I recently had the good fortune of hearing Bill Ackman -- owner of lustrous silvery locks, an incredible long-term investing record, and a reputation for shaking things up at corporate do-badders -- speak at Value Investing Congress. Ackman's probably among the most noted and famous activist investors of our time. His approach is gloves-off, hard charging, and to the point.
This public perception, coupled to a cocktail of proxy fights and blistering letters to management, has given Ackman a bad boy image among activist investors. Ackman hedge fund Pershing Square's proxy fight at Canadian Pacific Railway
But at the VIC, Ackman painted a picture that's a little easier on the eyes: He's doing company stakeholders a service by getting involved, and they should welcome his presence. He is a concerned citizen trying to help. His words hearken to a recently rising chorus among new-school activist investors -- the notion of the "gentleman's activist." They call for change at companies, but a little more agreeably. Affectionately called "constructive engagement," this idea isn't a new one. And on the surface, the concept makes great intuitive sense: A little sugar helps the medicine go down.
Well, I'm a little more skeptical. Pointing out someone's faults, telling them to change, and not accepting "no" for an answer – nicely, at that -- is a delicate art. All of that raises the question, can activist investors really create value for shareholders, and nicely? The short answer: Yeah, it's possible. But I wouldn't expect this cottage industry to gain steam. Why, you ask? Read on.
I expect this topic, among others, will be front and center at DealFlow's Activist Investor Conference -- which I'll be attending next week.
Activism in Concept
To understand why first requires an examination of shareholder activism. It's predicated on a simple notion: Accountability works. On their own, most managers are a mess of emotions, personal biases, and sometimes irrational tendencies. Their deputies do a poor job of holding them accountable, because of that little thing we call career risk. And besides, being agreeable is just more fun.
Managers build personal fiefdoms, pursue value-destroying pet projects, and surround themselves with people who say yes. It's not that managers are willfully ripping shareholders off. They're subject to the very same decision-making foibles as their less wealthy, human counterparts. Consider a few bits of evidence:
- On mergers and acquisitions: A McKinsey study found that "patterns of deal size and frequency have made little difference in performance as measured by excess total returns to shareholders among the world's top 1,000 companies … the size and number of deals matter less than the discipline with which they are identified, priced, integrated, and managed." Translation: Deals often do not create value, and if they are intended to, price and strategic fit matter. Shocking.
- On share repurchases: A separate McKinsey study noted, "[F]or the years 2004 to 2010, our analysis finds that a majority of companies repurchased shares when they and the market were doing well -- and were reluctant to repurchase shares when prices were low relative to their intrinsic valuations." Translation: Repurchases, during the 2004 to 2010 period at least, destroyed shareholder value, when viewed in aggregate.
- On sustainable growth and value creation: In a sample of 1,800 companies with sales above $500 million, Bain consultant Chris Zook found that only 13% achieved 5.5% real sales and earnings growth while maintaining total shareholder returns in excess of the cost of capital in the 1990s. Translation: Most managers aren't able to create value and grow their firms, at least not sustainably.
That's where activist investors come in. No one's perfect, and activist let managers hear it. sometimes they need to hear it. But that doesn't mean a gentle, friendlier approach to fault-finding is better for your portfolio.
The data and the reality
A June 2007 paper examining shareholder activism from 1994 to 2005 found the "risk-adjusted annual performance of hedge funds practicing aggressive activism and/or seeking changes in corporate governance is about 7% to 11% higher than for non-activist hedge funds and hedge funds pursuing less aggressive activism" -- that is, funds without specific motives.
You can question the sample data, ask whether the survey is statistically significant, or nit-pick the company targets (the survey population) all you like, but if there's any punch line here, it's two words: aggressive activism. It might be ugly, intellectually unappealing, and sometimes disruptive. But it also works. Nice guys can finish last, and in this circumstance, usually do.
For all of its intuitive appeal, constructive activism bypasses a logical rule of thumb. Change is hard, uncomfortable, and combative in the best of times. That doesn't mean it's bound to fail: David Nierenberg of D3 Family Funds has very successfully served on boards at Radisys
But for my part, I don't think the business of activist investing is about to get cuddlier.