An increasing number of UK companies are being targeted by investors demanding change
Thursday 08 Aug 2019 Author: Ian Conway

Activist investing isn’t new, but the reason we’re hearing more about it is the activists themselves are getting increasingly savvy about communicating to the public.

Activists come in all shapes and sizes, from ‘lone ranger’-style individuals to the largest fund management and private equity firms.

On the whole, they tend to get results. They challenge long-held views and bring a new perspective to companies which have typically lost their way or their focus.

They also shake up boards who are meant to act as a counter-weight to management but too often are just a rubber stamp instead.

By targeting under-performing companies and forcing change activists typically unlock value for themselves and other shareholders. Not all campaigns are successful - no activist can fix a broken company - nor are they all popular, but without activists many investors would be worse off.

Anyone who wakes up and finds something in their portfolio now has an activist investor on the shareholder register should sit tight as there could be a good chance of value generation over the short to medium-term.

A BILLION-DOLLAR HAMMER

Nearly 600 companies around the world were subject to activist demands in the first half of 2019 according to activistinsight.com. Companies in the US and UK make up an increasing proportion of these campaigns.

With hundreds of billions of dollars of funds at their disposal, private equity firms are among the most prolific activists. As the saying goes, to someone with a hammer everything looks like a nail.

The UK has become an increasingly popular hunting ground as its stock market has under-performed most other developed markets in recent years, especially in dollar terms.

In most cases, activists tend to view having a seat in the boardroom as the most direct and effective way of implementing change, and more often than not these board seats are obtained through a settlement agreement with the company.

However, some activists take a much more aggressive approach, demanding a wholesale change of strategy or change of management in order to ‘unlock value’ for shareholders, including themselves.

HIDDEN VALUE

Activists typically target under-performing companies as there is little point in changing things at firms that are doing well.

One of the earliest and most successful US activist investors in UK stocks is the US firm ValueAct Capital.

In 2008 ValueAct became the biggest shareholder in software firm Misys with a 26% stake, having appointed a former partner to the chief executive role two years earlier. In 2012 Misys agreed a bid from US private equity firm, Vista, at a significant premium to the market price. Investors who followed ValueAct and bought into Misys could have more than doubled their money.

The same year that it sold its stake in Misys, ValueAct invested in process automation firm Invensys. Within months Invensys sold its railway business to Germany’s Siemens for £1.74bn, revealing how undervalued the company was (Invensys’s market capitalisation was just £1.8bn at the time).

In 2013 the rest of Invensys was sold to France’s Schneider Electric for £3.4bn, netting ValueAct and other shareholders further substantial gains.

MAGIC WAND

In late 2017, as shares in Merlin Entertainments (MERL) drifted back to their 2013 flotation price, ValueAct moved in and bought just over 9% of the company.

In May of this year as the share price dipped to the flotation price again, ValueAct broke cover and issued an open letter to the board of Merlin urging it publicly, as it had previously been pushing for privately, to look at options for leaving the stock market and being a privately-owned firm.

The activist argued that while Merlin was right to deploy growth capital given the opportunities to open more hotels and theme parks, the stock’s valuation and ‘excessive focus by analysts on near-term earnings per share rather than future free cash flow’ meant that a listing on public markets was no longer appropriate.

In fact Merlin was no stranger to private equity ownership, having passed through the hands of Apax Partners, Hermes and Blackstone, and in late June it succumbed to a bid from a consortium including Blackstone and the family owners of Danish firm Lego at a healthy premium to the market price.

WHEELS OF INDUSTRY

Another highly successful US activist fund is Elliott Advisors, which stepped up its activity in the UK dramatically last year pushing for change at nine companies compared with just one in 2017.

Among its successes, it backed the £8bn buyout of GKN (where it owned a 3.8% stake) by Melrose (MRO), the biggest contested takeover in the UK since Kraft bought Cadbury in 2009.

On the face of it, Melrose’s bid had substance. GKN was struggling and had issued several profit warnings in 2017, while Melrose had delivered a 3,000% return for shareholders since it floated on the stock market in 2003. However GKN insisted that its management could do a better job.

Elliott called GKN’s record on margin improvement ‘unimpressive’ and described the company’s turnaround proposal as ‘pure fantasy’. Melrose eventually paid a 40% premium for GKN netting Elliott and other shareholders a healthy gain.

SMELL THE COFFEE

Elliott was also successful in pushing Whitbread (WTB) to sell its Costa Coffee business to Coca-Cola for £3.9bn last year and continues to apply pressure on the firm to offload part of its £5.8bn property portfolio.

Whitbread’s Premier Inn chain has over 75,000 rooms yet unusually for a hotel firm it owns most of its properties. Elliott wants Whitbread to sell up to a quarter of its hotels and begin operating hotels for other companies.

Earlier this year Elliott surprised the market by taking a stake in retirement services firm Saga (SAGA) whose shares have fallen over 75% since floating in 2014.

The over-50s insurance brand is strong but the group is unlikely to attract a buyer when it includes over £500m of cruise and travel assets so splitting the two would make sense. It’s also not clear that insurance and travel have strong synergies except in the obvious case of travel insurance.

Homegrown activism

Most UK institutions, along with shareholder lobby groups like Institutional Shareholder Services (ISS) and Pensions and Investment Research Consultants (PIRC), are only activist in the sense that they use their position to hold companies to account over corporate governance issues such as executive pay and board diversity, as discussed in our feature on ESG.

Crystal Amber Fund (CRS:AIM) on the other hand is a listed company which invests in under-valued UK companies, typically between £100m and £1bn in size, specifically ‘to promote measures designed to correct the under-valuation’.

It uses its own screening processes and network of contacts, including shareholders, to find stocks which are cheap on ‘replacement value, cash generation ability and balance sheet strength’. The fund looks at a business ‘as is’ and ‘as it could be’ if shareholder value were maximised.

Most of the fund’s activism takes place in private although it says ‘we are willing to make our concerns public when appropriate’. A recent example was the public battle with van-hire firm Northgate (NTG) where it demanded the removal of the chairman Andrew Page.

The fund described Northgate as ‘a fundamentally good business with enviable positions in each of its markets, but (which) suffers from the inadequate stewardship provided by the board led by Mr Page, which is preventing it from achieving its true potential’.

Page left Northgate in March of this year, after which Crystal Amber increased its shareholding. The full year results released in June showed strong growth in vehicle hire and profit leading to a sharp rise in the share price, although the shares since have relinquished some of their gains.

DON’T TALK, JUST EAT

In some cases activist investors may own shares in two companies and try to engineer a merger for their own advantage. The decision by fast-food delivery firm Just Eat (JE.) to merge with Dutch rival Takeaway.com looks to be a case in point.

Since the beginning of the year US activist Cat Rock Capital has been highly critical of Just Eat’s management, regularly posting open letters on its dedicated website justeatmustdeliver.com.

Cat Rock described itself as ‘a long-term supporter’ of Just Eat, while at the same time it owned shares in Takeaway.com. When Just Eat was demoted from the FTSE 100 last year after losing 30% of its value, it decided to intervene.

Despite Takeaway.com being a much smaller business than Just Eat, shareholders in the Dutch firm will own just under half of the merged company which seems like a poor deal for minority owners of the UK firm.

Also the price which Takeaway.com has offered is less than half the multiple of profits that it paid for another food delivery business just last year.

While on paper Just Eat shareholders will own a small majority of the merged company, ultimate control clearly rests with Takeaway.com with the corporate headquarters being located in Amsterdam and the chief executive of the Dutch firm taking over the same role at the new business.

The net result is that Cat Rock has grabbed itself a bigger slice of Takeaway.com by using its Just Eat holding as leverage. UK shareholders of Just Eat are being offered shares in the enlarged Takeaway.com, which the company hopes will be admitted to the premium segment of the main UK market, but on much less attractive terms than they might have hoped.

PREPARE TO REPEL BOARDERS

US activist Coast Capital, the biggest shareholder in UK bus and rail firm FirstGroup (FGP), has mounted a high-profile campaign to turn the business around and correct the share price slide of the last few years.

Coast claims that the poor performance of FirstGroup’s shares relative to those of its closest peer National Express (NEX) is the result of mis-management due to almost no-one on the board having experience in the surface transport industry.

In June it proposed replacing FirstGroup’s chairman, chief executive and four other board members with its own candidates. Despite shareholders voting more than four-to-one against its proposals, the chairman has since stepped down, two more directors have announced their intention to leave and the shares are trading towards the highs of the year.

The fight is far from over though. Coast wants FirstGroup to sell its US rail operations and First Student school bus division and focus on its home market while the management wants to spin off its UK bus arm, so it looks as though there is plenty more mileage in Coast’s campaign.

The inside view

Russell Fradin, partner at US private equity firm Clayton, Dubilier & Rice, believes that more often than not activists are right and management doesn’t want to face it.

‘When I recently joined the board of a public company, I asked them if they’d looked at how an activist would attack them. If a company hasn’t, that tells me it’s not on their minds. What do you think the activists would be picking on? If management is not open to that alternative viewpoint, it’s not a good thing.’

Michael Carr, co-leader of global M&A at Goldman Sachs, agrees. ‘Many shareholder activists make a living out of criticising companies’ portfolios of businesses, and there are times when they’re absolutely right. It’s extremely disruptive to your organisation when you sell a business, but everybody has to make those hard decisions. The best CEOs have the guts and the ability to sell businesses that aren’t earning their cost of capital’.

‘If you feel that your business is starting to degrade, or the market in which it operates has some structural challenges, you need to act. You need to be your own activist. Get ahead of it, because otherwise you won’t have enough time to put together the necessary effort to beat the clock.’

Interview in McKinsey & Co Quarterly, August 2019

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