Boards must prepare for activist wars

The boardrooms of corporate Australia have been relatively insulated from the growing trend towards shareholder activism in the United States and Europe, but that may be about to change.

For many years, activist funds have targeted US companies they see as underperforming their peers, accumulating small stakes either directly or via derivative positions, and then agitating for change.

Investors such as Carl Icahn and Daniel Loeb and funds including Jana Partners and Pershing Square Capital Management then push to install their own board nominees, replace management, effect a capital return or more dramatic structural change such as a demerger.

Daniel Loeb's hedge fund Third Point Management, with some $US17 billion in assets, targeted Dow Chemical Co last year, arguing the share price had underperformed and urging a break-up of the business. In November, his fund won two board seats.

The tactics can be aggressive and sometimes turn ugly and public. Loeb made an online video attacking Dow. Icahn, dubbed the 'godfather' of activists, ran a long campaign against eBay last year, accusing the chief executive of “inexcusable incompetence” and successfully pressuring the company to spin off Paypal.

Last year saw a big increase in both the number of activist campaigns in the US to an estimated 280, and their success rates with large and small companies.

Much of that success is due to the growing support of large institutional investors, according to a new survey by FTI Consulting.

Of the 100 US institutions surveyed, an overwhelming 84 per cent believed activism added value to the target company.

Fund managers saw the greatest benefits as providing a catalyst for change; aligning the interests of the board with shareholders; and improving strategic focus. There was little support for the more radical short-term changes such as a sale or spin-off of assets (13 per cent).

And here are the key numbers for Asian firms. Some 76 per cent of big funds supported the spread of US-style activism to countries overseas. These funds hold a collective $US1.7 trillion in assets under management, and 43 per cent have a global mandate, including many in the Asia-Pacific.

Fresh from many successful stoushes targeting US and, increasingly, European firms, bankers and consultants believe activist hedge funds will soon turn their sights to Asia, including Australia where corporate governance does not always reflect global best practice.

Australia has a solid base of corporate law and the two-strikes rule introduced into the Corporations Act provides a tempting target. Under the 'two-strikes' law on remuneration, a company board can face re-election if shareholders oppose the company's executive salaries and bonuses.

Activists have been increasingly successful in pushing their own candidates onto US boards, winning 56 per cent of their more sophisticated campaigns for seats in 2013 and 2014, compared with the average win rate of 36 per cent for the entire period 2001-2014. Much of this seems due to support from fund managers.

Some investment banks have built up entire practices to advise companies on how to deal with activist tactics, including Goldman Sachs, Credit Suisse and Deutsche Bank. Goldman Sachs considers itself a market leader in defending company boards against such activism globally, and has a dedicated team based in New York that works with corporate clients solely on this issue.

Companies' vulnerabilities might be extra cash on the balance sheet, a share price trading at a discount to peers, or a board that could be more engaged.

Goldman Sachs bankers in Australia have discussed with clients the emergence of domestic activist funds as well, although so far such fights have been few and far between.

Mark Carnegie has been a vocal example. Carnegie and Perpetual lobbied against the cross-shareholding between Brickworks and Washington H. Soul Pattinson, and have won the right to take their case to the Federal Court this year.

Under a structure that is no longer allowed except under a grandfathering deal, Brickworks owns 43 per cent of Soul Pattinson -- and Soul Pattinson owns 44 per cent of Brickworks.

If local fund managers display the same enthusiasm for activist tactics as their US peers, boards will need to be especially vigilant they do not become an easy target when US-style activists turn their attention to Australia.