A number of activist funds are making significant investments coupled
with publicly-disclosed reports or letters praising managements and
boards of their target companies for a job well done.
by Ron Orol
Activist
hedge fund managers typically buy large minority stakes at targeted
corporations and agitate for M&A, spinoffs and stock buybacks. And if their
demands aren’t met, insurgent managers will escalate their efforts by writing
nasty fight letters and launching proxy contests to push companies into
acquiescing.
However,
in a move that many might find surprising, an increasing number of activist
funds are making significant investments coupled with publicly disclosed
reports or letters praising the management and board of their target company
for a job well done.
And,
in some cases, corporations are actually seeking out some activists to buy
large stakes and write positive reports because they believe the move will help
prop up a sagging stock price or protect against more aggressive insurgents
knocking at the door.
Industry
insiders call this kind of investment strategy “validation capital,”
and so far, it happens rarely. Even the few companies receiving this type of
attention may not be completely in the clear. A more traditional activist
campaign could be around the corner anyway.
Consider
Carl Icahn’s validation capital play in June when he announced-out of the
blue-that he had acquired a large position in Botox-maker Allergan plc (AGN).
The investment was coupled with a statement that he is very supportive of the
specialty pharmaceutical company’s CEO, Brent Saunders, and is confident in his
ability to enhance value for all shareholders. The investment was made shortly
after Allergan’s $150 billion megadeal with Pfizer Inc. (PFE) fell apart after
the Treasury Department issued new rules limiting cross-border tax-avoidance
deals.
However,
as with other validation capital-type investments from activists, Icahn’s
allocations with Allergan also come with some “suggestions.”
The
two had interacted with each other in 2011 and 2012 when Icahn had launched an
activist campaign against Forest Laboratories over a poorly performing stock
price and a lack of effective succession planning. Saunders later agreed to
become Forest Laboratories’ CEO.
Shortly
after the investment was made, Saunders had a phone conversation with Icahn.
The billionaire investor, Saunders told a governance conference last month
organized by The Street and The Deal, praised him for his involvement at Forest
Laboratories and concluded that he believed in Allergan, the management team
and wanted to make more money. After being pressed repeatedly by Saunders to
explain what he really wanted, Icahn acknowledged that he might push for
additional share buybacks after an authorized $10 billion share repurchase
program was completed.
Officially,
an Allergan spokesman said the pharmaceutical company welcomes and is grateful
for all investors-new or long-term-who recognize the value of its business.
Most
companies when they are targeted by an activist won’t get the pleasure of
receiving a validation capital type of investment. A much more likely scenario
a company will face involves having Icahn launch a more hostile campaign and
proxy fight, especially if there are share-price problems and unresolved
succession issues.
Still
other validation capital examples are out there. Trian Fund Management LP’s
$2.5 billion investment in General Electric Co. (GE) last year, an allocation
that came with a white paper mostly backing the industrial giant’s recent
moves, is a good example. Also speaking at the governance conference, Trian’s
founder, Nelson Peltz, noted that GE chief executive Jeffrey Immelt urged him
to make an investment in the aftermath of the multinational conglomerate’s
announcement that it was divesting most of its massive GE credit business. GE
is on the road to making over $180 billion in asset divestitures as part of an
effort that succeeded in substantially reducing its regulatory burdens in
Washington. Last month, the U.S. government moved to remove a
“systemically important” designation on GE that would otherwise have
saddled the industrial giant with significant regulatory costs.
However,
shortly after the massive divestiture plan was announced in April, 2015, Immelt
met with Peltz and expressed concern about GE’s stock price.
“We
met with Jeff and he said ‘Look, the stock went up briefly and came right back
down,’ and he said, 'I really want you guys as shareholders,’ ” Peltz
said. “I said, 'Jeff that comes with bite.’ ”
As
part of an effort to gain their backing, Immelt agreed to let Peltz and Trian
analysts tour a variety of the conglomerate’s facilities and meet executives.
After exploring facilities focusing on healthcare, power systems and aviation,
Trian produced an 80-page GE white paper released in October, which was
followed up by their large equity allocation.
“He
allowed us to visit every operation, meet with all the heads of the
businesses,” Peltz said. “And I don’t mean meet for an hour and have
a show-and-tell. We went to aviation and got there in the late afternoon, had
dinner with management, came back in the morning, met the rest of the
management team and we really spent close to 24 hours in Cincinnati to
understand some of the questions we had about where aviation was going.”
Trian’s
white paper mostly praised Immelt and GE’s divestiture move. However it also
had “some bite” as Peltz suggested, urging GE to take on greater
debt, hike its already mammoth share buyback program and consider joint
ventures or IPOs. And now that GE is de-designated it is a real possibility
that Immelt could start taking some of the actions Peltz is seeking, including
an incremental leverage hike.
One
potential point of contention: Peltz doesn’t want GE to make a large allocation
in biotechnology or any other new sectors or focus areas. “If Jeff were to
make a huge investment in biotech or something like that where they don’t have
any history and get a new vertical, we would be quite upset,” he said.
In
many cases, corporations threatened by an aggressive insurgent fund may seek
out a minority investment from a more collaborative activist or even a
reputable private equity firm, often referred to as “white squire”
investments.
Peter
Michelsen, partner at CamberView Partners LLC in San Francisco, suggests that
some of the more “constructive” activist firms have been sought out
by companies as a defensive tactic to preempt a more aggressive activist.
“These
investments are not common yet, but the question is, will they become more
common as the differentiation between constructive and aggressive activists
increases?” asked Michelsen. “For instance, when Relational Investors
was still active, their name came up several times in board discussions as a
possible 'tough but fair’ counterweight to a more aggressive activist such as
Icahn.”
Some
advisers suggested that Blue Harbour Group LP founder Clifton Robbins, or
ValueAct Capital Partners LP’s Jeff Ubben also fit the mold of validation
capital. Blue Harbour, for example, will make private suggestions for value
creation but buys stakes in companies only when Robbins supports the top
executives - and he will never launch a proxy contest.
In
addition, in some cases buyout shops have been pitching themselves privately to
companies, particularly in the technology sector, as long-term
“validation” investors. “PE firms can position themselves as
long-term investors with deep operational and industry experience, who can help
reduce pressure from short-term investors and provide some level of protection
against activists,” Michelsen said.
However,
companies considering these kind of investments have to consider what they will
do with the proceeds and how other shareholders will react to the investment.
“If you use the proceeds to buy back shares, the question is who is buying
in and who is selling out?” Michelsen asked. “If the company is
taking on a 10% investor that is friendly with management, who does not add
strategic value or operational expertise to the firm and the investment is
structured favorably for them, then it will likely be viewed by the rest of the
public shareholders as an entrenchment effort.”
However,
in some cases private equity validation capital helps protect the company from
an aggressive activist at the same time as it is embraced by the overall
shareholder base. Consider Symantec Corp. (SYMC), which was targeted privately
earlier this year by activist investor Elliott Management Corp.’s Paul Singer.
The fund, according to a person familiar with Elliott’s thinking, accumulated
Symantec shares in late 2015 and early 2016 and urged the cyber security
company not to use proceeds from a recent sale of its Veritas unit for
acquisitions and. instead, spend it partly on capital distributions to
shareholders.
Around
the time that Elliott was urging the company for buybacks private equity firm
Silver Lake Partners LP acquired a $500 million stake in February in the
Mountain View, Calif.-based cyber security company in a transaction that
included the installation of a director onto its board. The company agreed to a
$5.5 billion share buyback using funds partly from the investment and the
recent unit sale. Michelsen suggests that the deal helped ensure Elliott
wouldn’t escalate its campaign into a full-out proxy fight. The deadline to
nominate directors for Symantec’s 2016 annual meeting is Aug. 5, but a contest
is unlikely at this point.
“Silver
Lake was brought into the fold as an economic owner with a depth of
experience,” Michelsen said. “It is hard to argue that their
investment was not beneficial for the broader shareholder base. Silver Lake
will do a lot of work for Symantec.”
Another
potential validation capital example involves Cerberus Capital Management LP’s
investment in Avon Products Inc. (AVP) in December 2015. Avon agreed to sell an
80% stake in its North American operations to Cerberus and receive a capital
investment in return. In addition, Cerberus made a large equity investment in
the parent company through convertible preferred shares and added directors to
the company’s board. The investment came as a group of activists led by
Barington Capital Group LP’s Jim Mitarotonda pressed ahead with a proxy contest
that was eventually settled in a deal that allowed the activist fund to work
with Avon to identify one independent director for its board. The deal,
however, was a blow to Barington’s efforts to oust Avon’s CEO, Sheri McCoy.
Nevertheless,
Barington partner Jared Landaw said he viewed the Cerberus investment in Avon
as a strong positive. “They [Cerberus] bring to the table a talented team
and experienced directors that can help Avon unlock its value potential,”
Landaw said.
Some
corporations experiencing volatility also seek out Middle Eastern and Asian
sovereign wealth funds for investments as a form of long-term validation
capital. One of the most sought out validation capital investors, of course, is
the Oracle of Omaha-Berkshire Hathaway Inc.’s (BRK.A, BRK.B) Warren Buffett.
His investment is often sought out by companies when they are most
vulnerable-and his involvement also can discourage an activist from buying
shares and launching a change campaign.
“Having
a well-known value investor like Warren Buffett make an investment in a company
can be viewed as a catalyst in that you would expect that he wold be sharing
his views and experience with the company and they would be more inclined to
take action to unlock shareholder value creation with him there,” said one
activist. “Buffett may get the ear of the CEO and board.”
Probably
the most high-profile Berkshire Hathaway “validation capital”
investment was when Buffett’s firm made a large minority investment in Goldman
Sachs Group Inc. (GS) during the height of the 2008 financial crisis, as the
markets were imploding, in a move that was intended to calm the markets. Lehman
Brothers, which famously collapsed in 2008 expanding the economic meltdown, had
also sought out validation capital from Buffett, according transcripts from the
Lehman bankruptcy examiner, but failed to receive it.
“It
was about getting validation from Warren Buffett to say that everything was
alright,” Michelsen said.
Whether
it is Buffett, Peltz or Silver Lake, watch for more validation capital
investments in the months and years to come.