Executives and board members used to fear hostile bids above all else. In response, they devised defense mechanisms like poison pills and staggered boards to thwart attacks.
Today, hostile deals are on the wane, but a new threat has emerged that has put boardrooms on edge: activist investors.
“Companies now view the threat of shareholder activism similarly to how they viewed the threat of hostile takeovers in the 1980s,” said Gregg Feinstein, head of mergers and acquisitions at Houlihan Lokey.
Until recently, many companies responded to activists by simply refusing to meet with them and hoping they would go away.
When Daniel S. Loeb of Third Point Management took a stake in Yahoo in 2011, the company was initially dismissive. In an early phone call between Mr. Loeb and Yahoo, the company’s chairman, Roy Bostock, reportedly hung up on him. But a year and a half later, Mr. Loeb had forced out Yahoo’s chief executive and was on the board.
After a string of such debacles, and with activism today more established and prolific than ever before, that approach has fallen out of favor.
“The bunker mentality that had been advised in some quarters is fading as an approach,” said James C. Woolery, deputy chairman at Cadwalader, Wickersham & Taft. “Today you need real substantive preparation and real engagement.”
Now, with dozens of activist hedge funds pushing for change at companies large and small, executives, directors and advisers are scrambling to calibrate their defenses to this new and in many ways more challenging threat.
“Activism is here to stay,” said Paul Verbinnen, co-founder of Sard Verbinnen, a public relations firm. “People are at a heightened state of readiness.”
But with activists varying widely in their tactics and intentions, there is no one cookie-cutter defense that works. Instead, companies and advisers are adopting more nuanced tactics.
Many companies are preparing for activists before they even show up.
“Your defense today before an activist shows up is all about blocking and tackling, dynamic self-assessment, followed by really enhanced investor outreach,” said Chris Young, head of contested situations at Credit Suisse. “It’s a dialogue, not a monologue.”
Mr. Young is one of a few bankers who spends almost all of his time advising companies on how to prepare for and deal with activists. William Anderson of Goldman Sachs has a similar role. Smaller investment banks, like Evercore, are now devoting more resources to activism defense practices as well.
To prepare for activists, who often show up with detailed white papers assailing a target’s performance, companies conduct a handful of exercises to give management and boards a better understanding of their perceived vulnerabilities.
Small teams that include management, a banker, a lawyer and an outside public relations specialist are often assembled to prepare a response in the event of an attack. The goal, advisers say, is to see the company through the eyes of an activist, especially at a time when activists have gone from being outspoken agitators to rigorously analytical financial engineers.
“The level of sophistication of the activists has increased,” Richard Grossman, a partner at Skadden, Arps, Slate, Meagher & Flom. “They’re hiring headhunters, using banks to help them come up with white papers, and the quality of their board candidates is increasing.”
Assessments include whether the company’s stock is trading at a discount to its peers, whether it has excess cash on the balance sheet and the youth and engagement of its directors. In a recent report, Citigroup called this kind of preparation being “white paper-ready.”
“Boards are preparing for the possibility that activists may come,” said Robert Kindler, global head of mergers and acquisitions at Morgan Stanley. “Part of it is proactively reviewing areas of vulnerability and seeing whether or not there are things you should be doing anyway.”
When vulnerabilities are uncovered, companies sometimes take action, spinning off divisions or instituting return of capital programs to quell the dissent before it begins.
EMC, the data storage company, began paying a dividend earlier this year in part because it was worried activists could focus on its large cash pile, according to people with knowledge of the company’s thinking.
With paranoia at record highs, some companies are going further.
One company invited an activist investor into the boardroom to explain how he might think about undertaking an assault. A multinational company had a banker write a mock letter from an activist, then tested executives on their response.
“This proactive preparation, what I call ‘the activist fire drill,’ is new technology, so to speak,” Mr. Young said.
Part and parcel with this more proactive assessment of a company’s own performance is communicating better with passive institutional shareholders.
In recent years, many big companies have put more money into their investor relations departments. And instead of simply sending out the head of the department to meet institutional investors, they are sending out the chief executive, chief financial officer and chairman.
“It’s important that the first time a shareholder hears from you isn’t when an activist files a 13-D,” the regulatory filing announcing an activist’s stake, Mr. Grossman said.
In the best case, the situation never goes public and is resolved before a 13-D is ever filed. “The tone of any dialogue will be much more constructive when you can have that out of the public eye,” said Daniel Kerstein of the Barclays strategic finance group, which advises companies.
When situations do play out in public, companies have to be especially sensitive.
For example, when Starboard Value singled out AOL last year, agitating for it to sell patents and proposing a new slate of directors, the company was able to withstand the assault. Shareholders supported the strategy of the chief executive, Tim Armstrong, and voted against Starboard’s board nominees.
And even though Starboard was aggressive in its communications, AOL remained relatively cordial throughout the exchange to avoid appearing dismissive of overall shareholder concerns.
“Other investors are watching,” Mr. Kerstein said. “You need to be mindful of the fact that you are dealing with a constituency who is sensitive to how you are going to treat that one shareholder.”
Another tactic is to simply bring the activists into the fold, defusing tensions before they can become public and affect a company’s reputation and share price. When ValueAct Capital took a stake in Microsoft, the technology company quickly vowed to work with the hedge fund and gave it a board seat.
Of course, situations between companies and activists still do become contentious. And when this happens, new twists to old techniques can come in handy.
A new version of the poison pill, which was originally devised to ward off takeovers, is being tailored to prevent activists from acquiring too large a stake.
After Jana Partners, led by Barry Rosenstein, took a stake in supermarket chain Safeway and began agitating for divestitures and a return of capital, Safeway adopted a novel shareholder rights plan. It stipulated that no investor filing a 13-D, which designates an activist, could acquire more than 10 percent of the company. Passive investors, however, filing 13-G forms, could acquire up to 20 percent.
Even this tactic, however, is of limited use. Like most activists, Jana has no interest in actually owning the company. Instead, it needs only enough of a stake to get the attention of other investors.
“There are no longer any structural defenses,” Mr. Young said. “It used to be that you could set up staggered boards and put in poison pills. But there is no moat to build around your company anymore.”