Why Ackman Failed vs. Target

06/03/09 - 02:19 AM EDT

TGT

Eric Jackson

When Bill Ackman of Pershing Square Capital Management attended Target's (TGT Quote) annual meeting in suburban Milwaukee last Thursday it was the final culmination of a months-long proxy fight with the company's incumbent board. Although some observers, including me, predicted Ackman's slate would win one or two seats out of the five he was seeking, he came away empty-handed. Target announced at the meeting that all incumbent directors were re-elected with at least 70% of the vote.

The mainstream press immediately declared it a rout against Ackman. "Target Triumphs Over Ackman" said BusinessWeek, "Ackman Misses Target" said the New York Post. The New York Times headline read, "Target Shareholders Strongly Reject Dissident Slate."

But the truth is that the vote was far closer than how Target spun it.

The language from Target's press release includes words like "shareholders appear to have" elected the incumbent directors by a "comfortable" margin. Gregg Steinhafel, Target's chairman, president and CEO, goes on to thank shareholders for their "overwhelming" support of management. Towards the end of the press release, Target suggests it will get around to actually releasing "preliminary" voting results in three to four weeks. Final results will come later, but no timeline was provided. Technically, Target doesn't have to share the final results until the end of August -- 60 days after the end of the quarter in which the annual meeting took place.

I find it insulting to shareholders that companies can get away with not releasing voting results immediately after the meeting. A month ago, Bank of America(BAC Quote), a much larger company than Target, with more votes to be counted, and also facing a large number of dissenting shareholders, provided a detailed accounting of its tally before 5 p.m. the same day as the meeting. Target gets to drag its feet for three months, while posturing to the press working on deadline that it enjoyed a sizable win.

Doesn't this sound more like how a banana republic runs itself, rather than one of the largest retailers in the world?

Another aspect of the vote that inflated the results in Target's favor were the broker non-votes. We are now close to the end of the 2009 proxy season. Thanks to some recent changes by the Securities and Exchange Commission this will be the final year in which brokers can take all the non-votes they receive from their underlying shareholder clients and, in one fell swoop, throw the votes to management's favor. This happens in 99% of the cases in which they vote.

The Wall Street Journal recently concluded that, in most large company votes, these broker non-votes going in support of management amount to 15% to 20% of the overall votes counted. These votes should count as abstentions, since the real owners of the shares haven't indicated a preference. Starting in 2010, thanks to the SEC, that will happen.

Let's assume Target received the "overwhelming" support of 70% of their shareholders. Assuming a normal amount of broker non-votes landing on Target's side of the ledger, it appears that the vote, if it had taken place under next year's rules, would have been up for grabs.
Scott Galloway, New York University Stern School professor and activist investor with Firebrand Partners, who also serves on the New York Times (NYT Quote) and Eddie Bauer (EBHI Quote) boards, sent a tweet out after the vote saying that it was "a blow to activists everywhere." For the reasons I've outlined, I'm more sanguine. However, I think it's important to understand where things went wrong in this campaign, as I certainly thought Ackman had adequately made his case sufficiently to win at least a couple of seats.

Here's how things went off the rails for Ackman.

1. Winning a proxy contest is like passing a major bill in Congress. It's not enough to be right, an activist has to put forward an argument that is politically palatable to other shareholders. Ackman ultimately failed in his proxy contest because he failed to win over the support of the biggest holders such as the large mutual fund companies and pension funds.

Although these investors pay close attention to corporate governance matters, their primary concern as fiduciaries is the long-term health and success of the company. Activists sometimes shoot themselves in the foot with these shareholders when they advocate solutions that are perceived to provide only a short-term boost to the stock instead of a more sustainable move. Ackman's real estate investment trust plan for Target, designed to unlock value in the land under Target stores, and creative from a financial engineering perspective, got no support. It was successfully painted by Target as "risky" and out of step with the current environment. Ackman never should have included it as part of his plan.

2. The messenger is a big part of the message. Any activist investor in a proxy contest should be able to convince fellow investors that they are advocating solutions which will benefit the company in the long term. Far too many activists formerly looked for short-term levers to pull to create value in their shares owned, such as paying out a large dividend, taking on debt, selling off a division to a private-equity firm, or doing a big stock buyback.

For the most part, these strategies have hurt the target companies. There are also many activists, and Carl Icahn is probably the most well-known example, who have cultivated an image of force and intimidation.

Hedge fund managers -- and activists especially -- are still seen by outsiders as short-termists. In the case of Ackman, he is who he is: a big New York hedge fund manager. He can't change that, but that image likely did bleed away potential supporters who, when they reviewed his REIT plan and heard about the number of Target derivatives he owned, prematurely dismissed his slate for not being a "long-term investor." In the final days before the vote, Ackman went out his way to issue press releases saying he was committed to holding his personal Target shares, not his fund's shares, for at least five years if he was elected to the board. By then, it was too late to change how he was viewed by his fellow shareholders.

3. Pick bulletproof fellow directors for your dissident slate. Ackman didn't help himself with the pick of Jim Donald as a fellow director on his slate. In TV interviews leading up to the vote, Donald didn't provide a compelling list of things he was going to attack once he got elected to the board. It fed into the view that Target wasn't really badly in need of improvement.

Ackman made a big deal of Donald's experience heading up Wal-Mart's (WMT Quote) grocery division, pointing out that Target should emulate Wal-Mart's performance there. Yet Donald also brought the baggage of his bio for being ousted from Starbucks(SBUX Quote) by the guy who hired him. It's not necessarily fair, but this baggage diluted the message Ackman was trying to get across.

4. The worse the stock performance track record of a company is the easier it is for an activist to make the case for change. Joe Nocera of the New York Times took Ackman to task for his Target activist campaign. Nocera questioned why Ackman would go after Target in the first place when the company's 10-year stock performance was actually better than Wal-Mart's. Not every poorly-performing stock makes an attractive activist target, but it's clear that poor performance is a necessary condition for any activist to win over broad support.

Under the SEC's 2010 proxy rules, just as many Target shareholders agreed with Ackman that Target's performance should have been better in recent years as other shareholders who would have sided with Nocera that all this was a waste of time. Yet, as Ackman made constant suggestions that Target should be more like Wal-Mart, it would have helped him more if there was clearly a stark difference between the stock performances of the two companies over some time. It wasn't compelling enough.

I am heartened by how many shareholders last week voted for an activist campaign that, although far from perfect, would have improved on the status quo at a sleepy board. Ackman made mistakes in this campaign that lost him the trust of the long-term holders of the stock. Even still, the final tally likely will show a very close contest.

And next year's new rules from the SEC will mean that investors like Ackman will no longer have to pay $15 million to run proxy contests. Target's vote is more likely to be an early warning of future activist successes than a death knell.

At the time of publication, Jackson owned no shares in the companies 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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Ackman Vs. Target

05/27/09 - 12:07 AM EDT

TGT , WMT , COST

The much-anticipated annual meeting of retailer Target(TGT Quote) is Thursday and large shareholder Bill Ackman of Pershing Square has been in a long-running battle for the past several weeks to win five seats on the board.

Ackman has spent $10 million to $15 million of his own money on his campaign thus far. Although he's won over the support of two influential proxy advisory firms -- RiskMetrics and Proxy Governance -- he faces a daunting task in winning Thursday's vote. In its latest issue, Barron's magazine proclaimed that Ackman's campaign was "off-target," stating that "Ackman's initiative could be one of the worst-conceived efforts in recent years by an activist investor."

On Tuesday, Ackman pledged to retain his stake in Target for at least five years if he's elected to the company's board. He said his personal stake in Target is now worth more than $55 million.
Here's my view on the campaign.

A Review of the Fight

Ackman's Pershing Square has been a shareholder in Target for more than two years. In 2007, he opened Pershing Square IV, which was a fund solely dedicated to investing in Target. Pershing's funds own 3% of the stock outright with options to purchase at least another 2%, many of which are already in-the-money.

From very early on in his stock ownership of Target, Ackman has been an outspoken critic of the company. His calls for the company to unlock value in its real estate holdings date back to at least 2007.

Earlier this year, Ackman apologized to investors in Pershing Square IV after his option bets on Target had gone against him resulting in a drop in fund performance of 89.5% as of the end of January. Target management has used Ackman's option holdings to imply that he's more a short-termist than other investors and that his proposed changes are riskier.

Ackman's plan for Target consists of four parts: (1) unlock up to $40 billion in real estate value by placing the land under the stores in a real estate investment trust structure and then leasing back the land from the REIT; (2) sell the entire credit card operation; (3) improve the quality of the board of directors; (4) close the performance gap over time with Target's No. 1 competitor Wal-Mart Stores(WMT Quote).

Proxy Governance has supported Ackman's activist efforts and his full slate of nominees for Target's board. RiskMetrics, the more influential of the two proxy advisory firms, has recommended two of Ackman's five nominees (Ackman himself and Jim Donald, the ex-CEO of Starbucks(SBUX Quote)). Glass Lewis, another proxy advisory firm, has rejected Ackman's nominees and supports Target's full slate.

In the weeks leading up to Thursday's vote, Ackman has taken to the airwaves to make his case. He's an exceptional communicator. He's clear, thoughtful and forceful in making his case. I don't think there's a better activist investor currently practicing today when it comes to communication skills.

Target, for its part, also has been pushing its rebuttal to Ackman's criticisms, taking 10 minutes at the beginning of its most recent earnings call to cast doubt on the Pershing plan.

What's Worked With Ackman's Campaign

1. Target's performance has clearly lagged Wal-Mart's recently, and that's relevant. Barron's includes figures in its article that show Target's total three-, five- and 10-year returns vs. Wal-Mart, Costco(COST Quote), and the S&P 500. The results are through April 30, and cite Morningstar. The reported returns imply that Target's returns have been pretty good on a five and 10-year basis, even though they've lagged their peers in the last three years.

I was incredulous after reading this and so I went to Morningstar to revisit these numbers. What I found on its site tells a different story than the Barron's numbers. On the currently reported numbers (through May 22), Target's year-to-date, one-, three-, five- and 10-year returns all clearly lag their industry and the S&P, although the five and 10-year are roughly comparable with Wal-Mart).

2. This Target board is out of touch, like many corporate boards. There are many compelling points Ackman makes about how out of touch the Target board has become. Its directors currently own only 0.27% of the total Target shares outstanding. Many directors only hold shares given to them through options or equity grants. They've consistently relaxed the director tenure limits to allow directors like former Telstra CEO Sol Trujillo to serve up to 20 years on the same board.

Most corporate governance experts would tell you that a director no longer has "fresh eyes" to look at a company's issues and challenges after eight years on the same board. A two-decade term limit is outrageous. It's also ridiculous to hear that Target's nominating committee refused to meet with Ackman or his nominees about joining the Target board last year but paid themselves fees for sitting on this committee, even though that committee didn't meet once formally during the year. I can't recall seeing that in a recent large company proxy.

Target's board deserves a revamp. Its practices suggest a cozy group of insiders seeking to protect their job security as directors, rather than doing the right thing for shareholders. Things likely will change significantly in future boardroom battles, as last week the Securities and Exchange Commission threw its support behind "proxy access," which would make it much less expensive to mount campaigns and give shareholders a real choice in who they want to represent them on the board instead of only choosing from the incumbent slate. If Target's board doesn't change Thursday, it most certainly will next year.

3. This is a legitimate campaign -- not a distraction. As the Barron's article stated over the weekend, there is no shortage of management apologists who come out of the woodwork when there is a dissident proxy fight. Most of the time these commentators who support the status quo usually complain that the company isn't the worst of the bunch and therefore an activist campaign is a waste of time and a distraction.

That approach has allowed mediocre boards to persist in this country for decades. As the points I've mentioned verify, this campaign certainly has merit. What's more, Ackman has paid his way to put it on. He has real "skin in the game" -- unlike most, if not all, of these kinds of critics. The fact is that if more mediocre boards had been "distracted" by legitimate activist campaigns over the past two years it's likely we'd have a much stronger capital markets system today than the one which absolved itself of any risk management responsibility.

4. Ackman's made a great case. I tip my hat to Ackman, including his spirited attack of the Barron's article, for being a very precise and skilled communicator. I think he's made about as strong a case as an activist can make at this time against Target.

What Hasn't Worked

1. Target's poor performance relative to Wal-Mart hasn't been compelling enough. It's hard to win an activist campaign arguing what Target should have done in the last few years. Shareholders are human. They take short-cuts, they summarize, they look for sound-bite logic for understanding a campaign, and then they base their voting decisions on this incomplete information. Some shareholders rely heavily on what the major proxy advisory firms say when deciding how to vote. Although Ackman's made some salient points on how Target has lagged Wal-Mart, he will not gain as much shareholder support as he could have if the gap had been much more compelling.

2. The REIT component of Pershing's plan doesn't match today's environment. A large part of Ackman's plan includes increasing shareholder value through creating a new Real Estate Investment Trust. It matters not that Target uses Richard Sokolov, the president of Simon Property Group (SPG Quote) (who competes against General Growth Properties, of which Ackman is a large owner), to discredit Pershing's plan. The optics of the plan don't match the current environment we're operating in even if the substance of the plan is on the mark. It will be difficult to convince many investors to take a leap of faith on a sudden creation of $40 billion in value from moving a few shells around. At the moment, skepticism reigns.

3. Jim Donald's communication skills haven't matched Ackman's. As RiskMetrics' recommendation confirms, there appears to be the most support for Donald as a second pick for the Target board after Ackman.

During a recent joint CNBC appearance, Donald, who also helped build Wal-Mart's grocery business before leaving for Starbucks, failed to match Ackman's oratory skills. When someone questioned Donald about what changes as a director he'd like to see Target make, he deferred, saying that he needed some time to study things in more depth. It was modest and diplomatic but not in keeping with a bloody-nosed proxy fight.

What's more, it played to what Target has tried to press -- that there's nothing that significant to fix at the company. It would be ideal if all shareholders took the time to review all candidates' utterances prior to forming their selections, but unfortunately sound bites matter, and that one hurt.

When all is said and done Thursday, I expect that Ackman will win two seats on the Target board, along the lines as RiskMetrics suggests. In the long run, it should greatly help Target's other shareholders and prove the naysayers wrong. Ackman hasn't run a perfect campaign, but it's been very effective, and he will consider it a success with this kind of outcome. It also will give him the chance to further press his views at the board level. It's likely that Thursday's showdown will be a preview of many more activist contests to come next year, once the new SEC proxy access rule goes into effect. Sleepy boards should get ready for more distractions.

At the time of publication, Jackson had no positions in the companies 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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SEC May Shift Board Control

05/20/09 - 08:42 AM EDT

TGT , BAC , C

On Wednesday, the Securities and Exchange Commission will hold meetings on whether and how shareholders should be allowed to nominate directors to boards of companies in which they hold stakes. If a rule is agreed upon and put in practice in the next 90 days it could dramatically change the relationship between shareholders and management teams for years to come.

The normal course of business since the SEC was created decades ago was that management holds all the cards in selecting its board and insulating itself from criticisms from shareholders. Management picks the directors it wants, it can stagger its re-elections to make it next to impossible to overturn the board in any one year, and shareholders face huge costs and long odds in putting up their own candidates.

Even after the Enron and WorldCom scandals earlier this decade, the SEC saw fit to change nothing with respect to making corporate boards more accountable to shareholders. That's about to change.

With the latest downturn, and the large antipathy directed towards the SEC from the media and shareholders thanks to its overlooking Bernie Madoff and doing nothing to prevent large institutions like Citigroup(C Quote), Lehman Brothers, and Bear Stearns from imploding, the SEC can no longer look the other way. Chairwoman Mary Schapiro was brought in with a mandate and, so far, she's giving every indication that she's cleaning house and going the extra mile to give shareholders a voice for their concerns. All this has implications for the number of shareholder activist battles we'll see starting in 2010 and beyond. But more importantly it should truly improve the risk-adjusted returns for all public companies.

A few weeks ago, the SEC took an important first step in helping shareholders have more of an impact in annual votes. It announced it intended to get rid of "broker votes" being counted in favor of a management team's incumbent slate.

To explain how this works, take the recent case of Bank of America's (BAC Quote) annual meeting last month. Most press coverage focused on how a shareholder resolution was passed with a majority (50%) vote that stripped CEO Ken Lewis of also holding the chairman title. However, the truth is that broker votes played a key role in preventing other significant changes from occurring at the same meeting.

Here's how it works: Broker votes are those placed by brokers who hold the stock in the name of their clients. If these brokers don't receive specific instructions on how to vote their shares during proxy season (which happens the vast majority of the time for the vast majority of proxy votes), the brokers can vote them in the manner they see fit. About 99% of the time this means voting the shares in favor of management, artificially raising the perception of how much support there is for management among shareholders.

For Bank of America's vote, the Wall Street Journal calculated that broker votes would account for about 22% of the overall vote. This means that if BofA's vote had been held in 2010 instead of 2009, when broker votes will not be counted towards the election results, the shareholder proposal to separate the chairman and CEO titles would have been 64% instead of 50%. Moreover, based on last month's shareholder results, it's likely two other shareholder propositions would have passed: (1) allowing shareholders to call special meetings to possibly replace members of the board and (2) an advisory vote of executive compensation, or so-called say-on-pay. Two directors, Lewis and Temple Sloan, also would have received enough votes to vote them off the board entirely.

With the debate about allowing shareholders more "proxy access," the SEC is suggesting shareholders receive a more direct say on who will be elected to a board, at a significantly lower cost. Until now, it's been entirely the choice of management who gets elected to serve on the corporate board. Shareholders simply get to vote up or down on these nominees. The SEC wants to allow shareholders to put forward their own nominees for directors to be voted on. If there are eight spots open on the board, and eight put forward by management and four put forward by shareholders, the SEC is saying, "Let the best eight candidates with the highest number of votes serve." Sounds very democratic, doesn't it?

It's quite conceivable that in a few years at least the largest shareholders will see all potential directors parade through their offices in the weeks leading up to an election, pressing the flesh and making their case to be elected, much like politicians do in general elections.

The SEC's proposed rule, which will be debated Wednesday, will require shareholders to hold 1% of the company's shares outstanding in order to nominate directors to serve on companies with a market capitalization greater than $700 million. For companies under $700 million in market cap, shareholders will need to hold 3% in stock; for companies under $75 million in market cap, shareholders will need to own 5% of the shares outstanding.

By asking for "skin in the game" from shareholders who want to suggest candidates, the SEC hopes to ensure the candidates are of the highest quality and the suggestions are from the most serious shareholders.

Take the current battle being waged by Pershing Square's Bill Ackman, who is seeking to elect four directors to Target's(TGT Quote) board. He's estimated the current proxy battle, which will be resolved next week, is costing his firm $10 million to 15 million. He will pay this out of his own pocket, even while the incumbent board pays for all of its costs out of shareholders' pockets. It shouldn't be so costly or on such uneven terms to put forward some candidates for consideration.

When I hear management -- like that of Target -- complain that a shareholder challenge is too distracting and costly that it keeps it from running the business, I think to myself that if management had done a good enough job of running its business to begin with in the first place, shareholders wouldn't have been forced to take up a crusade against it.

These new shareholder-friendly rules from the SEC will serve all shareholders better than the old skewed rules. There will be a burst of challenges in 2010 and 2011 in response to these new rules and many boards will see their composition change significantly in response to the challenges. My prediction is that this initial "cleansing period" will prompt other boards to preemptively change themselves before being forced to by their shareholders. Counter-intuitively, I expect these new rules, in the long run, to lead to fewer shareholder showdowns, not more. Sunlight is the best disinfectant and the ability to cost-effectively run a credible proxy contest against a sleepy board will rouse many of these boards to heal themselves of what afflicts them.

At the time of publication, Jackson had no positions in any 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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Cheering for Bill Ackman at Target (TGT)

I read Jesse Eisinger's great profile of Bill Ackman of Pershing Square in my final copy of Portfolio Magazine.

Bill took some shots when his Target (TGT)-only fund was down 93% earlier this year. He had to apologize to his investors, loosen the fund terms and injected $25 million personally into the fund. AG Andrew Cuomo even called Ackman up to compliment him for how he handled the situation.

The last I heard, Ackman's TGT-only fund's return was -50% -- still a big loss, but a remarkable achievement in a little over a month off the bottom. This jump corresponds with TGT's move from its early March bottom of $25 to around $40 today.

Ackman's results show how quickly a one-investment fund, combined with the use of options, can see performance dramatically increase (or decrease). (Ackman has already said he'll likely never do a single investment-fund again.) There is still a good chance that this formula will assure he returns all the original money to his investors and, who knows, maybe even return them a small profit.

I'll be cheering for Ackman. He's got ideas in spades, which is something the world needs more of these days. And, besides, who doesn't love a happy ending?

Position: None.

Originally published in RealMoney.com on 5/6/2009 1:37 PM EDT

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Activists Must Adjust Their Aim

HEARD ON THE STREET

APRIL 27, 2009

By GREGORY ZUCKERMAN, The Wall Street Journal

It's hard to scare a target when you are on the run yourself. But that is the awkward position in which activist investors find themselves.

Activist funds lost almost 10% in the first two months of this year, after falling almost 31% last year, according to Hedge Fund Research. That's worse than other hedge funds and in line with the overall market, suggesting that many are simply long-only investors who take concentrated positions in single stocks.

Meanwhile, many of the largest activists are dealing with unhappy investors who are fleeing their hedge funds. A focused fund started by William Ackman succeeded in getting Target to buy back shares, among other things. But Target has resisted some of his other suggestions. And amid the market downturn, Mr. Ackman's Target fund has lost more than 50% since its launch.

Despite such setbacks, activists might again be trying to flex their muscles, pumped up by gains of 9.3% in March. Carl Icahn has been pushing top executives at Amylin Pharmaceuticals to trim waste and not resist any possible sale. Smaller hedge funds such as Ironfire Capital are preparing to launch campaigns, according to people familiar with the matter.

The question is what playbook will work in today's environment. Activists have spent much of the past few years pushing companies to take on more debt and pay out cash to shareholders. It turns out that many of the companies were correct to try to conserve cash for a rainy day, given the tsunami in the markets and economy that subsequently resulted. Companies should easily shrug off pressure to return cash right now.

Another activist favorite, pressuring companies to break up or sell themselves, also could be a challenge. Financing markets remain in disarray and valuations are distressed in many cases.

And such attempts have included notable failures. Investors jumped into Yahoo stock when Mr. Icahn last year pushed the company to sell to Microsoft, figuring he could bridge the gap between the two sides. But they still are dragging their feet, and Yahoo is down more than 40% since he got involved.

A more fruitful area could be on forcing cost cuts. Activists have often targeted entrenched and overpaid managers they believe are looking after themselves rather than shareholders. With many executives receiving generous compensation packages, even as their companies struggle, there could be plenty fodder for activists. A range of academic research suggests that hedge-fund activists have had a positive impact in areas such as reining in executive pay and perks.

Research also shows that activists can have a positive impact on long-term share prices, although some studies cover bull-market periods when companies could be successfully prodded to sell themselves or certain assets and pile on debt to boost payouts. In today's leaner times, activists have their work cut out demonstrating that they aren't a spent force.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com

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Activist Investors Sidelined by Brutal Market

From TheStreet.com

By Eric Jackson

04/06/09 - 12:12 PM EDT

S , HD (Cramer's Pick) , MOT , WEN , TIF , CSX , TGT , YHOO

Earlier this year, Ken Squire, who runs the consultancy 13-D Monitor, which follows those filings with the SEC, wrote an article in Barron's predicting that 2009 would be a "golden age" for activists (which I also predicted recently).

His article made several strong points for why this should happen, including the low valuations, a favorable political climate likely to ease hurdles for activists to challenge companies, and shareholder discontent at record levels. Yet, this activist activity has yet to materialize. Why and when will this change?

There is a finite set of large activist investors in the world today with the assets to take on large public company battles. Some of the biggest have included: Relational Investors (active in Sprint(S Quote - Cramer on S - Stock Picks), Home Depot(HD Quote - Cramer on HD - Stock Picks), and National Semiconductor(NSM Quote - Cramer on NSM - Stock Picks) last year), Trian (active in Wendy's(WEN Quote - Cramer on WEN - Stock Picks) and Tiffany's(TIF Quote - Cramer on TIF - Stock Picks) last year), Carl Icahn (active in Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) and Motorola (MOT Quote - Cramer on MOT - Stock Picks) last year), The Children's Investment Fund (or "TCI," active in CSX(CSX Quote - Cramer on CSX - Stock Picks) last year), Jana Partners (active in Cnet last year), and Pershing Square (active in Target(TGT Quote - Cramer on TGT - Stock Picks) last year).

Like most investors, they had terrible results last year, although their previous 10-year returns have been outstanding. These activists suffered more in 2009 than other hedge funds because of two reasons: (1) they typically run long-only or long-biased funds and therefore had very little hedged going into last fall and (2) they have concentrated portfolios of typically fewer than 15 holdings, which can work very well in up years but terribly in down years.

These large activist funds have seen heavy redemptions in the last six months, and there is no reason not to believe they won't see more for the balance of this year. Even Jana Partners, which had relatively positive returns in 2008, has been hit with large redemption requests reportedly affecting 20% to 30% of assets.

As a result, all of them have pulled in their horns on potentially new activist campaigns, in favor of working out existing investments. Some activists are even exiting existing investments, after spending significant time and money on winning board seats (e.g., Relational exited its Sprint investment and TCI plans to exit its CSX investment later this year), in order to focus on a smaller set of investments within their portfolio.

To meet redemption requests, large activist founders have had to inject significant personal capital into their funds. Carl Icahn, whose fund was down 36% last year, put $500 million in. Bill Ackman recently invested a further $25 million in his Target-only fund Pershing IV.

Christopher Hohn, founder and head of TCI, who was recently regarded as one of the top activist investors in the world (and who some former employees cattily referred to as the "Sun King" made waves recently when he indicated he is considering turning his back on activism.

He complained at a recent investor day that activism was too "expensive and unpredictable," citing the recent $10 million spent by his firm on a bitter proxy battle with CSX last year (which he ended up winning, taking four board seats. He plans to give up those seats at the next annual meeting, possibly signaling an intent to sell CSX shares later).

The redemption siege mentality gripping large activist managers (which carries over to other hedge fund managers as well) is, in my opinion, the biggest reason for the drop in large activist battles. The New York Times recently reported that new activist campaigns dropped by nearly 80% in the fourth quarter of 2008 compared to a year earlier, according to data from Thomson Reuters, and activists made 59 new investments last month, compared with 87 a year earlier, according to Hedge Fund Solutions.

Of course, the evaporation of credit has taken away one "quick fix" strategy out of the quiver of some activists: Call on the company to take on an unhealthy amount of debt in order to buy back shares to artificially boost EPS and immediately dividend out this cash to shareholders -- all in the name of "creating shareholder value."

Marty Lipton, who has been corporate America's top watchdog against activist investors, recently attacked these kinds of practices, asking: "Can the global economy afford to allow institutional investors, who are seeking to maximize the price of their shares on a daily basis, determine industrial business, policy and strategy of major corporations?"

Of course, there are examples of bad behavior at both ends of this spectrum: greedy, short-termist activists enriching themselves at the expense of long-term holders, and greedy, out-of- touch boards and CEOs filling their own pockets out of the company till while driving a company's value into the ground. There can be highly effective boards and CEOs, as well as highly effective activist investors who advocate actions that are in the company's and its long-term shareholders' interests.

The fact is that Ken Squire's thesis is still correct that the broader environment has made it much more favorable for activist investors to launch campaigns. There are many companies today trading at or near their cash levels. Some of these companies are in this situation due to the wash-out of the broader market, but many are there because of their boards approving poor capital allocations (buying back stock at the top of the market or taking on large amounts of debt which cannot be rolled over), poor acquisitions, excessive compensation, or simply leading their company to value-destroying mediocrity.

A year from now, the SEC is likely to approve a new "proxy access" rule making it much less expensive for activists and other shareholders in general to challenge boards doing a poor job representing their interests in overseeing the company's direction. It's likely that many smaller activist investors will be involved. The most active activists today are the firms going after companies below $2 billion in market capitalization -- on the assumption that they can have more sway over these companies because they can hold a larger percentage of shares than would be possible if they went after the larger public companies.

Yet even the most favorable conditions will promote activist campaigns against large-cap companies if the current generation of large activists continues to be inwardly focused by their redemption and performance problems.

This could be a generational succession moment for activist investors, where the elders give way to a next generation of activist investors taking on the largest companies in corporate America.

For this next generation of activists to successfully take over this mantle of their industry, they must do the following:

• Hedge, in order to preserve partner capital in the event of terrible years like 2008. The days of long-only are over.
• Build a reputation for always doing right for shareholders (especially long-term holders). Some of the "quick fix" activists of the last five years never won the trust of large mutual funds and pension funds, who tend to be the biggest holders of stock of the large-cap companies. As a result, proxy contests failed to win over the support of this important constituency, for fear of how these activists would represent their interests properly.
• Focus more on strategy and operations, less on single events. There will always be a place for activist investors to go after a company, advocating they sell a single division, or do a quick dividend to shareholders. However, these situations tend to be more prevalent in small-cap companies. Large-cap companies, by definition, have more complex problems and require more complex solutions. The next generation of top activists will understand this and have deep expertise in their firms on strategy and operations.
• Use the tools of the Internet and social networking. In 2007, when I ran a successful activist campaign against Yahoo!, which resulted in unseating Terry Semel as CEO after a large "no" vote at the annual meeting, I owned 96 shares of Yahoo! However, I was able to get my message out to large and small shareholders via my blog, YouTube, wikis, Facebook and Twitter. More than calling attention to my ideas, these social networking tools allowed fellow shareholders to pledge support to my group and encouraged them to suggest additional ideas for how Yahoo! could improve. I was most surprised and pleased with how many existing Yahoo! employees participated. Yet, their interests were perfectly aligned with our groups: We were all stockholders of Yahoo! and wanted to see the stock price go up through needed changes, which the current board and management were not making. The next generation of large activist investors will be masters at using the Internet to conduct their campaigns.
• Be more collaborative, less combative with target companies. It will always be necessary to run successful -- sometimes nasty -- proxy contests against entrenched boards and management. In my opinion, the Yahoo! board, for example, will never respond to a "nice guy" activist approach. It is so entrenched and disconnected from the opinions of shareholders that it would be impossible to reason with them. There's a time to knock heads. However, some activists only knock heads. They only know how to hit one key on the piano. The next generation of activist investors will be able to play hard ball but tend to be much more collaborative with the board and the CEO -- at least at the beginning, until reasonable dialog leads nowhere. Such an approach is also far less expensive than an "all-negative, all-the-time" approach.

There is a job opening in the activist investor industry. Wanted: the next generation activist investor leaders to take the lead in waging successful campaigns against large cap companies. Who will assume the mantle? We'll see over the next few years.

At the time of publication, Jackson was has 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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