West Face Capital, led by Greg Boland, acquired a 10 per cent stake in the company. Maple Leaf had finally come through the listeria crisis, during which 22 people died, and it planned to spend $1.3-billion to update its meat-processing facilities. But before the company could start, West Face launched a proxy contest that pitted Boland against Maple Leaf’s CEO, Michael McCain, and its powerful board, which included veteran corporate lawyer Purdy Crawford and a number of friends of McCain’s father, Wallace. Boland’s aim was to install hand-picked directors who were independent of the McCain family and to curtail the expensive revitalization plan, which Boland thought was unlikely to boost the company’s fortunes.
Boland eventually won a board seat and used his position to persuade Maple Leaf to slash its modernization plan in half. The company’s shares soared, and by the time Boland sold his stake in 2014 for $300-million, he’d doubled his investment. McCain, meanwhile, held onto his job.
Fred Green wasn’t so lucky. As West Face was wrapping up its campaign at Maple Leaf, Ackman and his fund, Pershing Square Capital Management, were taking aim at CP Rail, whose board (led by former Royal Bank CEO John Cleghorn) had allowed Green to post poor operating results for years, along with the worst operating efficiency of the Big Six North American railways. Ackman spent $1.4-billion to amass a sizable stake in the Canadian giant that grew to 14.2 per cent.
The plan was to take control of the board and replace Green with Hunter Harrison, the former chief of CP’s archrival, Canadian National Railway. The campaign turned nasty quickly. In January 2012, Ackman sent Cleghorn an e-mail with the subject line, “War and Peace.” In it, he darkly wrote that his campaign could turn into “nuclear winter.”
Ackman had just come off a humiliating defeat in his campaign against Target Corp., which he called one of “the greatest disappointments of my career to date,” and his reputation was wounded. But CP’s board failed to see that its own shareholders were fed up and desperate for change. Two pension funds – the Ontario Teachers’ Pension Plan and the Canada Pension Plan Investment Board – sided with Pershing, and in an astonishing capitulation, six of CP’s directors, including Cleghorn, agreed not to stand for re-election. Harrison was installed as CEO a few months later, and over the next two years, CP’s stock more than doubled.
The optics of both victories were powerful, because they showed that even Canadian giants could be shaken up. Activists came out looking like altruistic warriors, battling for common shareholders. “This is about restoring the balance of power back to the owners,” Ackman told The Globe and Mail in 2012. “The activist acts as the tip of the spear and is willing to take the body blows.”
Boards were forced to do some soul-searching (or at least some balance-sheet-scouring). They also drew up playbooks for how to engage with activists if they ever came knocking, often relying on an emerging cottage industry of strategists to counsel them. The common advice: Do everything CP didn't.
Money started to pour into activist funds. In 2003, there was about US$12-billion invested in the sector globally, according to HFR Industry Reports, which does research on hedge funds. By the end of 2014, that figure had multiplied almost tenfold, with most of the growth coming after 2009.
As the market grew crowded, it became harder to decipher each fund's motives. Were they in it to kick out do-nothing boards, or did they care more about quick wins and profits? In a research report early in 2015, bankers at JPMorgan warned that the influx of money could force funds to manufacture campaigns just for the hell of it: “This significant inflow of capital into the asset class comes with immense pressure to put capital to work quickly and in ever-larger campaigns.”
That speculation proved to be bang-on.
Bill George has long been among the most vocal critics of shareholder activism’s underbelly. The Goldman Sachs director and former CEO of medical device-maker Medtronic is all for activism in principle, but he worries that many investors are in it for a quick payoff and nothing else. “If a company is moribund and not going anywhere, I say go in and shake it up,” George says by phone from Minneapolis, where he is based. What he sees, though, are activists “almost intentionally attacking well-run companies.”
His career path helped fuel this skepticism. George rose through the ranks at Litton Industries and Honeywell International, determined to become an executive. By the late 1980s, however, “I looked at myself in the rearview mirror, and what I saw was a miserable person,” he told a Minneapolis magazine in 2017. It had been too easy to boost profits by firing workers and closing divisions. “I realized I was more focused on getting the top job than on the work I was doing,” says George. “I wasn’t building anything – I was just taking things apart.”
A similar argument can be made about activists, and George has been making it for years. In 2009, he even called out Ackman live on CNBC, lambasting him for his failed campaign against Target, on whose board George had served until 2005. Lately, though, George has grown incensed. Around 2014 the market for activism exploded and major funds started holding serious sway. By the end of that year, more than 10 activist funds each managed over US$10-billion, according to HFR. Executives dared not irk them for fear of being targeted.
What really bothered George was that some activists wouldn’t even acknowledge what they were up to. It all seemed like a game. In 2014, Dan Loeb of influential activist fund Third Point floated the possibility of dismantling drug giant Amgen, “which seemed to me like a ridiculous idea,” George says. He said as much publicly. Soon after, the two men met for the first time at the World Economic Forum in Davos, Switzerland.
“Are you Bill George? How could you say that? I didn’t say to break them up – I just said they should consider breaking up,'” George recalls Loeb telling him. George was gobsmacked. “Come on,” says George. “You go out and make a public statement about that, you go out and buy [some] of their stock? Don’t kid me.”
Activists also had a habit of glossing over the chaos they could create. In the summer of 2012, New York-based Jana Partners started spending more than $1-billion to amass a 7.5 per cent stake in Agrium Inc, and over the next nine months the two fought bitterly, with Jana hoping to install directors on Agrium’s 12-person board. The fund went so far as to suggest that Agrium consider splitting into two companies – one for fertilizer production and another for retail agricultural products. Ahead of the pivotal annual meeting in April 2013, Jana head Barry Rosenstein took some nasty public shots at Agrium, arguing that dismissing activists like him amounted to corporate governance from the 1960s. “It’s like watching an episode of Mad Men where all the doctors are smoking,” he told The Globe.
In the end, Agrium prevailed. But the company’s CEO, Michael Wilson, was so disgusted by all the energy and money the battle had sucked up that he gave a warning about the state of activism: “Based on what I’m seeing, this is the new wave – people who are looking for short-term gain versus long-term gain.”
Riding high on his CP Rail victory, Bill Ackman followed up with a campaign against Herbalife, an American multilevel marketing company that sells vitamins and protein bars. Ackman’s thesis was that Herbalife was little more than a pyramid scheme, with the company pushing often low-income clients to sell the stuff to their friends. He shorted the stock and tried to persuade regulators to intervene.
The battle turned ugly through 2013 and into 2014, and Icahn – who had never been a fan of Ackman’s – took the other side of the trade, saying Herbalife had “a legitimate business model, with favourable long-term opportunities for growth.” The pair sparred publicly, including during a now infamous segment on CNBC, during which Icahn called in to counter Ackman, the show’s guest. “Ackman has done pump-and-dumps. He’s got one of the worst reputations on Wall Street,” Icahn argued on live TV.
But Ackman was on to something. In 2016, the U.S. Federal Trade Commission fined Herbalife $200-million – though it stopped short of classifying it as a pyramid scheme. Nonetheless, the stock continued to climb. By the time Ackman finally unwound his short position last year, he was deep under water. After he first bet against the company, the stock plunged below US$25 per share. By the time he exited, it had jumped to US$94. Pershing investors got crushed.
The failure was even more spectacular at Valeant Pharmaceuticals, which was first targeted by activist ValueAct Capital way back in 2006. ValueAct helped install Michael Pearson as CEO, and he turned Valeant into a serial acquirer with a habit of jacking up the prices of drugs it now owned. Under scrutiny in 2015, the company nearly collapsed, and the stock plunged more than 90 per cent from its $346 peak. ValueAct had cashed out US$1-billion right before things went bad, so it didn’t fare so badly, but other activists had piled in on the way up, including Ackman and John Paulson. Ackman and his fund lost US$4-billion.
In a recent investor presentation, Pershing disclosed its annual gains and losses. Anyone who invested at the end of 2012, in the wake of the CP Rail victory, had almost the exact same amount at the end of 2018. Putting that same dollar into the broad S&P 500, meanwhile, would have nearly doubled their money. Ackman declined to comment for this story.
Many rival funds have also suffered in the last few years. Jana Partners, which went after Agrium, hasn’t beaten the broad stock market since 2013. The fund’s assets under management peaked at US$11-billion in 2015, but investors have since fled, and at the end of 2018, Jana managed less than half its record total.
This all seems to lend credence to a 2015 report by the Wall Street Journal, which set out to assess the merits of the activist boom, studying 71 campaigns against companies worth US$5 billion or more. The result: “Activism often improves a company’s operational results – and nearly as often doesn’t.”
Despite a number of colossal disappointments, activists are, somewhat miraculously, a bigger force than ever – and they’re only getting more aggressive.
Elliott Management, founded by Paul Singer, has become the most feared activist fund in the world, a reputation it earned when it bet on Argentinian debt and tried to seize one of the country's war ships after a government ruling hurt its investment. More recently, Elliott has been accused of flashing a six-inch-thick dossier during a meeting with directors that purportedly contained dirt on them and their families, and unearthing the old divorce records of a CEO it was hoping to get fired and allegedly leaking them to the media. (Elliott has denied these allegations and declined to comment.)
This unscrupulous behaviour has encouraged some investors – including short sellers, a subset of the activist movement – to test the boundaries. Carson Block and his fund, Muddy Waters LLC, is generally respected for exposing fraudulent companies; Canadian investors will remember him for calling out the sham that was Sino-Forest in 2011. Yet, last October, Muddy Waters released a scathing report on insurance giant Manulife Financial.
The campaign was unusual for Muddy Waters, because it had nothing to do with fraud or bad governance. Instead, it revolved around a lawsuit against Manulife (filed by a fund called Mosten) that was launched to exploit a potential loophole in decades-old insurance policies. As Muddy Waters claimed, the contracts allowed their holders to deposit an unlimited amount of money with Manulife and receive a guaranteed annualized return of at least 4 per cent. Block predicted the losses “could reach the billions” if Manulife were to lose the court battle and be forced to adhere to these terms. Asked why he had taken on this cause, given that it didn’t match with his history, Block told The Globe this past October: “Sometimes the fraud thing gets a little bit old.”
Block stands by the campaign against Manulife, arguing in an e-mail in early March that it's an important type of activism “because management has actively concealed this information, or has made outright misrepresentations, or even told lies.”
Manulife sees it differently. “The Muddy Waters report was a short seller's attempt to spread misinformation and confusion in order to profit at the expense of our long-term shareholders,” the insurer wrote in an e-mail. “We believe that Muddy Waters' continued exaggerated characterization of the Mosten matter is a textbook example of unrestricted behaviour by a selfacknowledged short seller.”
Even West Face's Boland, who still firmly believes activists have an important role to play in policing companies, says their tactics can be overused. “When your investment strategy is to be a hammer, then everything looks like a nail. That pressure leads to ill-founded campaigns,” he says. “Activism is a tool, not an investment strategy.”
He hasn’t given up on the idea because far too often, the only way institutional shareholders can voice their frustrations with management is by selling their shares, even though they might see potential for improvement. That’s where activism can be useful – if it’s done thoughtfully.
The trouble is that thoughtfulness is a rare commodity these days. Given the state of activism, companies sometimes focus too much on making themselves activist-proof. This worries Marty Lipton more than anything else. The veteran corporate lawyer is widely viewed as a dean of Wall Street and has been dealing with disrupters for decades – he created poison pills in the 1980s to thwart that era’s corporate raiders.
After defending these types of attacks for so long, he has concluded that the biggest threat activists pose is a cumulative one. As activism expands, he says, “all companies look at their strategy and their portfolio of businesses as an activist would. They adjust their operations and strategy to try to minimize the exposure to an activist attack, which is far more important than the attacks themselves.”
“There are companies that are not well managed, and every now and then an activist comes along and points that out, and actually does improve it,” he concedes. “But most of activism is financial engineering.”
After watching activists rack up some early wins, the advice given to boards of directors was to embrace them – show some love, maybe even offer a few board seats. It helped – a lot. Many campaigns are now settled privately, with the public never even hearing of them. It’s much less disruptive for everyone involved.
But that strategy only works if the activists give a damn about the ultimate fate of the company. What if they don’t? Regulators can’t simply ban activism, because for all the trouble it might cause, these investors can play a crucial role, particularly in small-cap markets that tend to be overlooked by watchdogs. In that way, activism is a bit like democracy – sometimes maddening, but perhaps the best option we’ve got.
“Making broad, general statements about activism or those who engage in it is a mistake,” says Zach George, a Canadian who runs FrontFour Capital in Greenwich, Connecticut, and whose recent targets include small Canadian real estate companies. “Each situation and strategy should be assessed on a case-by-case basis.”
The criticism that irks him most is the claim that all activists are out to make a quick buck. “The notion that activists are only focused on short-term results and thinking is a tired and false narrative,” he argues. “It is commonly used by defence advisers during campaigns and by corporate leaders who are incentivized to defer accountability for their own poor performance.”
That’s the rosy view. In reality, there’s a huge role for institutional investors to play. Some of the world’s largest money managers have already joined forces to preach the value of long-term investing, with the likes of BlackRock Inc. and CPPIB coming together to create a not-for-profit called Focusing Capital on the Long Term (FCLT). In a recent report, BlackRock CEO Larry Fink warned that “we’ve become mesmerized by the possibility of short-term, one-off gains.” Activism, at its worst, has exploited this failure.
To counter this fixation, the group emphasizes the power of incentives, especially with compensation. “If you’re paid to be short-term, you’ll be short-term,” says Sarah Williamson, who runs FCLT. Before joining the organization, Williamson ran alternative investments for Wellington Management, which oversees US$1-trillion in assets.
The harder task is retraining investors to think years, or even decades, out. Williamson says behavioural economics has shown that humans aren't good with trade-offs, “and we really don't do a good job with trade-offs over time.” That makes it tough to persuade investors to forgo some short-term profits.
But she’s optimistic. “I don’t think this is an impossible problem to solve,” she says, “because the long-term companies actually do better for their shareholders. The long-term investors actually do better.”
Recent research from Willis Towers Watson calculated that investors leave 0.5 to 1.5 percentage points of returns on the table each year by focusing solely on short-term results. That might not seem like much, but it's a lot in an era where money managers are competing with index funds, and it's even more when compounded over multiple years.
Already there's been some progress. Last year, behemoth money manager T. Rowe Price published its “Investment Philosophy on Shareholder Activism,” a key element of which reads: “The time frame we apply for decision-making in activist campaigns is a multiyear view.” The firm has let it be known that it has little interest in quick profits.
The hope is that more managers speak up in the same way. Because if investors with real sway starve the bad activists of oxygen, the mess might just sort itself out.
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