What to Do When Activists Attack
Today, CEOs and corporate board members of retail chains must run simply to stand still. Executives of publicly traded retailers face intensive pressure from activist investors to quickly and decisively increase shareholder value. Activists are known to secretly accumulate a significant stake in a company and without notice blind side the CEO with risky restructuring plans, force firms into unwanted mergers to removing board members and CEOs that disagree with their speculative strategy. Industry giants across the board have been attacked and forced to accept precarious financial and operational restructuring plans.
No company regardless of size, profitability or cash stockpile is immune from an attack. Proctor & Gamble’s attacker owned less than 1% of the firm and orchestrated an event that ousted the CEO and forced a change in corporate strategy. Activists are prepared for battle. They are armed with innovative business plans containing a mixture of investment banking style analysis, strategy consulting and financial restructuring business plans that are comparable to the top consulting and “bulge bracket” investment banking firms.
Activists also maintain a massive cash war chest climbing into the tens of billions along with a rolodex of who’s who of institutional investors (those that own large shares of your company's stock) that are more than happy to lend their proxy vote to assist activists in unlocking shareholder value.
Mounting a defense to fight off an activist can be extremely expensive in both time and cost. A defense strategy can quickly run into the millions because it requires the hiring of investment bankers, accountants, attorneys and public relations gurus. Collateral damage from a public fight not only is costly, but also exposes the firm’s weakness to competitors, shareholders, customers and business partners.
What can a CEO do to avoid an activist attack? Improve stock prices.
1. Don’t be undervalued
Avoid the cross hairs of an activist by not being undervalued and underperforming. A preemptive activist audit is essential to gauging your firm’s vulnerability to an activist investor. The audit will provide management with a deep understanding of the value creating proposals that an activist is likely to present.
Executives that identify and address operational underperform will benefit by creating an internal “Value Creating Turnaround” plan without the cost and distraction of an activist campaign. A strategic communication plan exposed to the investment community will erode the attractiveness, thus reducing the activist viability of a large payout. In the event that an activist campaign is launched, management will have a plan that can lead to a fast track of compromise and collaboration.
2. Eliminate financial and operational underperformance
What attracts an activist? Financial and operational underperformance. Activists are attracted to firms that demonstrate fundamental underperformance when compared to industry peers. These include firms experiencing growing negative margin gaps, sluggish revenue and increasing sales but at a decreasing rate.
Additionally, other key performance indicators include poor returns on assets, equity and employee performance, as well as those that have sub-optimal real estate assets. Tech-savvy activists are increasingly launching attacks on companies that maintain outdated technology and marketing capabilities and are ill equipped to compete in today’s hyper-competitive digital ecosystem. A company experiencing financial and/or operational underperformance versus its peers is more than likely already on an activist watch list.
For example: Consider a firm that does $40 billion in revenue, SG&A spend is 5% higher than the industry average thus resulting in $2b in over spend. The SG&A problem alone can be a difference of $10-$15 in stock prices. If the activist purchases three million shares and the attacked firm’s SG&A is aligned with industry peers, the activist profits over $400 million. There is a high level of certainty that an activist is building a plan of attack.
What is an activist audit? A review of an organization through the eyes of an activist
3.Performing an activist audit
An activist audit is a review of an organization through the eyes of an activist. By undertaking a preemptive activist audit, an analysis of operational and financial underperformance helps prevent a bloody battle, as well as mitigate the thunder from a surprise activist attack. The audit will help to uncover weakness and arm management with a roadmap for creating additional shareholder value thus making the firm less attractive to an attack.
Focusing the audit process on benchmarking the firm’s operational and financial critical performance indicators against its peers will provide a value creation plan designed to identify where weakness exist, as well as the starting point for creating a transformation strategy to improve financial (EPS, P/E and ultimately stock prices) performance.
Key critical performance indicators include the following:
How well does EPS, net income and P/E growth rates over the past 18 months compare to peers;
How well does your debt to equity and capital structure compare to peers;
How much cash will return to net income if the financial structure is optimized;
How efficient is your sales and marketing operations when compared to key competitors;
How effective is the current governance strategy;
Does the board have deep expertise in technology (cloud, social-local-mobile, CRM, big data, analytics);
How efficient is human capital when compared to peers;
How efficient is revenue, margins and equity contributing to the business;
Where is the firm experiencing operational performance/underperformance;
How efficient is your technology environment;
Is the current technology environment capable of competing in tomorrow's digital world;
Does your firm operate more like Google or Barnes & Nobles;
How efficient is inventory and cash management;
Is your firm's real estate portfolio optimized to contribute maximum returns to shareholders; and
How well does your firm invite customers to co-design products and create new services.
4. Create an aggressive turnaround plan and communication your strategy to stakeholders
After completing an activist audit or vulnerability assessment, the next step is to prepare a shareholder outreach strategy. Show investors how your turnaround plan is going to increase stock prices
Highlight weaknesses, while providing a clear roadmap designed to mitigate underperformance and aggressively unlock shareholder value.
The plan should include any new members or advisors to the management team as well as plans for reducing cost, improving profitability and/or spinning off unproductive operations. A well-designed value creation plan will help ward off potential activists.
Conclusion
An activist audit provides management with an activist perspective regarding creating shareholder value. Executing a review gives management the ability to reverse poor performance on their terms, as well as avoid a potential conflict with a heavy-handed activist.
Stanley Kirk is a partner at River Walk Capital, a management consultin