Ted White of Legion Partners and Skadden partners Ann Beth Stebbins and Elizabeth Gonzalez-Sussman discuss what draws the attention of activist investors to a company, how activists work with other shareholders and how they gauge the response of management when the activist first approaches a company.
Episode Summary
How do you know if your company is likely to be a target for activists? And what is the best way to respond when approached by an activist?
Skadden M&A partner Ann Beth Stebbins discusses the activist’s playbook with Ted White of Legion Partners Asset Management, a veteran activist investor, and Elizabeth Gonzalez-Sussman, head of the firm’s Shareholder Engagement and Activism Practice.
Activists seek to identify companies where value can be increased. Some activists will focus on operational or governance improvements, while others will press for transactions that could release value, Ted and Elizabeth explain.
Ted and Elizabeth observe that shareholders are not always forthcoming with management, which may make it difficult of a board to understand shareholder concerns. Ted notes that, as an investor, he has observed cultural misalignment in some companies experiencing underperformance, and stresses that it may be important for board members to hear directly from shareholders.
Elizabeth says that, when meeting with activist investors, management and directors should listen to the issues that are raised. Ted says his firm will be trying to gauge if management and the board are aware of the concerns expressed in a meeting, and are willing to address, or at least consider, those. He also notes that directors should assume that the activist has talked to other shareholders about the company and the potential issues that the activist has identified.
Companies should be careful about responding defensively to activists, Ted and Elizabeth say. If the company reacts hostilely or dismissively, that may cause other shareholders to perceive that there is a problem. It could also prompt a more aggressive campaign by the activist to replace directors in the future, and cause proxy advisory firms to be more critical of the company.
If activists succeed in electing new directors, the existing board should attempt to work with them collaboratively, Elizabeth and Ted say, even though the contentious nature of a proxy fight may make cooperation challenging. Ted notes that board dissonance may encourage shareholders to seek to replace more directors at the next annual meeting.
Voiceover (00:00):
From Skadden, you are listening to The Informed Board, a podcast for directors facing the rapidly evolving challenges of a global market. A compliment to our newsletter for directors, our aim with this podcast is to help flag potential problems that may not be fully appreciated, explain trends, share our observations, and give directors practical guidance without a lot of legal jargon. Join Skadden partners who draw on years of frontline experience inside boardrooms to explore the complex issues facing directors today.
Ann Beth Stebbins (00:34):
How do you know if an activist is looking at your company? And what actions should a board and management be taking in response to activist interest?
I’m Ann Beth Stebbins, a partner in the M&A group at Skadden. My two guests today will be sharing their insights on the activist playbook and how management and directors can most effectively engage with activists. Ted White is co-founder of Legion Partners Asset Management. He has had a long career in active investing globally and has held senior positions with the Council of Institutional Investors and the California Public Employees Retirement System. Elizabeth Gonzalez-Sussman is a partner at Skadden where she heads the firm’s shareholder engagement and activism practice.
Ted, we’ll start with you. We threw around the term activist pretty loosely. How do you define activist investing?
Ted White (01:23):
It’s a great place to start. You can kind of divide your shareholder base generally into active and passive, an active investor being somebody that’s made a conscious decision to be in your stock. There’s some reason that they like the company. They’re willing to engage to some degree directly with the company and have some agenda associated with that. There’s a spectrum of how aggressive those activists can be, but I would lump them all together with a group of active investors that would make conscious decisions to be in your stock.
Ann Beth Stebbins (01:50):
Elizabeth, anything to add to that?
Elizabeth R. Gonzalez-Sussman (01:52):
I represented many different kinds over the years before coming to Skadden. Ted and Legion were ones that were going to target companies that they viewed as undervalued. They were looking to engage and try to unlock that value by trying to change the strategy.
Then there were others that had more strategic interest in doing a transaction that prompted them to make an investment. Legion Partners is a perfect example of the kinds that often would want to privately engage for some time before going public, but there’s a lot of others that just jump out there publicly for a reaction first and then engagement.
There’s also different types of engagements, like do you want to be constructivist or do you want to be more hammer-over-the-head kind of activists? It’s important for companies to distinguish so that they know how to engage and how to react.
Ann Beth Stebbins (02:44):
Ted, you’ve been around the activism world for a long time. How have you seen activism evolve during your career?
Ted White (02:55):
Yeah. I started at CalPERS, where I was first involved in what was then called corporate governance-style investing, and from an evolution standpoint, the strategies have expanded almost in every direction. There’s more activists for sure. Some are part-time. Some are dedicated to a particular sector, geography, cap range. I’ve seen over the years an increase in sophistication and a proliferation of advisory services on the corporate side as well as on the shareholder side.
Ann Beth Stebbins (03:27):
Some common themes in activist campaigns have been corporate governance, strategic change, operational improvements. Elizabeth, have you seen any change in these themes?
Elizabeth R. Gonzalez-Sussman (03:40):
The activist is looking at, what are the drivers of under-performance? Sometimes you can’t recognize the full value of the company unless it goes private. Sometimes there needs to be a focus more on the core assets. Maybe the company has grown too big and there’s too many non-core assets that are distracting the company. Are there going to be buyers for these non-core assets, if that’s the thesis? Are there opportunities to take the company private in a market that may be hampered by high interest rates? A lot of it will be dependent on the opportunities that are available in the M&A space. If M&A is a little bit chilled at the moment, then activists are looking more at strategic operations until M&A markets really improve.
Ted, do you agree with that?
Ted White (04:30):
I would think that the themes really more as a means to an end. The central theme remains and will always remain valuation issues. That tends to be the primary driver of why an activist starts looking at a security and eventually ends up investing in it, but the theme may be driven by market conditions. It may be driven by some level of specialization from the activists. There can be some variations. You have some firms that are operational by nature, have a private equity bent or some that are just governance-oriented. Early on, a lot of the activist themes were probably heavier governance.
Elizabeth R. Gonzalez-Sussman (05:06):
Ten, 15 years ago, there were a lot of classified boards and there was a massive push by the activist investors to declassify boards. There wasn’t majority vote policies. If it was an uncontested election, you didn’t see as many independent chairs.
Ann Beth Stebbins (05:22):
There were rights plans.
Elizabeth R. Gonzalez-Sussman (05:23):
There were rights plans. The governance has dramatically improved. However, governance still is an element for many activist investors as they think about drivers of under-performance. That’s the new governance. Is the board independent of management to oversee the strategy and to hold management accountable? That has evolved in how activists are approaching governance in modern day activism.
Ted White (05:51):
That is a great point, Elizabeth. Technical measures of governance have certainly improved, right, and they’re all driven basically by a checklist type of approach. It really doesn’t tell you enough about the qualitative aspects of the governance, the real substantive alignment and the culture. You no longer just define a board as poorly governed because it’s classified.
Ann Beth Stebbins (06:15):
Instead, you see under-performance and you’re looking for the reasons why and maybe the reason is the board culture.
Ted White (06:21):
The challenge for directors is to have an understanding of the culture of the company, how the company is actually perceived by shareholders. When we’re engaged with a company and asking for substantive change, we’re needing to prove to other shareholders and prove to advisory services that there’s something wrong with the alignment here. Some people want to say, “Oh, the markets have been fixed. Governance is good. Look how many companies in the S&P 500 have classified boards and committee structures.” Well, that’s true. It’s really only the tip of the iceberg.
Ann Beth Stebbins (06:49):
Ted, I want to demystify for our listeners the activism playbook. Understanding that all activists are not the same, and your responses may be specific to Legion or to other organizations that you’ve worked for, is there something that you’re looking for in a company that makes it a potential opportunity for improvement?
Ted White (07:16):
I can generalize a little bit and give you some examples that are specific to us.
For most activists, the driver is value. You really need to understand what external constituencies think about your performance. There’s a lot of instances in which we’ve done our work, we’re pretty convinced that a company is undervalued by public markets, and we go to talk to the company and they don’t agree with that. Most directors don’t have an awful lot of contact with shareholders, and so sometimes there’s just a plain old miscommunication about whether the company’s actually doing that well.
And then in a close second to that, most strategies are also looking at something I think is undervalued. Is it something that I could help address? And then you’re looking at the risk profile of what you think needs to change. How long will it take? What industry, macro factors?
Ann Beth Stebbins (08:04):
What kind of diligence do you do on that company before you decide to take the next step?
Ted White (08:10):
One, we’re looking at the history. We want to understand how the business has evolved, how the story has evolved, how the board has dealt with it, so it’s more like a movie than it is a picture of valuation. And two, that work never stops. It’s evaluation. Think of private equity-style understanding a business, multiple valuation methodologies, looking at peer evaluations. It’s really digging in trying to understand how a company ticks, how it drives value, what might be the detractors from value in the current markets.
And then you begin looking at management, the board’s effectiveness, the culture, the governance. When you think about those two aspects of the decision, one is very empirical. There’s still some art to it, but it’s more science. The second part is much, much more qualitative. There is no ranking where you can just look at this and say, “Ah, the culture here is an A, and the culture of this one is a C.” At times it feels a little bit like investigative journalism where you’re really trying to understand the drivers of a story. If we think there’s value there, we really want to understand the risk profile of trying to affect it.
Elizabeth R. Gonzalez-Sussman (09:14):
And Ted, what’s your exit for most companies? How long do you envision yourself being in the stock?
Ted White (09:21):
We start with a three-year horizon and there’s situations where it’s going to take much longer than that. That just goes into that equation of your risk-reward. We’ve had investments that have been much shorter, and that just could be that we’ve come along in a period where something’s already started to change.
Ann Beth Stebbins (09:38):
Ted, you’ve mentioned culture several times. How do you assess the culture of management and the culture of the board?
Ted White (09:47):
It’s a bit more of an art than it is a science, and I’ve actually had directors chafe at me when we talked about culture to say that they couldn’t even understand the company’s culture, which that in and of itself was an indication that they might not have had a very good culture. It’s putting together a bit of a mosaic.
I’ll tell you one of the primary inputs, your engagement with them. That tends to be very telling. You get windows into culture from that interaction and responsiveness to things. The product of the board tells me a bit about that culture and alignment. We do a tremendous amount of work looking at years to decades of evolution of compensation plans, how they follow the business. How much has management been rewarded in response to what type of performance?
We also do investigative journalism type work. We call former employees. We look at different sites where people post commentary type stuff. There can be some negative threads to some of those, but you can begin to put a picture together, not just take the disgruntled employee and say, “Ah, bad culture.”
Ann Beth Stebbins (10:47):
When do you first make the approach to the company requesting a meeting with one or more directors, and how receptive are companies generally to that approach?
Ted White (10:59):
So it does vary a little bit. We will have had some interaction with the company before we buy at least substantive amounts of shares. We will tend to just start even with IR, we’ll just methodically work our way up to higher senior levels of management and don’t always end up requesting board meetings, but it’s most common that we do. And we probably had an investment for some time by the time that we’re having substantive engagement with the board.
Ann Beth Stebbins (11:23):
And when do you decide to go public with your campaign?
Ted White (11:29):
As Elizabeth was getting at early on, there are some strategies that are probably far more oriented towards a public campaign. We have a preference to engage privately. That’s usually our plan going in. I think companies can do some certain things to keep it from being public or keep it from being unnecessarily negative if it does go public, and that’s a little bit just in the preparation and thinking about, how do we want to communicate? How do we want to be perceived when we communicate?
We’ve had some instances where we’ve had some fairly contentious engagements with management, and by the time we get to the board, they weren’t even aware of it and it was not the board’s strategy to have management start down this path of aggressive confrontation with shareholders. By then, the damage had been done. And so one of the things I think boards can do is have some kind of plan. How is it that we want to engage with people? How do we want to be perceived?
Ann Beth Stebbins (12:25):
There should be reporting at every meeting from IR, or at least from the CEO, CFO, who are meeting with investors as to the substance of what was discussed, what meetings have been requested from new shareholders or potential shareholders, just so the board has awareness of what these discussions are. It doesn’t come as a surprise when you’re down the road and the wrong atmospherics have been created, and without the board’s knowledge.
Elizabeth R. Gonzalez-Sussman (12:51):
Sometimes independent directors need to hear the message directly, particularly if management is in the line of fire. Sometimes this is all very personal. Nobody likes to be criticized for their performance and as a CEO, you may get criticized for your performance and emotions can rise. Try not to have strong reactions, be in listen-only mode so you can hear it and then react, take it back to the board and make sure you speak with one voice so the whole company is being represented as opposed to one figure. I think that is often why activists are requesting meetings with the independent directors to make sure management is speaking on behalf of the board.
Ann Beth Stebbins (13:32):
And Elizabeth, how do you prepare a director for that meeting?
Elizabeth R. Gonzalez-Sussman (13:36):
The first initial meetings should be to listen because you don’t want to get out in front of the board. If you’re an independent director who’s been authorized to speak with an activist investor, you want to hear what they have to say, take it back to the board, make sure the full board understands it, and then as a board make a decision. Whether there’s some valid points, whether the board’s already been doing much of what the activist has already said, but it’s a communication issue that you haven’t been communicating, that you’ve already been doing a lot of this work. Maybe it’s understanding we do need to take a harder look at this issue. First listen, then make sure that there’s consensus in the boardroom on how to respond.
Ann Beth Stebbins (14:15):
What kind of shareholder engagement do you find most effective?
Ted White (14:19):
When we’re engaged with a company, we’re first looking to get some understanding of whether or not they realize there may be a potential issue with valuation. Is there some level of understanding, some level of acceptance, or just outright denial? There’s also the situation where we could just be wrong and there’s no upside to the stock.
What I find to be encouraging is situations where there is some level of understanding that there’s a problem and they’re open to a partner to help them address it. We have a pretty good perspective from the outside looking in of why the public markets value the stock the way they do. I would even add to that that I think there’s a lot of instances in which shareholders don’t really give their full perspective, certainly of the negative points to management.
Elizabeth R. Gonzalez-Sussman (15:05):
Ted, you raised a really important point about shareholder engagement and how a lot of shareholders don’t share their true concerns with management. You’re not going to enter into a situation unless you feel like you have a critical mass of like-minded shareholders that will support you. Oftentimes companies believe that, no, no, no, I talk to my shareholders all the time and they’re supportive of me. This 2% holder, I don’t have to deal with them. Having independent directors go out and meet shareholders from time to time is a really important thing because that’s what the activists are doing. It’s really making sure that you understand the shareholders’ sentiment and you can react before the activist shows up.
Ann Beth Stebbins (15:51):
Ted, are you talking to other shareholders before you approach a company?
Ted White (15:55):
That’s very common. It’s a huge mistake for directors to assume that shareholders aren’t somehow generally aware of others’ perspectives. Even at the passive funds, we will get calls from them from time to time. It’s not real common, but even from the passive mutual funds where if they’re just frustrated with the name or they see some kind of behavior, they will call and say, “Have you looked at this?” They need an activist.
Ann Beth Stebbins (16:19):
That approach comes to you from the institutional investor in a name that you’re not in because there’s something in that company that the institutional investor doesn’t like. You’re a more effective spokesperson to address it.
Ted White (16:33):
There’s quite a few investors out there. They talk to management. They have some interaction. They don’t really have to engage. Doesn’t mean they don’t get frustrated. You asked about how we get insights into culture. Some of it’s that. Companies sometimes interact with us different than they do with other shareholders. We’re putting pieces of a puzzle together.
Ann Beth Stebbins (16:52):
So we talked about effective engagement, give us the what not to do.
Ted White (16:58):
It’s really free fodder when you’re trying to drive change and the company’s acting in an aggressive or dismissive, entrenched type of manner. Sometimes people when they’re being criticized for the performance of the company and they lash out, that doesn’t help. It’s not the types of things that will make an unsuccessful campaign successful, but it’s certainly supportive when you’re trying to make a case to other owners to say, “This team doesn’t have our collective best interests at heart.” Lack of responsiveness, short meetings, inconsistent communication, those types of things that we’ve seen. The advisory services pay a lot of attention to that. It’s good insight into whether or not the company is responsive to its shareholder base.
Elizabeth R. Gonzalez-Sussman (17:38):
ISS, Glass Lewis is increasingly focused on engagement. A lot of the institutional investors also pay attention to it. They will ask questions about, “Did you try to resolve this? What made the activists unreasonable?” Or vice versa. Some activists can be extremely aggressive and come in and say, “I don’t need to talk to you. You’re going to be gone,” to the CEO. How can you have engagement with an activist who comes in and says, “You’re going to be gone”? The proxy advisory firms and the institutions will look at both sides of the coin and determine whether or not to support change.
Ted White (18:13):
That is a great point. When we think about the engagement, we’re fully cognizant that if this has to come to a proxy contest, it’s going to be laid out chronologically. We’re going to be judged on that same criteria, and companies can be aggressive to us, too, and sometimes it’s obvious they’re trying to prod us into saying some things that are too aggressive.
I know there’s a thread of advice that comes out from the defense community that has probably an overly aggressive tone to it. In most instances, that’s probably a mistake, that you’re painting that picture when it comes to a contest. For the most part, I’d say it’s that type of aggressive approach to that, it’s just a mistake.
Ann Beth Stebbins (18:52):
You’re creating a record.
Ted White (18:53):
Process matters.
Ann Beth Stebbins (18:54):
Yeah, it’s going to be played back. It’s going to be part of the record, and if a company is dismissive, that’s not going to play well to the ultimate audience.
Ted White (19:04):
Hopefully you have the right business case, right. And you want the decision that shareholders are going to make to be focused on the business case. Is this the right team? Is this the right strategy? Is this is the time we need? All of the communication errors can really divert attention away to things that might not be your strongest arguments. We prefer to be having that debate about the business case. What’s gone right with the business? What’s gone wrong with the business? What can it change, what its opportunity set is? That’s how you can really drive the change there, but it’s also what’s most interesting to the other shareholders.
Ann Beth Stebbins (19:35):
How do you engage, Ted, with ISS and Glass Lewis? Do you get an audience with them where you can make your case and when would that happen?
Ted White (19:46):
The answer is yes. If you’re going to run a proxy contest, you’re going to have an audience with them. They have an important role. They are a communication channel to other key constituencies, particularly our shareholders in some institutions pay more attention to the reports when it’s a contested contest. They have a very detailed, very well done, very sophisticated analysis. They’re valuation driven. They’re usually a component of the interaction with them focused around the performance issues, the peer comparisons, the operational performance.
But what’s interesting about that process is you have opportunity to convince them. One of the challenges is you’ve been engaged with a company for some time, probably years in many cases. You probably know the situation pretty well. You probably have some insights into the board’s effectiveness and its culture. That’s pretty hard to communicate in an hour or two hour meeting in a slide deck. There’s a bit of an art and a skill to that, but keep in mind that the decision rubric for the advisory services really is whether change is warranted. Once you convince them that change is warranted, then you’re down into that second level about do you have the right individuals, the right strategy? But you’ve got to a point where the recommendation is likely generally favorable to you in recommending change.
Ann Beth Stebbins (21:00):
And to implement that change, you mean board change, how are you identifying directors who can influence the strategy, performance, improvement that you’re trying to drive?
Ted White (21:14):
It’s a good area to talk about. We tend to be a little bit different than most firms on that front. It’s in most cases, we prefer to put other people onto boards rather than us. We have gone on boards in several instances ourselves, but it’s very much the minority. It’s almost like a reverse engineering the resume and the experience and the background of a person that would be a good fit and go out and find those individuals that fit that and start to interact with them.
And here’s the advice for directors. When you think about the board, board refreshment and how the outside world is viewing the board, what we’re looking at is whether or not the board’s experience and skillset is actually a good fit for the business currently and going forward. One of the criticisms of boards is they tend to get stale.
(22:00):
I realize that it’s pretty hard to look at a colleague that you like and you worked with for a long time and respect and say, “It’s time to move on.” It’s not a personal thing, it’s not a failure, but it’s generally good for boards to evolve with a company and actually fit the challenges and opportunities. That’s probably an area where there’s still the most opportunity set from an activist standpoint and a campaign to drive change is because it’s so typically hard. And we have had instances when we’ve been engaged with companies where it’s pretty clear that board leadership would like some change and they’ve just been unable to drive it. And we actually fill a role to give them a little better rationale to say, “Geez, it’s not me. It’s those activists. We’ve got to make some level of change. Sorry, but it’s necessary.” We’re a catalyst for that, which can be a healthy thing.
(22:46):
And then you asked where we find them. For us, it’s an original research process, so we’re looking through proxies of competitors for people that have retired. We start networking. We’ve got a database of people we’ve met over the years, and we tend to categorize people by areas of expertise, experience, specialization, those types of things. But we also think about cultural fit because there’s situations where we think somebody needs to be more aggressive, able to drive a certain level of change, have a certain experience set. We’re not always fixated on people who have been on boards before. It’s one area I just disagree with the advisory services on that.
Ann Beth Stebbins (23:21):
And Elizabeth, what advice do you give to boards as to how they can best work with the new directors as they join the board?
Elizabeth R. Gonzalez-Sussman (23:30):
It depends on who’s joining the board. A lot of times if things go to a full vote, things are very contentious, and there may be a view that all the nominees that have been recommended by the activists will be a unit and then viewed as an us versus them. We have to break that down and see if there is a way to work collaboratively together because, at the end of the day, you’re going to have new directors go on this board, and the board still needs to function, and it can’t be an us versus them mindset.
With independent directors, it’s hopefully easier because they’re not the principal. Going on a board sometimes when a principal goes on board, it can really change dynamics. They can have very out-sized views, but not all activists are the same. So it really will depend on the activist firm because there are some that are definitely more aggressive and potentially disruptive. For boards, it’s generally, let’s try to move forward if it’s a contested election. If it’s through a settlement, once again, let’s try to work together to improve the business, because that’s what everyone should be doing is working together to try to improve the business.
Ted White (24:40):
When you think about a situation where somebody comes on a board and if the board’s not accepting, all they’re doing is making their case for further change next year, and I’m not convinced that they always think of it that way. But when shareholders usually want some change on a board, the last thing in the world they want is for you to come back the next year and see that everybody was fighting and no progress was made. Their likelihood to be open to even more substantive change in the board goes way up at that point in time.
Ann Beth Stebbins (25:05):
Ted, how do you measure success? The business has improved based on your ideas and your influence. The board is a winner because they’ve delivered value. The shareholders are winners because the stock price presumably has gone up. Is that how you measure success?
Ted White (25:21):
So how do we measure success? I come from the public pension world who are basically permanent holders in capital markets, and they’re incredibly beholden to the efficiency of public markets, in particular, to pay the beneficiaries over decades. For us, how does that translate into success? It’s helping companies create sustainably better values over time.
And, come full circle to why do you focus on the board? Why is so much change at board levels? It’s because we view that as the place to help make the most lasting changes. We’ll be investors for a year or two or three or four or something like that, but you also measure success and how well a company does even after we’re gone. Did we help? We really don’t mind situations where we buy in and we come meet with a company and they say, “Great idea, guys. We’re doing it all.” And they go do it, and the stock does well.
Ann Beth Stebbins (26:10):
And that’s success?
Ted White (26:11):
That’s perfectly fine. That means you’re a good stock picker too.
Ann Beth Stebbins (26:14):
Well, on that note, Ted, I’d like to thank you and Elizabeth for joining us today on the Informed Board. Hopefully, we’ve demystified for our listeners, the activist investor.
Elizabeth R. Gonzalez-Sussman (26:25):
Thanks for having us.
Voiceover (26:27):
Thank you for joining us for today’s episode of The Informed Board. If you like what you’re hearing, be sure to subscribe in your favorite podcast app so you don’t miss any future conversations. Additional information about Skadden can be found at skadden.com. The Informed Board is a podcast by Skadden, Arps, Slate, Meagher and Flom, LLP and affiliates. This podcast is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.
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