Carl Icahn pressured Apple (AAPL) to increase its dividend, and eBay (EBAY) to split itself up. Nelson Peltz and Dan Loeb arranged the marriage of two chemical giants, DuPont (DD) and Dow Chemical (DOW). Jeff Smith convinced Yahoo (YHOO) (parent of Yahoo Finance) to scrap a big spinoff plan and put itself up for sale. And Bill Ackman just muscled his way onto the board of Valeant (VRX), the stricken drug firm that seems likely to be the story stock of the year.
These men are all “activist” investors targeting some of corporate America’s most noteworthy citizens. Activists aren’t new; Warren Buffett arguably began his career as one, including his original takeover of Berkshire Hathaway (BRK.B) in the 1960s. But activists have become one of the most powerful forces in financial markets, triggering fear in boardrooms—and sometimes, grudging respect. Activists targeted 350 public U.S. companies last year, up 9% from 2014 and 217% from 2010, according to research firm Activist Insight. Nearly 400 activist investors made public demands of at least one company in 2015, up from 116 in 2010. And America is the activism capital of the world, with U.S. firms representing two-thirds of all activist targets worldwide. Virtually no company is immune, with giants such as Pepsi (PEP), Microsoft (MSFT) and Target (TGT) landing in the crosshairs in recent years.
With the outsized influence of activists likely to continue, Yahoo Finance asked, why now? What led to the rise of the activists? Are they good for companies and investors? Or do they merely enrich themselves at the expense of workers, smaller shareholders and the broader U.S. economy?
Activists typically operate by accumulating shares in a target firm—often stealthily—then lobbying for change once they become a top shareholder. One new twist is that some activists these days accumulate a relatively small stake in target companies--say, 1% to 2% of the company's stock--then use media exposure as leverage to pressure management and persuade other institutional shareholders to join the crusade. The most likely targets are companies underperforming in some way, giving activists an opening to improve the return to shareholders.
Some activists call for stock buybacks or larger dividend payments, as Icahn did with Apple in 2013 and Harry Wilson did with General Motors (GM) last year. Other times, activists seek one or more board seats, to force cost cutting, operational change or strategic rethinking. About 20% of activist moves seek a merger or acquisition, as Ackman’s firm, Pershing Square Capital Management, attempted when calling for Valeant to buy botox maker Allergan in 2014. He failed, but the Valeant bid raised the price of Allergan for another buyer, Actavis, and Ackman pocketed a $2.6 billion profit from the spike in Allergan shares he owned that rose in value as the bidding for Allergan ramped higher.
Low rates and institutional support
Back in the 1980s, “corporate raiders” often sought a quick payday by buying troubled companies, saddling them with debt to finance the purchase, selling off profitable parts and paying themselves lavish management fees. The fees are still there, but activists these days are also likely to team with other big shareholders that are traditionally more passive, such as mutual fund companies like Vanguard or Fidelity, huge pension funds such as Calpers or Calsters, insurance companies with big pools of money to invest, or charitable foundations with an endowment. “Activists have been here a long time, but the dynamic now is the tacit support for them by the big institutions behind the scenes,” Jeff Gramm, author of "Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism,” tells me in the video above. “The passive investors are supporting a lot of the activists.”
The phenomenon of super-low interest rates worldwide may also be a factor. “Investors are looking for yield,” says Aaron Gilcreast, deals partner at PwC. “With activists you can usually get some pretty good returns for a relatively low investment, maybe a 3% to 5% stake in a company.” That suggests fewer investors might be willing to line up behind activists as interest rates rise, pushing up the return on high-quality bonds. Of course, rates have stayed lower for longer than just about anybody anticipated, with monetary easing in Europe and Asia likely to keep depressing rates there.
Activists have also managed to improve upon the image of the bloodthirsty Gordon Gekko carving up hapless companies in the 1987 film "Wall Street." Many activists these days are familiar, media-savvy faces who often claim they’re protecting small investors from greedy, underperforming CEOs. “Their brand today is sort of like a white knight coming to save shareholders,” Gilcreast says. “They’re in the press, they’re using social media to win hearts and minds. It’s a messaging battle.
Ackman has used frequent media appearances to talk up his big bets on companies such as Valeant, J.C. Penney (JCP) and Herbalife (HLF) (which he bet against as a short seller). Icahn, who bet long on Herbalife at the same time Ackman went short, is another frequent media presence, who also has 275,000 followers on Twitter. Icahn tweets infrequently, but when he does, it can be market-moving news, such as recent announcements involving new investments in AIG (AIG) and Pep Boys.
So do activists actually make companies better and improve returns for shareholders? Data suggests yes. S&P Capital IQ recently analyzed the 12-month change in share price for companies with the highest and lowest percentage of shares owned by activists. The group with the heaviest activist influence performed 4.3 percentage points better than the group with the lightest activist influence. That’s not bad, but in the same analysis, hedge fund ownership correlated with even higher returns than activist involvement. (The distinctions can get confusing: Some but not all hedge funds take an activist approach, but activists can also be private-equity firms or other types of institutional investors.)
The legitimization of the activists might be best demonstrated by the boards who seem willing to listen to them. During the heyday of the corporate raiders, many activist moves were met with defiance, as companies resisted the meddling and proxy fights often ensued. These days, boards often give activists a hearing and sometimes cave. Nelson Peltz of Trian Partners and Dan Loeb of Third Point Capital joined forces to squeeze Dow and DuPont into a merger, and met resistance for well over a year. But the two target companies finally acquiesced in December, with each activist snaring a nine-digit profit.
Yahoo has more of a mixed record with activists. Loeb was instrumental in bringing CEO Marissa Mayer to the firm in 2012, and he made about $2 billion when he sold most of his stake the following year. Everybody parted happy. But Yahoo has struggled since then and another activist, Jeff Smith of Starboard Value, has pressed Yahoo to grant his firm three board seats and sell its core business, which would most likely mean a change of leadership. Yahoo has grudgingly agreed to explore the sale, but instead of allowing Starboard to fill three recent vacancies on the board, Yahoo chose its own candidates. A proxy battle may yet ensue.
For their widespread influence, activists have struggled to produce returns lately. An Activist Insight index of stocks held by activists fell 7.7% in 2015, while the S&P 500 was essentially flat. So activists underperformed the broader market. One factor may be the sheer number of investors using activist tactics, since returns tend to disspiate as more jump on the trend.
The brash Ackman, to some extent the face of activism, has lost $3 billion on Valeant since last year. In mid March, he sold 20 million shares in another company, the food giant Mondelez (MDLZ), which some traders interpreted as a forced sell. Standard & Poor's warned it could lower Pershing Square's credit rating on account of a rising debt-to-assets ratio associated with the plunge in the value of Valeant shares. Ackman, meanwhile, says his firm sold down its stake in Mondelez to reduce an "outsized" position in the company. Whatever the reason, Mondelez isn’t struggling, and it has no connection to Valeant, other than Ackman. But the sudden sale pushed Mondelez shares down nearly 2.5% all the same. Power is sometimes measured not by how much money you can make, but by how much damage you can do.
Editor's note: This story has been updated to include Bill Ackman's explanation for why he sold 20 millions shares on Mondelez.
Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.