Activist Investors In Minnesota - A Primer For Officers And Directors
Minnesota-based companies have not been immune to attacks by
activist investors. This article discusses what is driving the
trends in investor activism, what companies are susceptible to
activist investors, why activist investors are successful,
strategies of activist investors, target defenses and responses
and other recent developments.
Activist Investors in Minnesota
A number of activist investor campaigns have occurred in
Minnesota, including:
In 2004, Opportunity Partners announced it had taken a
position in the stock of Hector Communications (Hector). In
April 2005, it requested the Hector board consider a sale of
the company. In September 2005, Opportunity Partners offered
to purchase Hector. Hector responded in November 2005, asking
why the purchase was not blocked because Opportunity Partners
was an "interested shareholder" under the Minnesota
Business Combinations Act and had not received the requisite
board approval prior to becoming an interested
shareholder.
In March 2006, Pirate Capital filed a Schedule 13D
announcing its intention to elect a majority slate to the
board of PW Eagle. Caxton Associates filed a Schedule 13D
shortly thereafter also announcing a position in PW Eagle. In
April 2006, PW Eagle entered into agreements with Pirate
Capital and Caxton Associates conferring control of the PW
Eagle board. PW Eagle was subsequently sold.
In July 2007, Pershing Square Capital Management acquired
stock in Target Corporation and filed a Schedule 13D stating
Target's common stock was undervalued and it intended to
explore ways in which that undervaluation could be
corrected.
According to press reports, an activist fund, the Clinton
Group, announced a campaign in 2008 to unseat the CEO of
Select Comfort Corp. The campaign initially began by seeking
cost-cutting initiatives and other marketing
improvements.
Driving Forces Behind Investor Activism
Perhaps the largest force behind investor activism is the
large sums of money available to hedge funds. By some reports,
hedge funds have more than $1.5 trillion to invest. The funds
look for ways to earn high returns, and activist investing has
been one way to do that. Activist investors who seek a sale of
the company also have had the tailwinds of an active mergers
and acquisitions market until recent times, and those tailwinds
will return in the future. The Wall Street Journal
(July 31, 2008) reports that some activists are currently
focusing on operational initiatives given the inactive mergers
and acquisitions market.
In addition, the rising power and influence of ISS
Governance Services (ISS), a division of RiskMetrics Group, has
contributed to the trend of investor activism.1 The
rise of ISS can be attributed to a ruling by the U.S.
Department of Labor that provided that pension funds have
fiduciary obligations when voting proxies. The SEC also
contributed, by adopting a rule requiring that registered
investment advisers vote proxies in the best interest of
clients.
As a result, many of the affected participants determined
the best way to comply was to outsource the analysis for
shareholder voting, and that is the service ISS provides. In
the opinion of some, ISS has a decidedly activist bent.
Over time, the SEC also has made it easier for activists to
engage in hostile proxy solicitations through rule
changes.2 In 1992, the SEC adopted rules allowing
insurgents to solicit not more than ten shareholders (Rule
14a-2(b)(2)), to engage in free communications without SEC
review in certain circumstances (Rule 14a-2(b)(1)), and to use
a procedure when an activist seeks a minority of the board, the
so-called short slate (Rule 14a-4(d)). In 1999, the SEC adopted
Rule 14a-12, which permits unlimited communications before a
proxy statement is filed without SEC clearance, provided that
no proxy card is provided and the written materials are filed
with the SEC. As a result, the proxy battle is usually won or
lost before a proxy statement is filed.
Recently the SEC adopted Rule 14a-16, which permits
insurgents to avoid the expense of printing paper proxies by
making proxy statements available over the Internet. While not
widely used to date, it provides a potent weapon to activist
investors to engage in full-scale proxy battles at reduced
cost.
Objectives of Activist Investors
Typical objectives of activist investors include:
Gaining a minority or majority of board seats.
Replacing the CEO or management team.
Increased dividends or share buy-backs.
Sale of the company.
Sale or spin-off of selected assets.
Business strategy initiatives, including cost-cutting
initiatives.
Preventing a pending acquisition.
Elimination of take-over defenses.
Implementation of perceived better governance
practices.
Realizing value on the balance sheet, such as
"putting cash to work."
What Companies Are Susceptible to Activist Investors?
Surprisingly, activist investors do not necessarily focus on
poorly performing companies.3 The following have
been identified as attributes of companies targeted by activist
investors:4
Low capitalization—it takes less cash to accumulate
a significant stake in a company with lower
capitalization.
Perceived undervaluation—leading to ultimate gains
when the activist strategy is executed.
Ability to cut costs—taking costs out of the income
statement can increase value and be a springboard for other
activist tactics, such as a sale of the company.
Excess cash—large cash balances can be used to
finance buy-outs and share repurchases.
Borrowing availability—the ability to leverage a
balance sheet can be used to finance an acquisition or a
share buy-back. In part, managing a business to maximize cash
flow can therefore be an advantage to activist investors if
unnecessary amounts of cash are retained.
Diversification of asset base—value is sometimes
perceived to be obtained through asset sales and
spin-offs.
Significant institutional ownership—concentration
of holdings in institutions can be a perceived advantage for
shareholders supporting an activist campaign.
Poor disclosure and governance practices—pointing
out poor practices may make it easier for activists to make
their case.
One commentator has posited that certain industries may be
more susceptible to activist investors. In particular,
industries with valuable hard assets but sluggish returns may
be targets.5
Success of Activist Investors
Activist investors are surprisingly successful in achieving
change. Research indicates success rates of 66% to 84%, which
includes any cognizable concession by management to an
investor's demands, no matter how immaterial.6
While these statistics may inflate the notion of success, there
are indications that activist investors historically have
achieved full success approximately 40% of the time.
The success rates can be attributed to the activist
investors making credible demands, a track record of past
success, and the ease with which the investors can go hostile
as a result of relaxation of SEC rules. Success is also
attributable to the so-called wolf pack phenomenon. When one
activist investor announces a campaign, other activist
investors, commonly referred to as the wolf pack, also take
positions in the stock. At that point, long-term investors may
sell...
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