As shareholder activist interest in Europe grows, we increasingly need to factor their influence into the M&A landscape. This week we look at what’s influencing activist activity in Europe, how that activity is evolving and how companies should respond to activists and changing shareholder dynamics.
If you can’t beat ‘em… should you join ‘em ?
In a few short years, shareholder activism has gone from a niche hedge fund activity, almost exclusively focused in the US, to an increasingly global activity.
“The number of European corporates targeted by activist investors doubled between 2014 and 2016, with the run-rate in 2017 running higher still”
Credit Suisse: European M&A – Getting Active, 21 July 2017
According to recent report from Credit Suisse, whilst global activist demands have fallen in 2017; European levels have continued to increase. In 2016, 111 European companies received activist demands, compared to 80 in 2015. In the first half of this year, this figure stood at 62.
According to Credit Suisse and Activist Insight, almost half of global campaigns (47%) are ‘board related’. But, almost a quarter of activists (22%) are linked to M&A, followed by related activities such as business strategy (9%) and balance sheet restructuring (8%).
What does this mean for M&A activity in Europe?
Give me an M…
It’s vital in all of this to remember the prime motive of the activist: to achieve an increased return through improved shareholder value. This isn’t deals for deals sake, they still need to add up and make sense in the current economic and structural environment. Looking across, the deal space in Europe, the cycle remains supportive, with plenty of macro and structural motivation for deals. The improving economy is making European assets more attractive and there are still significant opportunities to unlock value through disposals and mergers.
Still, we can’t draw a straight line between increasing activist demands and actual deal activity. Not all activist activity is carried out in public, so figures may underestimate activity. On the other side of the equation, some activists will set out to block deals. This isn’t typical, but shareholders have always taken action if they think deals offer insufficient value. Plus, of course, not every activist demand is successful. Europe has different hurdles to jump than the US and there are many competing voices, including greater union influence in some areas.
But, what we can say is that activists are more involved across Europe and one way or another they are looking to have their say on deals, creating new conversations and new dynamics. So, where might we expect more activity?
…give me an A!
According to Activist Insight, there are four factors that make companies vulnerable to activists. Two relate to performance: a below average return on equity and a total shareholder return over a 12-month period that’s weaker than its peers. Activists don’t need a long-term fall in performance to become interested. The other factors are a high level of institutional ownership and the presence of shareholder(s) who have run activist campaigns in the past. It’s obviously much easier if activists only have to win over a small group of shareholders – especially if they are likely to be receptive.
In terms of location, the UK still leads the way due to the powers available at 5% of shareholdings. The fall in sterling means Brexit has provided greater incentive than deterrent for now. Northern Europe – especially Switzerland and Germany – would seem to be a more conducive shareholder environment. Although – as The Financial Times, recently noted, Italy is becoming a new “battle ground” with activists “spurred on by improving corporate governance and the weakening of traditional company owners during Europe’s sovereign debt crisis”.
In terms of sectors, Europe seems to be following the US model, with most activity in consolidating sectors, like chemicals (e.g. Clariant, Azko Nobel) and consumer staples (e.g. Nestlé, Parmalat), where 3G has also shown what can be done on margins. These more traditional sectors can offer opportunities to unlock value from the sale of under-scale, under-valued or under-invested subsidiaries. Unlocking value could also be motivation for activists to look at real estate angles, like retail and restaurants. Local factors are also influential. In the US, technology and finance have lead the way. Where we’re very unlikely to see activity is in areas subject to regulatory or government interest, like aerospace & defence and utilities.
So, what should companies do if an activist intervenes? Whether it is to promote or stop a deal the approach should be a calm and rational one that engages with the activist(s) and other shareholders. Activists will generally do a tremendous about of work before investing and setting out their strategic view. Therefore, it is worth hearing them out and setting out your opposing case – if applicable – with equal care and detail. They are also likely to be media savvy, so companies need to give equally compelling and clear responses.
Outright hostility is likely to be counterproductive. Attitudes towards activists are changing as research consistently shows that their interest can be beneficial to shareholder value. In the US – which is further down the activist timeline – it is more common for companies to accept that activists have a strategic role to play, including a board seat. We may not be there in Europe yet, but as “traditional investors”, including large asset managers and pension funds, are increasingly making their voices heard, the lines between activist and non-activist are become blurred. As exemplified by The Financial Times front page headline last week: “FTSE chiefs hit with £1m pay cut following outcry from investors”.
If you can’t beat ‘em….
Therefore, one of the best forms of defence is offense, i.e. anticipating or, even better, avoiding activist interest. The best way of doing this may be to think and act like an activist! Ultimately, public company boards and activist investors are aligned in wanting to maximise shareholder value. Admittedly, there are different views on timescales. Typically activists work on look a year ahead rather than management’s five year timetable. But, if companies are engaging shareholders and presenting and delivering a robust strategy, the role of the activist may be moot.
Thus, companies should maintain a close eye on their shareholder register and maintain an on-going dialogue with investors to ensure that their concerns are aired and addressed. They should regularly subject their portfolios – along with their balance sheets and corporate governance – to the same level of rigour as they’d expect from an activist investor. When presenting a deal, boards should be able to articulate a very clear strategic rationale that anticipates any objections from their shareholder base. Scenario planning can be useful here, to help structure communications and deal structures. Companies should also subject their governance and remuneration policies to scrutiny.
There have been bumps in the road for activists. High-profile failures have contributed to reduced fund inflows in 2017. The market will need to evolve as larger companies get savvier and if valuations become less attractive. Carl Icahn commented in 2016 that “Current market valuations do not provide an opportune time to embark on large new investments.” Hence, why small or microcap activism is a growing trend.
One of the most notable trends of the year was the strengthening of small cap activism, at the expense of the large targets activists have increasingly pursued – Active Insight
Activity in Europe will benefit from the any move away from US large caps and from the development of a ‘home grown scene’. According to Active Insight, of the investors making public demands at European companies in 2016, nearly eight out of every ten were based in Europe.
Therefore, we expect to see activist interest grow across Europe. We expect this and this interest to include deals – mostly to promote, occasionally to question. We also expect this interest to evolve. It’s not surprising that we’re seeing more crossover between activists and PE. And we also expect shareholder relationships to evolve, spurred on by activist dialogue.