An old investing adage states, “more money has been lost through corporate mismanagement than at the point of a gun.” By simply running their finger down a list of history’s biggest (or smallest) corporate disasters and missteps, an investor can quickly spot several common themes emerging: flawed strategies, improper capital structure, capital misallocation, poor governance and so on. Curiously, (mis)management can be singled out as the common thread amongst all of these precursors to gloom.
The investor of yesteryear was therefore held captive largely by the capabilities possessed by the management of the company into which they had bought, as opposed to the dynamics of the underlying business itself. Buying into a bad business can at times turn out to be a good investment, whereas buying into a bad management almost certainly will not.
Whilst over the last few years management capabilities haven’t dramatically improved for the most part, the emergence and prevalence of ‘activist investing’ has implied that shareholders can now retaliate against or influence almost all forms of corporate wrongdoings in a more effective, organised (and sometimes public) fashion. All the while, these activist investors have enjoyed lower risks and longer term outperformance that is largely uncorrelated to the broader market – not to mention gaining the ability to look at a broader range of opportunities, seeing as they are not reliant on previous ‘bet-on-the-jockey-not-the-horse’-type investments.
Shareholders and their relationship with companies
The sharemarket presents a strange dichotomy: shareholders who, as providers of capital, own the underlying company they invest in never actually control how their capital is used once it is handed over to the business. Instead, shareholders entrust the oversight and management of their company to the board and the executives, respectively. Therefore, it is no surprise that poor governance is often at the top of an activist investor’s watch list, as an activist strategy is often undertaken in the presence of a management or a board following (hopefully unintentional!) procedures that destroy shareholder wealth. The activist investor must therefore first think carefully about whether a company has the right board.
Stranger still is the fact that few investors (read ‘owners of the company’) have the opportunity to actually meet with the directors of a listed company. Observations or opinions about boards are usually third or fourth hand at best, or are formed from what shareholders see, hear and read in the media. We find that asking questions at an AGM is always a good opportunity to directly ‘test’ directors.
However, shareholder activism is not just about corporate governance. Governance is only a means to an end, not the end itself. An activist investor becomes a shareholder of a company initially because they believe there is some inherent value and that, by seeking change, they can create or enhance that value. Outsized investment returns and the unlocking of latent value are the ultimate destination and activism is a quicker path to get there. It is important to not lose sight of the main objective of increasing your future dollars above and beyond the risk you have taken in forgoing today’s dollars.
Activism techniques
Luckily, Australian shareholders have, through the Corporations Act, one of the most shareholder-friendly legislative frameworks globally. Most parts of this law operate with minimum requirements where shareholders seeking to exercise these rights must either hold more than 5% of the shares on issue or there must be at least 100 shareholders making the request. Subject to these and some other requirements, activist shareholders can, amongst other things:
- Call for a general meeting
There are two ways of doing this. The first is where those shareholders call on directors to call a meeting (section 249D). The second (rarer) method is where the shareholders call a meeting themselves, and then are responsible for the expenses of calling and holding the meeting (section 249F).
- Put forward shareholders’ resolutions
Shareholders who meet the minimum thresholds outlined above can give a company notice of their intention to put forward resolutions to be considered at a general meeting. The majority of resolutions can be passed by shareholders by a simple majority of votes cast, including the removal and nomination of directors.
- Require that a company distribute a shareholders’ statement
Shareholders who call for a resolution can also request the company distribute a statement to all shareholders, which would typically be used to make the case for the particular point of view those shareholders are espousing.
- Seek the removal of a director
Shareholders can call for the removal of one or more directors of a public company (section 203D). Practically, this would occur by calling for a general meeting at which a resolution to remove one or more of the directors would be put to shareholders.
Shareholders can also nominate directors. As above, shareholders would usually need to call for a general meeting at which one or more resolutions to appoint directors would be put to shareholders.
The points listed above are very much the public face of activism. However, the work of an activist often takes place behind closed doors. Lobbying privately for a particular course of action can be far more productive than taking a very public route.
It is important when formulating a strategy to ensure that other shareholders are likely to support it. If an alternative strategy cannot obtain support from other shareholders, then it is likely the strategy needs more work. Sometimes though, support can be difficult to garner because of investors’ differing investment objectives. For example, sometimes retail and institutional investors may have different time horizons.
Shareholders should not abuse these rights by exercising them flippantly and frequently. Each time a meeting is called, it costs the shareholders money.
Role of shareholder activism
We believe shareholder activism is best applied to situations where shareholder value has been destroyed or where there is a persistent failure to deliver. Companies have to take risks and sometimes they do not pay off – that’s just how business works. However, if a company persistently takes business risks that do not pay off, then one has to start asking some serious questions. This is where it all starts. Through their investment endeavours, activist investors keep companies and their boards in check.
There are few examples of activism at work in Australia, and that is not necessarily a negative. In the world of investing, the less the merrier, seeing as knowledgeable participants travelling along a less-crowded investment path are usually more handsomely rewarded for their insight.
Of the few examples, many have been driven by labour or environmental agendas, as opposed to compelling investment opportunities. When they have been investment-driven, we would characterise them more as being ‘reactive’ activism. Reactive activists are shareholders who have sought to take action because a company in which they are invested has failed to deliver or it proposed to undertake a course of action the investors did not support. In contrast, the dedicated activist (a ‘thoroughbred’ in investment-geek parlance) is the investor who actively seeks out companies with the intention of engaging directly with the board and management.
Overall, we see the role of the activist investor as important to the efficiency of the Australian capital markets and in the protection and enhancement of common shareholder wealth. There has been increased interest in this investment strategy, which we see as beneficial to all market participants, especially shareholders.
Gabriel Radzyminski is the Founder and Managing Director of Sandon Capital. Sandon Capital is an investment management and advisory firm and has been involved in a number of ‘activist’ engagements, advising both shareholders and companies.