Thursday, December 11, 2008 Why 2009 Will Bring More Activism


By Eric Jackson

12/11/08 - 09:59 AM EST

With the market's tumultuous last few months driving down the price of equities, activist investors around the world have seen their stock investments take major hits.

  • Carl Icahn has watched the value of his Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) stake drop in half since May;
  • Ralph Whitworth of Relational Investors recently resigned from the board of Sprint Nextel (S Quote - Cramer on S - Stock Picks) but kept his stake in the company, even as shares have dropped 80% this year;
  • Chris Hohn of The Children's Investment Fund exited his J-Power position at a loss earlier this year, after his calls for change were beaten back by the Japanese utility. Some market-watchers suggest that after 10 to 12 years of growth as a strategy, investor activism is dead. Why? Poor returns, they say, and because the freezing-up of the credit markets prevents activist shareholders from calling on companies to lever up with debt to fund stock-buyback plans or increase dividends.
However, 2009 could very well prove one of the busiest years for activist investors in the last decade. I count 10 reasons why.

1. Obama will look favorably on pro-shareholder measures. Republican Securities and Exchange Commissioners have typically supported pro-management/Business Roundtable policies. Democrats have been much more supportive of shareholder activists. The Business Roundtable and other pro-management groups have portrayed shareholder-friendly measures -- such as making it easier to run alternative board candidates on the company's proxy -- as moves that empower fringe, or special interest, shareholders such as the AFL-CIO and Teamsters at the expense of plain-vanilla investors (retail or institutional).

Obama supports a different view and will likely equate more shareholder rights that promote better governance with better shareholder returns over time.

2. The new SEC Chair will sponsor several new shareholder-friendly measures. Obama will appoint an SEC chairman in the image of the last Democrat to hold that position, Arthur Levitt -- someone who will fight for openness, fairness and rights for all shareholders.
"Proxy access" was an initiative supporting the rights for shareholders to put forward alternate names of directors to be elected at the annual meeting proxy vote. Instead of having to fund a proxy contest themselves (vs. an incumbent board funding their re-election with the shareholders' money), "proxy access" would have allowed for these alternate names to appear on the company's own proxy and let the shareholders simply vote for the most qualified people to represent shareholder interests. This initiative died when the two Democratic SEC Commissioners retired and were not replaced.

Expect "proxy access" to return in the new administration in some form, helping to ensure the best possible people are serving as directors on our boards.

3. Valuations are on the floor. Activist investors are typically value investors who layer their activist efforts on top of a buy-and-hold approach to an undervalued stock. Value investors have been especially hard hit this year. Fortunately, the mass selling appears to have stabilized. While cheap should never be confused with value, it's likely that valuations will rise over the next 12 months and take the fortunes of activist investors with them.

4. A flight to quality in hedge funds will benefit activist investors. The hedge fund industry is going through a remaking of itself and will no doubt be a much smaller industry two years from now. The biggest and most successful ones will grow in a flight to quality. Activist investors with long and successful track records will benefit, even if their returns in 2008 are poor. Institutional investors can understand the activist strategy and how it's executed. It's not a black box and that is going to be helpful to activists in raising capital over the next few years.

5. Management and corporate boards will not want to be viewed as anti-shareholder. After seeing their market capitalizations decimated over the last 12 months, boards and management teams at public companies are sensitive to criticism. Lavish pay and executive perks are out. Assuming activists have legitimate arguments about actions that will unlock shareholder value, it will be much easier for them to get the ear of managements and boards in the next 24 months.

6. There will be a wave of industry consolidation. M&A has dried up in 2008 as corporate acquirers and targets kept their heads down in the foxhole. That's about to change. With valuations so low, there's never been a better time for stronger players to pick off the weaker ones in their industry.

At the same time, no board wants to make the mistakes that Yahoo! and Take-Two (TTWO Quote - Cramer on TTWO - Stock Picks) did this year by playing hard to get when a rich buyout offer came along. Activist investors will play a background role. For example, look for Bill Ackman of Pershing Square to push together Barnes & Noble (BKS Quote - Cramer on BKS - Stock Picks) and Borders (BGP Quote - Cramer on BGP - Stock Picks) (as he has a stake in both companies).

7. Activists have the longest lock-up periods of any hedge fund class, so they can put fresh capital to work. With hedge funds reeling from heavy redemptions, the funds in the strongest position this year are the ones with the longest lock-up periods. A lock-up is the amount of time a hedge fund investor must keep his/her money invested in the fund before being able to redeem.

Activists, at least the most successful ones, have among the longest lock-ups in the hedge fund industry, at 3-5 years. The logic for asking for such a lock-up is that activists understand that their hold period in a particular position might be many years, comparable to a private equity holding period. Unlike private equity, though, activist investors have their positions marked to market every day.

Activists know a six-month investment return in Sprint is likely to differ from a three-year investment return. With these long lock-ups, activists will be less affected by heavy redemptions this year than most other hedge funds. This means they'll have more money to put to work next year.

8. Limits on short-selling will benefit activists. As previously mentioned, the SEC is about to become more shareholder-friendly under the new administration. The agency also will likely seek to promote growth in the stock market. Short-sellers could come under more restrictions, promoting long-biased investors. Although no outright ban on short-selling will occur, a return of the uptick rule is likely. Any limits on short-selling like this will help long-biased investors like activist investors.

9. Activists will become more balanced on the long and short sides. Even though activists have typically been long-biased or long-only before 2008, the only investments that have made money this year are short bets. Activists will learn from this year's action to have a more balanced portfolio of investments on the long and short sides. Some activist investors like Greenlight Capital and Pershing Square have always taken this balanced approach. Expect others to follow their lead. This will improve performance and provide them with more capital to put to work in additional activist campaigns.

10. There's more to get "active" about than ever. Even post-Enron and post-Sarbanes-Oxley, 2008 has shown shareholders that there is more than ever to get outraged by in the actions and inaction of corporate boards.

Where was the oversight at Bear Stearns, Lehman, Citigroup (C Quote - Cramer on C - Stock Picks) and GM (GM Quote - Cramer on GM - Stock Picks) this year?

We hear a lot of CEOs and boards refer to a "perfect storm" occurring this year, an attempt to place responsibility for their companies' results on events outside of their control. Bob Rubin, director at Citigroup, recently said it wasn't realistic to expect a year ago that housing prices would drop as precipitously as they have. Although no omniscient board has yet been found, there are many that did an excellent job at protecting and growing capital in the last year.

As activists challenge the poorer-performing boards, the result will be stronger companies and better performance in the future. If these shareholder representatives are not questioned and are allowed to continue rubber stamping the will of management, we will have learned nothing from the debacle of the last 12 months.

At the time of publication, Jackson and his fun had no positions in stocks mentioned.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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