Why is there a lot of negative sentiment towards activist investors and Shareholder activists?

Of late, activist investors are grabbing a lot of negative headlines in the media by floating negative campaigns against the target company.

So who are Activist Investors and what is their role?

• Activist investors are firms that acquire large volume of shares of a company and become minority shareholder thereby getting a voting seat in the board.
• After gaining the board seat they try to bring changes in the functioning of the board and indirectly influence the way the management is running the company in order to generate profits on their investments.Once they book their profits they exit the board.
• Most of these activist investors are hedge funds or short term investors who hold the company shares for short period of time to generate quick profits.Some of the prominent activist investors are Elliot Management, Icann Investments and Starboard.
• The activist investors are very popular in US but now they are gaining prominence in other regions like Europe and Asia as well.

So how do Activist investors target companies?

• Activist investors targets companies that have strong business fundamentals but are currently facing a short term crisis.The activist investor feels that by stepping into the board role it can influence management to take corrective actions and generate shareholder value.
• For instance a company who is a leader in a business sector might grapple with excessive costs or does not focus much on its core competencies.The activist investor can influence the management to significantly prune its costs structure or hive off assets that are not core business drivers to the company thereby unlocking value and money that can be distributed to shareholders.

Role of a Traditional activist investors

Traditionally the role of an activist investors revolved around four basic tenets

• Corporate Governance - Analyzing the current corporate governance standards basically on ESG standards which are Environmental, Social and Governance to ensure if the company stays true to its role of change agent to society and environment. Recently the investors have tried to look at the organization culture and see if the working conditions are not hostile.It also looks at the competency of board and ensure all board members are competent and qualified to advise management on key issues thus protecting the interests of its shareholders. It also fights for gender diversity within the board to ensure that minimum representation of women are there.
• Corporate Strategy - The activist investor tries to understand the target business and its future strategy on how it intends to add value to the shareholders. It evaluates if the company is focusing on its core competencies and is able to adapt to the changing business conditions and what are its steps to gain market share and increase profitability
• Corporate Restructuring - The activist currently looks at the capital structure of the company and advise if any changes could be done.The investor would recommend management to buyback its excess shares if the business has excess cash reserves so that EPS of the company can increase.In some cases it demands excess dividend payments or to close it's long term loans with its debtors.
• Corporate M&A - The activist investors looks at M&A deals that the company is looking at and might encourage or block the deal depending on the benefits that it sees to itself and shareholders.It also demands management to spin off its non core assets to unlock shareholder value.In other cases it also looks at the bid it receives from another company for acquisition.In some cases it encourages the bid even if the management does not want to proceed.

Recent controversies

The activist investors have been in controversy in recent times and have been criticized for their ulterior motive to get profits against the long term interest of the company.

The classic example of this was in Cognizant case where under pressure from Elliot Management the management had to change their strategy which resulted in it losing significant market share to its competitors.

Curious case of Cognizant

• Cognizant is a growth company that provides IT outsourcing services to global organizations. The company core strategy is the labour arbitrage by which it hires significant workforce in India to provide services from offshore.
• Cognizant does not provide dividend payments to it shareholders but invests its retained earnings towards the growth of the company.The shareholders were also happy with its decision as this reinvested earnings helped in the growth of the company.Cognizant grew much more than its competitors over a 10year period from 2005 to 2015.
• After Elliot came into the board of Cognizant, it advised the company to spend the excess cash by going for share buybacks which Cognizant has never done in its history. Hence the excess cash that Cognizant could have spent on future growth of company by investing in M&A or next generation technology went towards the shareholder. Due to share buybacks the EPS of the company increased which in turn boosted the stock price.Elliot also forced Cognizant to focus on margins than revenues.Hence the company had to forego all bids that did not meet specific EBITDA margins thus losing many of these bids to competitors. Thus cognizant revenues dipped and was not able to meet its quarterly targets.Meanwhile Elliot had exited the company booking profits once Cognizant share price had increased.
• This resulted in entire revamp of Cognizant board and management with the entry of the new CEO.Cognizant had gone back to it's old strategy of capturing market share at the expense of margins and reinvesting its excess earnings towards future growth of company.

Conclusion

• Shareholder activism has been gaining prominence in recent past.In many cases it was seen that these investors had ulterior motive to book quick profits and was not aligned to the long term strategy of company.In many cases the activist investors had floated negative campaigns in the media against the company when the management does not approve of their requests.This is the indirect way of pressurizing the management to yield to their demands.
• With activist investors gaining prominence the management of the company need to find a way to how to react to such situations in future.The activist investors put their money when they see that the company is currently vulnerable to short term shocks.
• Hence the board and management needs to introspect and analyze their vulnerabilities and where they are going wrong so that corrective actions can be taken.
• The management needs to have a open dialogue with its key investors and share holders and understand their pain points and suggestion.Being receptive to their investors towards a constructive dialogue and explaining their point of view can go a long way in preventing ugly situations in future.