Hostile public company investors routinely garner headline coverage in media outlets like the New York Times and the Wall Street Journal by engaging in aggressive tactics with public companies – a strategy typically referred to as shareholder activism. Through increasingly sophisticated techniques, this group of shareholders now has approximately $190 billion of assets under management, and shows no signs of letting up in their efforts to push short-term value creation initiatives within public companies. Moreover, recent years have shown that no company or industry is immune to shareholder activists. This includes REITs, which have seen an uptick in this kind of activity. To be better prepared for what has become a trend in the sector, REITs should develop shareholder activist strategies to avoid the change of control typically associated with shareholder activism, which we outline below.
In the old era of shareholder activism, activists were often viewed as self-interested outsiders, whose gruff tactics and proposals were not legitimate methods to increase shareholder value. They targeted companies that were perceived to be undervalued, and arrived on the scene pushing for a sale or other disposition through the initiation of a tender offer or solicitation of another liquidity transaction. With respect to REITS, the old way of thinking was that activists generally avoided targeting REITs due to a variety of natural defenses, including: complex structural and tax issues that present challenges to activists looking for easy financial fixes, incorporation in Maryland, a corporate-friendly jurisdiction with inherent legal defenses, and charter limitations on share ownership. It was thought that these natural defenses, along with legal defenses like staggered boards, poison pills, and the ability to “just say no” would repel any would be raider.
In today’s public REIT realm, those thoughts should be relegated to the sideline. The reality is that REITs are just as likely to be targeted by shareholder activists as other public companies and that up to 21% of REIT targets are acquired within the initiation of an activist campaign.1Virginia Commonwealth University School of Business In fact, last year there were 26 activist campaigns against REITs compared to six in 2011. This may be a result of better understanding and acceptance of REITs by the investor community, as the growing transparency of the asset class allows investors and activists to identify stock trading at a discount to net asset value using industry standard methodology (i.e. discounted cash flow analyses and reviews of current, historical and projected capitalization rates based on the market). Accordingly, the truth is that legal “preventative” takeover defenses, including those inherent to REITs incorporated in Maryland, are no longer sufficient by themselves to defeat determined activists convinced of potential unlocked value.
Proactive defense & offense and shifting alliances in the shareholder base
Pure legal defenses do not work in the new era of shareholder activism which subjects a company’s board and management to intense public pressure, employing a number of sophisticated and multi-pronged attacks that are intended to create a wedge between a company’s board and management, on the one hand, and its shareholders, on the other. In today’s world, a company has to think like a shareholder, taking into account not just the view of the activist shareholder, but also the views of other investors (which are multifaceted), including passive investors, the permanent owners whose assets under management have increased steadily since 2008 and dominate today’s shareholder landscape, actively-managed investors, state pension funds and other constituents.
While the investor base historically viewed most shareholder activists negatively, today some of the world’s leading and most widely respected institutional investors, including state pension funds, participate in activist campaigns. It is not unusual for institutional investors to refer potential targets to their activist counterparts, and in some cases non-activist investors have taken activist positions publicly. The line has begun to blur with respect to traditionally non-activist, but actively-managed investors like Neuberger Berman and D.E. Shaw, the former of which has taken a 20% stake in Jana and gone public in campaigns against Amazon, Ultratech and Covisint, and the latter which has criticized EQT publicly, and recently hired a former portfolio manager from Elliott. This frenzy is partially a result of the dominance of passive investors like BlackRock, which has driven actively-managed portfolios like the aforementioned, to hold hands with the devil.
This legitimization of shareholder activists by mainstream investors can put companies in difficult positions when responding to an activist, since forcefully rejecting an activist that is backed by large shareholders can be perceived negatively. Instead, companies approached by activists should consider engaging in a dialogue that articulates well-thought out responses to the inquiry. Companies should specifically consider monitoring their investor lists for prospective activists and be prepared for those discussions based on the history of these activists. Reaching out to a who’s who of investors is typically the most challenging part for companies because it means figuring out who the contact is at the funds for these types of conversations. It could be the portfolio manager, the governance department, the analyst or another officer that is in charge of evaluating the company. Figuring that out, and building out those relationships is one of the most important things a company can do in acting proactively against shareholder activists.
Accordingly, when dealing with a potential shareholder activist’s public campaign, the best strategy available for companies is to communicate a clearly articulated corporate strategy that lays out an achievable path to increase shareholder value, a story that is much easier to sell if the proper relationships have been built during a sunny day. In addition, focusing on the strategy will help companies identify potential transactions that could be viewed as unlocking value by activists and put the management team in a position to discern whether a particular path works for the company and its shareholders before it is ever raised by an activist. We strongly believe that the intersection between activism and M&A provides numerous buy-side opportunities if a company is on its front foot and pursues a time-sensitive acquisition strategy.
Another important precaution in today’s investment landscape is for a company to have frank, open discussions with its Board regarding potential activist activity.
Board education sessions should cover the full spectrum of potential activist attacks and the company’s intended response plan, including the team that would be part of any response. Just as the management team should be able to clearly articulate the company’s vision, the Board should also be positioned to endorse that strategy if it is the right one for the company. An ill-prepared Board or a soft-response in support of management will create vulnerabilities to activists seeking to make a change or otherwise shake up a target. Depending on each company’s situation, a lead director can often create the lines of communication needed within the company so that screening and monitoring will ensure that the Board is never off-sides or surprised in dealing with potential or current activists.
In summary, the challenges from today’s shareholder activists are generally not the direct hostile transactions that traditional corporate takeover defenses were designed to combat. Instead, the battle today is focused on winning the hearts and minds of stakeholders, including significant shareholders and their proxy advisors. The key for any management team is to get out ahead of potential attacks. The simple strategies outlined above will form a solid platform when dealing with potential activists.