It’s no secret that shareholder activism has been on the rise in recent years and is now simply a fact of life for most public companies.  Some fights are quite public but many others are settled behind closed doors via negotiations between the Activist and the Target. In any event, Activists have successfully re-branded themselves as defenders, and in some cases creators, of shareholder value and now have the ear, and often the support, of traditional institutional investors. As such, Target boards and management should make contingency planning for the threat of shareholder activism a regular board meeting agenda item.  And all companies should consider themselves a potential Target.

Who is a Target?

A typical Activist has a 1-3 year investment period and is looking for opportunities to generate a significant return on investment during that period.  They will target any company where they believe they can effect change, or exploit weakness, that will unlock value.  They will traditionally target companies with one or more of the following traits:

1.    Underperformance/Mismanagement: 

• Target has underperformed relative to its peers.
• Problems are fixable under new strategy and/or new management.

2.    Under-Leveraged / High Cash Reserves: 

• Target is under-levered or has excess liquidity.
• Target should return capital to holders by way of a share buy-back or dividend.

3.    Potential For Spin-Off or Asset Sale:

• Target is undervalued.
• Target should maximize value by selling certain assets or spinning-off one or more divisions.

4.    Corporate Control:

• Target has maximized its value in current format, or Target is undervalued, or a proposed acquisition is overvalued.
• Target should put itself up for sale, or Target should seek a higher premium for a proposed sale, or Target should abandon a proposed acquisition.

5.    Governance Problems:

• Target has governance issues, a captive board, management compensation issues, etc.

The Activist Playbook

The Activist typically spends considerable time and effort researching a Target and developing its strategy before the Target is even aware that the Activist has an interest in the Target.  The typical Activist Playbook reads as follows:

1.    Research Target:

• Identify strengths and weaknesses of business, board and management.
• Identify potential strategic alternatives.
• Identify Target shareholders:
• Key shareholders, their shareholdings, their investment goals and their voting habits.
• Percentage of institutional vs. retail shareholders.

2.    Acquire Shares:

• Quietly acquire Target shares.
• Typically anywhere from 1% to 9.9% to avoid insider reporting thresholds.

3.    Engage Advisors and Develop Strategy:

• Proxy solicitation firms (i.e. DF King, Kingsdale, Laurel Hill Advisory Group, etc.).
• Lawyers (i.e. Linmac LLP).

4.    Engage Other Shareholders:

• Gauge support.
• Typically informal to avoid rules applying to parties “acting jointly and in concert”.

5.    Send Letter to Board/Management:

• State demands.
• Request meeting with Board and/or management.

* Usually sent privately but Activist may make it public concurrently or at a later date.

6.    Go Public:

• Press release demands.
• Initiate proxy contest.

As you can see, the Target is often not even aware of the Activist until late in the Activist’s Playbook.

What Should the Target Do Before the Activist Surfaces?

As mentioned above, the Activist has typically been researching the Target, planning its strategy and buying Target shares for quite some time before it approaches the Target.  During this time it has fully investigated the Target’s business, its board, its management, its shareholders and the viability of the course of action that it will propose.  As such, the Activist is typically well-prepared for any and all responses that the Target may have to its demands.  This puts the Activist at a significant advantage unless the Target itself is well prepared.

So what should the Target do?  It should think like an Activist and be prepared by essentially taking many of the same steps as the Activist:

1.    Objectively Assess Target:

• Identify strengths and weaknesses of business, board and management.
• Address weaknesses that are capable of being addressed.
• Identify potential strategic alternatives.
• Identify shareholders:
• Key shareholders, their shareholdings, their investment goals and their voting habits.
• Percentage of institutional vs. retail shareholders.

2.    Engage Advisors and Develop Strategy:

• Hire them before the Activist does.
• Proxy solicitation firms (i.e. DF King, Kingsdale, Laurel Hill Advisory Group, etc.).
• Lawyers (i.e. Linmac LLP).

3.    Engage Shareholders:

• Develop a shareholder engagement program.
• Gauge support.
• Repeat consistently.

4.    Prepare communication strategy:

• Remember that everything you say and do can and will be used against you.
• Determine special committee members.
• Determine company spokespersons authorized to speak (i) to the Activist and (ii) to the public (and make it known throughout the company that no one else is to do so).
• Develop message and communication strategy.
• Conduct fire drills.

What Should the Target Do After the Activist Surfaces?

Once an Activist does surface, don’t ignore them. As mentioned before, they have likely spent considerable time researching your company and developing their strategy before communicating with you, either privately or publicly.  And these fights are typically expensive so they wouldn’t initiate the fight unless they were fairly confident in their chances of success.  A Target that has been approached by an Activist should:

1.    Listen:

• Listen to the Activist regardless of perceived shareholdings.
• The Activist might even have a good idea.
• As mentioned above, everything you say and do can and will be used against you so at the very least demonstrate that you were willing to listen to your shareholders.

2.    Be Objective:

• Objectively assess the merits of the Activist’s requests/demands.
• Objectively assess support for the Activist’s position.
• Objectively assess support for the position of the Board/management.

3.    If Appropriate, Settle:

• Weigh pros and cons of potential settlement/concessions.
• Implement if in the best interest of the company (i.e. consistent with long-term value creation).

4.    If Necessary, Fight

• Implement communication strategy.
• Implement strategic alternatives, if available and appropriate.

Conclusion

All companies should consider themselves a potential target for shareholder activism. As such, Target boards and management should make contingency planning for the threat of shareholder activism a regular board meeting agenda item as the best defence is to be prepared.  And the best way to be prepared is to think like the Activist and look for every opportunity to strengthen your company and add shareholder value.  It is also critical that you know and understand your shareholder base.

Invitation for Discussion:

If you would like to discuss this article in greater detail, or any other securities law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Linmac LLP.

Disclaimer:

Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.