Rob Swystun, Pristine Advisers
Activist investors target companies with poor performance, right? But, what exactly constitutes poor performance?
Ava Seaves, principal and co-founder of consulting firm Quantum Media, and a teacher at Columbia Business School and Columbia Journalism School, shed some light on this in a column for Forbes recently.
With the help of “wisdom from consultants, investors and academics in the field” she identified five triggers that serve to paint a target on firms for activist investors.
- Below Optimal Operating Margins
Having lower operating margins than peer companies is a sign of weakness that activist investors are attracted to like the proverbial sharks to blood. Also, if a larger company that should have advantages of scale when compared to its peers only has comparable margins to those smaller peers, that is another sign that is sure to attract activist investors.
- Unprofitable growth
I’ll let Seaves handle this one: “When a business without barriers-to-entry invests in growth, it does so on higher-than-market terms. In addition, without barriers, other companies can just enter as they please to make it even harder to earn decent money. … In short: investing where costs grow faster than revenues is a map to future stupidities, and a good thing for an activist investor to put a stop to.”
- Inappropriate Capital Structure
Building fancy, but unnecessary offices, holding onto excess cash and running frequent restructuring charges can funnel investment resources away from things like products that are core to the company’s business and that need investment to grow. This type of inappropriate handling of capital can bring activists calling.
- Price Wars
“Companies that don’t understand legal cooperation within their industry and find themselves in a price war are vulnerable as they destroy their profits,” Seaves says.
- Poor HR Practices
A company that is going through a constant cycle of hiring and then having to lay people off (not counting seasonal hires) rather than just not hiring in the first place, set themselves up for added expense and unnecessary expansion. This is a demonstration of poor human resources management. Lack of succession planning is also a demonstration of poor human resources management, which can equal activist investing.
What attracts activists to these five targets is that they give ample evidence that activist investing is needed within the company. If activists try to proceed without any evidence of at least one of these triggers, things don’t always work out for them.
Despite all that we hear and read about them, it turns out that activist investors may not be quite as prevalent as the media and hack bloggers (ahem) make them seem. Seaves points to a CNBC interview in 2014 with Ken Squires, founder of the activist investor research firm 13D Monitor, who says activism gets a lot of coverage in the media, which leads some people to believe it’s virtually everywhere. His company, however, covered 78 companies in its 2013 research that had activist 13Ds. A lot of those so-called activists were amicable and working with management. According to Squires, the percentage of companies being targeted by activists “now is much lower than 2%.”
What the Companies and Activists Say
As for what companies and activist investors themselves believe attracts the activists, the Shareholder Activism Insight Report interviewed 50 U.S. senior executives and activist investors. The group ranked the importance of what they considered the main attraction to a company for shareholder activism. The top ranked catalyst? The vague-sounding “financial performance.”
Any of these five triggers can paint a virtual target on a company. By staying on top of good governance practices and competent management, a company can help stave off any of activist investors who look like they’re circling in the water.