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Activist funds will need to enhance their own value in 2019 as redemptions accelerate
21 Dec 2018 10:45 pm
This has been a record year for activist funds in terms of campaigns launched and board seats won. But for fund performance, it’s been the worst year since 2011, leading to an accelerating outflow of investor capital.
The pressure to add value to their own portfolios will hang over the activist industry in 2019, influencing choice of targets and tactics.
According to financial advisory firm Lazard, there have been a record 240 campaigns so far in 2018 against companies with a valuation over $500 million, compared to 194 for all of 2017. Activists have won 160 board seats, up from 100 in 2017 and the previous high of 145 in 2016.
But while pressing companies to enhance value, the activists themselves have spurred losses. The HFRI Activist Index, which tracks funds in which activist investments make up at least half of their portfolio, was down 5.52 percent year-to-date as of Nov. 30, versus a gain of 2.4 percent by the S&P 500 during that period.
It’s the index’s worst performance since 2011, and only the third loss on an annual basis in the Index’s history, with the other being in 2008. Additional stock market losses in December have likely driven the index down further.
Meanwhile, investors redeemed an estimated $9.1 billion in the third quarter from event-driven funds, which include activists, accelerating from a $3.1 billion net outflow in the second quarter, according to HFRI.
In the words of one proxy solicitation adviser, “There is a sense out there that a lot has been achieved, but as an industry they need to prove they can continue to outperform.”
So in 2019, activists are expected to try to do more with less, using their reputations rather than money to force changes, and seeking quicker returns by encouraging companies to monetize assets rather than forcing out management teams in expensive proxy fights.
Using reputation, not money
One expected cost-saving strategy is funds using their oversized influence to push companies to change, even when holding a small stake, rather than employing their money in expensive proxy fights. In a recent example, Trian Fund Management, headed by Nelson Peltz, issued a 42-page white paper Oct. 25 calling for paintmaker PPG to oust its CEO and launch strategic review.
At the time, Trian held a 2.9 percent stake in PPG, far smaller than the 5 percent or more typically needed to launch an activist campaign. But PPG’s stock rose almost 14 percent in the weeks following the announcement as investors bet on Trian's reputation for forcing change.
Second bite of the apple
Activists spend much of their time and resources researching targets and developing relationships with management. So as share prices fall, expect to see funds focus on companies where they already have an established stake and board seats, including buying more shares, agitating for change on the inside and, if needed, resurrecting previously settled proxy campaigns.
Carl Icahn, for example, has upped his positions in several of his underperforming portfolio companies. Most recently, he bumped up his stake in consumer-productsmaker Newell Brands to nearly 10 percent to take advantage of a 24 percent decline in the company’s share price.
Trian, headed by Nelson Peltz, has spent years watching its investment in General Electric lose money. While staying silent on the matter, due to having a seat on the board, recent management changes and reports that GE has filed paperwork for an IPO of its healthcare unit are signs that Trian is making its presence felt.
Starboard’s recent public attack on Cars.com, despite still operating under a standstill agreement from a settlement reached in March, indicates a second proxy fight with the activist may be in the offing.
Asset sales over management change
Activists typically look for two traits when picking a target: a management change to shake up a company or assets to monetize.
When the US market was at record-high valuations, activists tended to focus on companies that were trailing their peers due to poor leadership. But the process of forcing out existing management, finding new leadership and then changing the company’s policies is expensive and time consuming, as seen with Icahn’s investment in Sandridge Energy and Third Point’s recent proxy fight with Campbell Soup.
But convincing an existing management to monetize assets can be done more quickly and cheaply, as shown by some recent activist successes in the industrial sector.
In Germany, ThyssenKrupp agreed to split into two separately traded companies following pressure from Cevian and Elliott, while Zurich-based ABB Ltd. agreed to sell off its power grid business, again under pressure from Cevian.
That trend looks to be accelerating in the US. In November, United Technologies, the 84-year-old maker of elevators and jet engines, announced it was spinning out two of its business segments, a demand made by activist Third Point and other investors.
Energy, real estate and medicine
Besides industrials, other asset-rich sectors expected to draw more activist attention in 2019 are energy, real-estate and healthcare. It’s notable that the largest number of 13D forms filled with the US Securities and Exchange Commission in the third quarter were for healthcare and pharmaceutical companies, followed, at a distance, by energy and industrial companies.
Elliott's privatization of AthenaHealth, announced in November, may be a preview for 2019.
Other notable recent activist investments in the healthcare sector include Third Point’s $300 million bet on Merck, and Starboard’s 9.8 percent stake in Magellan Health, announced Dec 12.
Funds working together
The trend of activist funds working together in so-called wolf packs, or activists working with passive investors such as pension funds, is also expected to become more prevalent in 2019.
By targeting ThyssenKrupp and ABB, Cevian and Elliott were able to take on some of the largest, most entrenched companies in Europe without having to unbalance their portfolios.
Having activists team up with pension funds, meanwhile, enables even small funds to have their demands heard at limited cost, as seen in October when Legion Partners joined with the California State Teacher’s Retirement System to demand change at Papa John’s pizza chain.
“As performance hasn’t been good, activism may lose some momentum,” said an executive at a major city pension fund. “But the outsize influence of activists means they will continue as part of the landscape, and institutions support that.”
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