Barron's Streetwise - Activists, Shmactivists

Episode Date: February 4, 2023

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With record levels of dry powder available for investment, find out what's in store for private markets in 2025 and beyond. Listen to Crafting Capital in partnership with UBS at partners.wsj.com slash UBS, Spotify and Apple Podcasts. Shareholder activism really only matters if it causes the firm to sell itself, to spin out something for sale, or to sell some assets. Their governance initiatives are worthless. Their strategic initiatives are worthless. Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe, and the voice you just

heard is J.B. Heaton. He's an investment lawyer and academic researcher who has studied the results of activist investors. Those are the ones that buy stakes in big, underperforming companies, then they demand board seats, strategy changes. And JB finds that these swashbuckling defenders of shareholder value against the forces of corporate squander and ineptitude don't generally have such great ideas. On average, we'd be better off sticking money in a stock index fund than turning it over to an activist fund. More from JB and others on activist investing in a moment. listening in is our audio producer jackson hi jackson hey jack just before we started recording you were talking about basketball and you had a basketball activist investor analogy in the column this week the peewee that my son plays in kind of more of a more of a peewee basketball circuit

and you're the coach i don't know if i want to mention you coach he plays on three teams you coach peewee basketball one of them okay yeah so you're a basketball coach i coach one of them i'm a parent in the stands on the other one and two of the other ones and the parents uh you know they they they coach from the stands you're not supposed to do that but it but it's hard not to. You say like, hey, you know, put your hands up, call for the ball, you know. So, I just, the analogy I use is picture one of those parents walking over the bench, sitting down, grabbing the clipboard, and then you start telling the kids, hey, stop chucking from the outside. You got to hit the boards. You go turn your shorts right side out in the locker room and, you know, the rest of you run the floor.

Like, that's kind of what an activist does and ceos appreciate that about as much as an actual coach would appreciate a parent doing that during a game there are basically two main models for investors butting in on a company's operations like that. One is the activist and one is the raider. And I call an activist a raider without the commitment. I'll tell you what I mean. A raider buys, let's say, 10% of the outstanding shares and then makes a tender offer, goes to the other shareholders and says, I want to buy your stock. And they have to sweeten the deal. So they typically offer a big premium. And by buying all that stock, they gain voting control of the company. And then they can replace the board. And once they do that, they can do anything they want. They can hire, they can fire, they can sell, they can merge,

they can borrow, they can switch strategies, whatever they want to do. That's a raider. They can switch strategies, whatever they want to do. That's a raider. Now, an activist buys maybe 5% to 10% of shares, and that's it. And then they try to get board seats or they try to make operational changes without buying control. They start by asking nicely. If they're turned down, might you know put out a slide deck saying hey the management of this company doesn't know what they're doing they might go and

really promote that like aggressively leak it to anyone who will will notice or or maybe um you know promote it i didn't know powerpoint could be so nefarious, it's got power right in the name. Oh, yeah. So they showed around on Twitter, and then they go to the shareholders, and instead of saying, sell me all your shares, they say, we want you to vote for us. We want to vote the board members out, or we want to vote the managers out, or we want to vote to managers out, or we want to vote to force these changes that we want to make. That's called a proxy fight.

Okay, so put that aside for a moment. We'll come back to the difference between raiders and activists. But right now, the activists are fully activated. We talked a couple of weeks ago, I think, on this podcast about Nelson Peltz and his campaign at Disney. And he had a fresh letter that he sent out this past week and it said, we cannot sit idly by. We got to get off the bench.

Got to get off the bench. And Salesforce. Salesforce, there's at least four activists the wall street journal our friends there call this an activist swarm i call it hacky's activist because it's like you know they're like surrounding the thing and just kicking it back and forth and saying do this do that do this do that so there's these four different activists involved there. There was a fight over at Splunk, over at Hasbro, and the journal documents this rising number

of what it calls swarming among activists, multiple activists going after the same company. And it really makes sense that any kind of activist activity would be on the rise. The whole thing is you go to a company whose shares have been underperforming. You can't go to a company whose shares are up 1,000% and say, I have ideas on how you should run the business. You're going to get laughed out of town.

The shareholders don't want to hear from you. They like the way things are going. But you wait until that company's stock falls by half. And then you come around and you say, no, you're doing it wrong. And let me tell you how you should be doing it. And then maybe shareholders are more receptive because, you know, the long-term ones are probably still way up, but they're down by half from where they were. And they start to think, hey, maybe this Wall Street person knows what they're talking about,

about how the board and the company could do things better. Maybe this Wall Street person knows what they're talking about, about how the board and the company can do things better. One activist recommendation for Salesforce really caught my attention. They recommended some asset sales, and one of those was a sale of something called Slack. Now, in the past, I can't quite remember when, but on this podcast, we had the founder of Slack back when Slack was a an independent company his name is stewart butterfield and he's preposterously wealthy from creating this messaging platform for companies what would you call it jackson i'm not quite on it yet but it's not it's like

it takes it takes a place on email corporate messaging platform yeah like the cool kids are on slack and and the old nerds like me are still doing email so there's a little bit of you know but i'm i'm i feel the heat you know try to get on Slack. I'll get around to it eventually. I know I've been saying that for years, but it's probably going to happen anytime now. The thing about Slack is Salesforce just bought Slack in July of 2021, right? For a lot of money. 27 and change, billion dollars. Wow. Which, I don't know, Slack is widely used and I'm sure it's quite valuable. I wonder if that was the right price because it just, it seems very fickle. You know, you pay that much for something. Then a year and a half later, everyone's saying that the best thing you can do right now to

unlock value is to sell that thing that you paid a lot of money for. And it got me thinking, do activists really know what they're talking about? The best thing you can do right now to unlock value is to sell that thing that you paid a lot of money for. And it got me thinking, do activists really know what they're talking about? On average, is there any reason to believe that this Wall Street person who shows up and gives a company advice on how to run its business from the outside that they know better than the company's management on how to do things? Even if it is a company that has made mistakes or a company that has some squander or whatever, is there anything that they're telling these companies that's non-obvious that's really creating value for shareholders? Basically, my questions were, do activists create value for the companies they target and do activists create value for their own investors? That's what I set out to learn this past week. Yeah. And you spoke with Josh Black over at Insightia.

Insightia, there was this thing called activist insights and it became Insightia and then Insightia was bought by a company called Diligent. But basically this is sort of intelligence for people who study activists and what they're doing and how to respond to them this is sort of intelligence for people who study activists and what they're doing and how to respond to them, that sort of thing. And so they have data on how these folks have done. And that's what I wanted to get to. So I reached out to Josh and he had some thoughts on the situation over at Salesforce. Starboard and Elliot are similar in the sense that they both focus on operations and margins. And so their views, I think, are going to be somewhat aligned. They may have different perspectives.

They may be pushing slightly different operating plans. We don't really know at this point. They haven't said very much publicly. And then you have Value Act, which has often positioned itself as the kind of activist that companies like to deal with, and has in the past been the one that companies have selected to invite onto the board. You know, we saw this at Exxon in the middle of the proxy fight, they pointed former Value Act CEO Jeff Ubbin to the board to try and stave off investor concerns that there hadn't been enough board refreshment.

And that's kind of what Salesforce has done by appointing Mason Morfitt to the board. The returns. Josh sent me numbers for something called Insightia Activist Index. And over the years, it has tracked dozens of activist funds. And he has numbers going back to 2008. And the index has returned 322% since 2008, which sounds wonderful. But the S&P 500 has returned 425%. So about 100 points more if you had just been sitting in a regular boring stock index fund versus all these headline-making activities by the activists. So, eh, not great.

And there's another index from Bloomberg. That one doesn't go back quite as far, but it's the same idea. The activist funds and its index have underperformed a regular old stock index fund. So Josh points out that there are times, there are certain markets when activist funds do well. Like last year, activist funds outperformed the S&P 500. It was a down market and value stocks outperformed growth stocks last year. And activists tend to favor, I guess, what you would call value stocks, beating down stocks. So last year, they fell, but they fell less as a group than the overall stock market. But the broad record just isn't good. And usually when an activist comes to town and says, we have ideas for your company, they put out something saying, our past returns are great. And look, I haven't examined every activist fund out there, but it's kind of the same thing with

active mutual funds. If we're talking about large cap stocks and we're talking about money managers out there who want to charge a fee to manage a stock portfolio, and then you say, well, look, the record says that overwhelmingly the majority of active fund managers underperform the benchmarks year after year after year after year. And in some years they have a good year and some do a little better than others. But it's hard to know ahead of time if I pick this one that has done well over the past few years, are they going to do well over the next few years? You don't really know, but the record for the group is not that convincing with active fund managers. And I don't think it is for activists either.

And the fees for activist hedge funds are typically much higher. Some of these funds can charge a couple percent every year and then slice off 20% of the profits in good years, which if you had that in an index fund in your 401k, it would just be death. I mean, I don't know how you overcome fees like that. I wrote that I should start an activist hedge fund. I call it bottom-up investment. And the idea of bottom-up is you buy a stake in a troubled company and you demand the board seats. And they say, you mean you want to appoint directors? And you say, no, no, I want the actual seats. Send me the chairs. And from now on, the whole board stands at every meeting until the stock price doubles. And they would say, well, how do we do that? And I'd say, I don't know.

I don't know the first thing about your business. You got to figure it out, right? And then I charged 2% a year and 20% of earnings. And I think the record suggests that bottom up might do at least as well as the average hedge fund activist out there, because even though I won't have any ideas, there's evidence that the ideas that the other activists have aren't really that good. And I knew just the guy to talk with about that. His name is J.B. Heaton, and he's an investment lawyer and a researcher.

And he wrote a chapter on activism for a book called The Oxford Handbook of Hedge Funds in 2021. You know, we love these stories because humans love to watch conflict, right? We love watching sports. We like to unfortunately read the news about the wars that are going on. We if we hear about somebody at work who was in a fight with somebody else, we want to know the details. So there's something that appeals to us about somebody like an Ackman or a Loeb coming out and calling names at directors and people like that. But when you really push and look behind, is anything really going on here? Their results are not good. JB says there's one exception where activists can unlock value,

and that's when they can convince companies to sell something big. Shareholder activism really only matters if it causes the firm to sell itself, to spin out something for sale, or to sell some assets. Their governance initiatives are worthless. Their strategic initiatives are worthless. But if they are able to convince the company to sell itself or sell some substantial part of its assets, then that does seem to benefit shareholders. Of course, it just begs the question whether anything has happened there other than moving assets into the hands of a more optimistic buyer who then overpays for them. That's certainly good for shareholders at the target firm, but, you know, sort of from the perspective of society

at large, or really you don't have to go beyond that, from the perspective of a diversified investor, if you're just sort of overpaying out of one pocket, you know, to buy something from the other pocket, then there's, you know, there's really not much gain from the activity. That takes me back to Salesforce and this recommendation that they sell Slack. I mean, it sounds like kind of just spinning the wheels because they just bought the thing. But then JB points out that sales usually work out pretty well for companies. And the reason is simple. When a company wants to sell something, it usually puts it out there to bidders. And who's the one who buys it? The one who bids the most. So whenever there's an auction, people tend to overpay.

It's like Jackson on eBay. Jackson, I know you have a story about getting way too much money for something on eBay. I was on the other end of that bet. I was eight years old and I spent my life savings on a Nintendo 64. On an auction? Can't you just buy one at the store? It was when it was three years old or something. Oh, you bought a used one. But once the time started counting down, it was connected to my dad's credit card or something. And I got in a bidding war with someone. And so you're admitting to a major fraud and you're assuming that the statute of limitations

is passed and that because you were a minor, you won't be held accountable. I don't know. I'm not a lawyer. Anyone out there? I think we might have a case here. I think I did it with permission, but. Okay. Okay.

So buyers tend to overpay even eight-year-old ones. And that's why if an activist can convince a company to sell something big, you know, it might be a good deal, might create some value, but that's about it. JB says there are other recommendations aren't really that useful. And we've seen that the returns they generate on the whole are not that impressive, but that leaves me wondering why are activist investors so rich? I mean, they're worth billions of dollars. And when a multi-billionaire rolls into town with recommendations on how to run a business, there's just this tendency to think they must know what they're talking about. I mean, how else would they have gotten so rich if they didn't have good ideas?

I asked JB about that. The way you get rich in the asset management industry is to convince other people that you've got a good story and they should invest with you. And I think activism is just awesome for that because your investors get to see you in the news. You know, if you're invested in Elliott and you get to see Elliott's, you know, now they're taking on Salesforce and, and, you know, they were taken on SoftBank and then they're taking on the next one. And you think that's my guy. I'm invested in that. Thank you, JB. How about we get a manager perspective? We're going to hear from a former CEO of Medtronic. That's next after this quick break. What's up Spotify. This is Javi. I remember this one time we were on tour.

We didn't have any guitar picks, and we didn't have time to go to the store, so we placed an order on Prime, and it got there the next day, ready for the show. Whatever you're into, it's on Prime. With TD Direct Investing, new and existing clients could get 1% cash back. Great! That's 1% closer to being part of the 1%. Maybe, but definitely 100% closer to getting 1% cash back with TD Direct Investing. Conditions apply. Offer ends January 31st, 2025. Visit td.com slash dioffer to learn more.

Conditions apply. Offer ends January 31st, 2025. Visit td.com slash dioffer to learn more. What's on tap for the weekend? Funny you should ask. EagleFest. There's an event near me called EagleFest every year in February. Why?

I do not know. So it's cold and it gets windy near the river. So it's always colder than usual. And this weekend, the forecast is for zero degrees. But at least you get to see some eagles, right? Well, no, because there's not really any eagles at Eagle Fest. It's a celebration of eagles. So you see slideshows and you talk with some eagle experts and you're in these big tents. I'm not doing it justice. I've only been once and it was a few years ago. Well, you see any, are there any birds of prey? Like do you get to, there's no actual birds, but I don't think I'm going. It's too cold. Welcome back everyone. I told you I would come back to Raiders versus activists. There is this Raiders versus activists.

There is this popular perception that raiders are these villains. They're very short term. They swoop in and they just want to make a lot of money quickly and then they leave the company in ruins. The model for it is Gordon Gekko, the character Gordon Gekko in the movie Wall Street. The point is, ladies and gentlemen, that greed, for lack of a better word, is good. I was struck by one at the time. He's talking with a young Charlie Sheen's character about why he has to get in on this, you know, dodgy investment idea. And he's telling him to wake up. And I'll read it to you. It says, I'm not talking a $400,000 a year working Wall Street stiff, flying first class

and being comfortable. I'm talking about liquid, rich enough to have your own jet, rich enough not to waste time. Fifty, a hundred million dollars, buddy, a player or nothing. And I heard that at the time and I thought, wait a second, on Wall Street, even the losers make four hundred thousand dollars a year. That sounds pretty good. I want to be one of those stiffs. I'll take flying first class and being comfortable. So I went to work on Wall Street in the 90s as a stockbroker.

Anyhow, where was I, Jackson? Raiders versus activists. Right. So the popular perception is that the raiders are the villains and the activists are these defenders of shareholder rights, right? They swoop in to companies that are lazy or they're squandering money, and they get them fixed up because they know so much about business. There's a professor at Columbia Law. His name is Zohar Ghosh, and he teaches corporate governance and securities regulation. And he challenges this view in a paper published back in November in the Yale Law Journal. And he writes, activists are no better than raiders. If anything, they are likely worse. And it comes down to what they call mistargeting. Remember I said that raiders do a tender offer where they try to buy a controlling position

or all of a company's stock. And they have to pay a big premium for that. So if you think about their cost, their cost could be 30 to 50% of whatever the stock market value of the company was before they swooped in. And that's a lot of money to put up. So they had better be careful about the targets they pick. Compare that with an activist. An activist has that initial outlay for shares. They buy 5% to 10% of the shares. But they're just buying shares at whatever the market price is. They're not offering a big premium at that time. And then they make their intentions known, and then they maybe need to wage a proxy fight.

And what does that involve? Some publicity, right? Things that are cheap. There was a study that figured that the average cost for an activist campaign ending in a proxy fight is $11 million. And that's not a figure that scales with the size of the company. That just seems to be kind of a flat figure. And it sounds like a lot of money, but that's cheap in the grand scheme of things of what

these activists try to do. And so if you're spending so little on one of these campaigns, I don't know, wouldn't you kind of go after them more? I don't want to say willy-nilly, but maybe you'd be less choosy than a raider, right? And if you're less choosy because you have less money at stake, maybe you make mistakes. I'll give an example. Carl Icahn is one of the most famous and respected activists. And surely a man who's been at this for decades and has amassed such wealth knows best how companies ought to run

things. And in 2012, he bought a position in a company called Netflix. And he said, it's time to sell this thing. This thing's a good acquisition target. I don't think Netflix is being well managed. I don't think things are going well. Time to put the company up for sale. And Netflix wasn't that profitable back then. And look, it's not tremendously profitable today. But the company has been very long term in its approach to building market share. And you can't argue with the stock market results.

Icahn failed in that attempt. And then he gave up and the stock is up more than 3,500% since then. There's a little secret that people don't know. And studies have shown this about stock returns. You know, when we all hold our S&P 500 funds and we do so well over time. And we think that's because all of corporate America is just rising in value in unison. It really doesn't look like that at all. It's because a handful of companies are tremendously successful over the long term.

And a lot of companies just stink. And a lot of companies are just OK. And if you miss out on one of those winners, if you miss out on one Netflix as a long-term investor, your index returns are not that great. And so if you have an activist who goes in early in the game for a company like Netflix and then the world never sees those big stock returns later, it's kind of bad for ordinary 401k savers. So the case that Zohar Ghosh makes is this reputation that the raiders are the

bad guys the activists are the good guys uh it doesn't really feel that that's warranted and also the law kind of protects companies against raiders much more so than activists and he feels that there ought to be changes in the law to reflect uh you know his view of the situation you're going to tell them about the pasta water? Well, yeah. Although I don't really think it's an example of anything. It doesn't really prove any points, but there's a company called Starboard Value and they waged an activist campaign in 2014 against a company called Darden, which is the owner of the Olive Garden.

And they put out a big slide deck, hundreds of pages, and they had all kinds of recommendations on how to run the business better. And one of the recommendations was to put salt in the pasta water. So again, I don't know what that example demonstrates, except maybe just that activists are kind of like those parents coaching from the stands. You know, like it becomes tempting to micromanage, right? You probably don't need pasta water level advice from Wall Street, I guess. Or I could be wrong. I'm a non-salter. Jackson, where do you come down? I'm a salter, pinch of salt.

Pinch of salter. Okay. You're a starboard guy. Now, I wanted to get some management perspective here. There's a man named Bill George who used to run Medtronic, which is the medical device giant. And he's got a book out on leadership. It's called True North Emerging Leader Edition. He also served on the board of Goldman Sachs, Novartis, Target, ExxonMobil, and Mayo Clinic. Right. So he knows plenty about corporate governance from a company's perspective. And here's what he had to say on activists. Well, in general, activist investors are in it for the short term. They want to make money. Often they're very noisy. People like Carl Icahn, Nelson Peltz, Bill Ackman get very actively involved on CNBC and other shows to try to hype the stock up because of their engagement. And then six months later,

they're gone. So the question is, are they doing the right things for the long term? And does the company and the board have the backbone to either make the long-term changes or fend them off? You know, an activist turns up and says, you're doing everything wrong. Here's my slideshow. Here's what you should be doing. You should sell this. You should cut costs over here. You should turn this upside down and that inside out.

What puts a company in a strong position versus a weak position? And what advice would you have for a company in that circumstance? Well, I think the companies I've seen have done it well. They think about what would an activist do and what is the right thing for our company? And are we missing things here? And they take the actions necessary. Now, when they do come and you're vulnerable, then I think you have to take a very careful look inside and see what needs to be done. And activists often have good ideas, but that doesn't mean they can run the company. So I think you can take some of their ideas and not others. What's the significance of the board seat?

These guys always seem to want a board seat or seats. What difference does it make for good or bad? Well, I actually supported Pelts going on the Procter & Gamble board, but in general, I don't Peltz going on the Procter & Gamble board, but in general, I don't support the activists coming on the board. In that case, I thought P&G needed a real internal hard look. And I think Peltz brought good thinking to Procter & Gamble. And I think they've done well since then, and not just because of him, but it certainly caused them to look at the issues. But it can be very disruptive to the board, and it can be to the point where you almost have two board meetings,

one with the activists and one without. I think that's a bad thing to do, by the way. But I do think that you want to have board chemistry where tough questions are raised, but I don't think you want to have an open-out fight on the board. I want to thank Bill and JB and Josh, and thank all of you for listening. Jackson Cantrell is our producer.

You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, please write us a review. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. It's at Jack Howe, H-O-U-G-H. Or you know what? Just come down to Eagle Fest. I think I changed my mind. We're doing it.

Snowsuits. We're hitting Eagle Fest this mind. We're doing it. Snowsuits. We're hitting Eagle Fest this year. We're going to celebrate those birds the right way.