Successful activism — what does it mean?

Understanding how activists gets paid will enhance corporates’ sensitivity to their shareholders and their ability to respond to a campaign

Shareholder activism has taken its place as a major feature on the corporate landscape, whether companies like it or not. Companies worldwide have seen an increase in the number of activist campaigns, with US investors leading the charge.

Interventions at companies headquartered in Europe were up 35 per cent from 2015 to 2016, a trend that shows no sign of slowing down in 2017. More and more campaigns are undertaken in Europe every year. For example, we have noticed a rapid increase in Germany; most likely activists have gained the confidence to tackle Germany’s two-tier board structure following TIC’s high-profile fight at Volkswagen. CBNC records a 170 per cent increase in activist campaigns in the UK since 2011.1 With Activist Insight recording that in 2016, 67.5 per cent of activist campaigns were successful, they are an asset class to pay attention to. A question remains, however: how do you quantify success in activism – and success for who?

Qualifications of success for an activist can be considered in a number of different ways

Understanding how activists get paid is fundamental to this discussion. Most activists charge a fee structure of two per cent of assets under management and 20 per cent for the success of specific trades. This 2:20 model focusses the activist on a few targets and when they proceed they have a high degree of certainty, given the reputational risk and the returns on the deep research conducted on the specific stocks, both internally and using external advisors. Success for the activist can be measured in three ways:

1Achieving their stated aim If an activist can achieve his/her objectives without calling a meeting or running a very media intensive campaign that is the best outcome. Secondly, putting those same demands to shareholders and getting them approved, either through a meeting or widespread pressure, allows the activist to continue to unlock value. Those are usually interim steps in a wider plan to create more value for all shareholders.

Cas Sydorowitz

CEO at Georgeson Corporate Advisory

Activists’ objectives can tackle a variety of corporate issues, with the highest percentage focussing on board-related interventions. Activist Insight records that 49.5 per cent of all activist campaigns conducted in 2016 were board-related and 48.8 per cent have been so far in 2017. The second most common activist demand focuses on issues of governance. The ways in which an activist goes about achieving his/her aims will depend on geography and the size of the holding. In the US, activists tend to achieve their stated aim by building a stake in the company and then engaging the media to spread word about what they believe needs changing. They will publish open letters to the CEO along with letters to shareholders, imploring them to vote in line with the activists’ proposals.

European activism has frequently been considered to be a more private affair, with settlements being made behind closed doors and cooperation between the activist and the corporate being demonstrated. It is estimated that around 50 per cent of European activism never enters the public domain.2 The US activist strategy has resulted in them being described as ‘corporate raiders’; however, a visible change in trends is occurring. We are seeing more European activists employing more US style tactics, including media fanfare, microsites and public feedback from other investors.

2Financial success of activist fund

Activists won’t just launch into a proxy fight on a whim; they take their time to conduct extensive research and hire multiple advisers to support them in their campaign. Activists will invest the equivalent of one to three man years of research in private equity- style due diligence. Financial success for an activist comes from unlocking material value in the stock of the target. They take their time to unlock this value. They make money when the stock price of their target goes up as a result of achieving their aims directly, or subsequently when the company is taken out.

RBR demonstrated the virtue of patience after it successfully placed a nominee on the board of Gategroup in 2015. This meant that by 2016 it was well placed to realise greater value through the sale of Gategroup to HNA instead of remaining independent.

3Marketing – attracting new clients from the success of an activist

campaign Critics are increasingly aggravated by activist campaigns that seek to boost their own profile. The Financial Times in 2014, published an article titled Activism has become a marketing strategy, in which it wrote that sentiment towards activism was short-term and opportunistic to catch the ear of the institutional investors.3 Successful campaigns, particularly those that generate a large media buzz, will attract more investor clients to the activist. Bringing in more clients also creates incremental value and allows the activist to look at more opportunities and perhaps even bigger targets. This is where the two per cent of assets under management for their fees starts to kick in.

UNDERSTANDING ACTIVIST ACTION

It’s important to look at how activists achieve their objectives

What does success look like for a company?

1Activist takes a stake in the company and exits again without going public

or making any demands In some situations, an activist may take a stake in the company and exit again without attempting to implement any changes. This activity implies that the stock price has closed the valuation gap the activist originally identified.

Sherborne Investors, having successfully generated returns of an estimated 70 per cent at F&C Asset Management, invested in 3i. Its holding never evolved into an activist campaign with it exiting its five per cent holding with a 38 per cent gain. It then entered the stock at Electra Private Equity with the profit generated from 3i and, through a very public fight, was elected to the board. Ed Bramson, head of Sherborne Investors, was recently elected as interim CEO and he ousted the manager Electra Partners. Sherborne holds a 29.9 per cent stake.

It is easier to pick a stock and let the valuation gap narrow on its own without having to run a very public and acrimonious proxy fight. It is worth noting that activists don’t select targets specifically to run proxy fights, instead, in order to create more value, they pick good companies that are mispriced in the market where there are levers to be pulled. If the value can be realised without having to pull any levers, the activist will created value without spending fees for advisors.

2Ensuring continued support for the existing management and strategy

Nothing takes the wind out of the sails of an activist campaign like a loyal and supportive shareholder base. The greatest factors that cause institutional investors to back an activist campaign are the failure of management to listen to shareholder concerns, underperforming share price and a poorly communicated strategy. Worse still is the absence of trust that the board can execute on that strategy. Successfully surviving an activist campaign is, in part, dependent on the continued support of shareholders.

Recently at GAM, a Swiss asset manager, investors backed the incumbent board over activist RBR’s dissident slate. Remarkably in this situation, shareholders (such as 19 per cent holder Silchester) backed management

As classic investors recognise that activist input can create enhanced alpha for their portfolios, we will most likely see more support in European campaigns, similar to the US. Success is subjective. Understanding how boards are paid and how activists are paid holds the key to determining who success rewards the most

despite proxy advisors ISS and Glass Lewis recommending in favour of RBR’s nominees. Support from shareholders comes from ongoing and regular interaction with the management and the board. It requires a frank and honest dialogue.

3The successful growth of the share price, as well as the divisional performance, and the reduction of costs

Much of the media coverage surrounding activism advises on how best to survive or resist an activist campaign. However, cooperation with a thoughtful activist can result in success for both sides. It begs the question; why don’t boards embrace more of the activist demands? Even so, it is unlikely that any activist will be met with open arms just yet, as companies continue to see activist involvement as negative. A NYSE Governance Services Report found that only 13 per cent of directors (polled from 300 directors of publicly traded US companies) would welcome an activist’s involvement and that 84 per cent believe it would create a negative distraction.4

Despite this, a McKinsey&Company study from 2014 concluded that shareholders ‘generally benefit’ from activist campaigns.5 The study of 400 US activist campaigns found that the median activist campaign reverses the target company’s weakening performance and generates returns that persist for at least three years.

The debate wages on about whether an activist campaign is beneficial or detrimental for a company long term. For now it seems that activism tends to improve corporate performance, however few boards are likely to embrace any external meddling.

Activists are trying to create more value for all shareholders; their goals should be perfectly aligned with other investors and the board. Most investors who hold hundreds or thousands of stocks in their portfolio cannot dedicate the resources to push for change at their portfolio companies. As classic investors recognise that activist input can create enhanced alpha for their portfolios, we will most likely see more support for European campaigns, similar to those in the US.

Success is subjective. Understanding how boards are paid and how activists are paid holds the key to determining who success rewards the most.

1http://www.cnbc.com/2016/05/09/activistinvestors-more-good-than-harm. html 2https://www.jpmorgan.com/ jpmpdf/1320656894344.pdf 3https:// www.ft.com/content/5d5209b2-1d6411e4-8b03-00144feabdc0 4https:// www.nyse.com/publicdocs/ Shareholder_Engagement_ Survey_Report_2016.pdf 5http:// www.mckinsey.com/businessfunctions/strategy-andcorporate-finance/our-insights/ preparing-for-bigger-boldershareholder-activists

GOLDEN DAYS

Madrid's Buen Retiro Park – the Park of the Pleasant Retreat

Proxy voting in Spain:

the investors’ autumn

There will be no ‘shareholder spring’ for Spain, but autumn will bring new responsibilities and activities for investors

In Madrid, we complain about the non-existence of a true spring season. After a cold but dry winter, followed by unstable and rainy weeks, a heatwave invades the country and temperatures suddenly rise up to near 40ºC to remain like that throughout the whole summer period. Then we enjoy a long and mild autumn with wonderful weather while we prepare for the next season.

During recent years, while US, UK, Germany, France and other European companies have been facing a shareholder uprising, with investors starting to raise their hands and challenge their agendas at the annual general meetings (AGMs), Spanish and Portuguese companies have remained relatively quiet, with a few exceptions.

Their investors, far behind their European peers, have not shown great interest in matters, such as corporate governance, responsible investment or engagement. When voting, and only for domestic companies, they would usually support the board proposals without much analysis or discussion. This

Juan M. Prieto

Founder and Managing Director of CORPORANCE ASESORES

approach is fast evolving and, with the new EU Shareholders’ Rights Directive (SRD II), Iberian asset managers and insurance companies will be encouraged to improve transparency and active investment. No spring then, but after the summer, autumn will bring new responsibilities and activities for investors.

The birth of the first Spanish proxy advisor, CORPORANCE, member of the international partnership of independent proxy advisors Expert Corporate Governance Service (ECGS) is another milestone in this process. It will increase the presence of the Spanish and Portuguese markets on the proxy map, both providing a better understanding of local practice globally as well as introducing international practices of voting and engagement policies for their investors. Proxy voting in Spain and Portugal

In terms of voting, Iberian markets do not differ much from other European countries. Average participation in AGMs (last three years, as percentage of total capital) in Spain was about 68 per cent and Portugal 72 per cent. Western Europe averages 66 per cent, ranking from 73 per cent in the UK and 70 per cent in France to 52 per cent in the Nordic countries.

We can see in Figure 1 below the typical shareholder structure of a listed Spanish company, also showing the level of participation in the AGMs within the different groups. Strategic investors still count for roughly one-third of the capital and they usually vote massively in favour of the board proposals. Retail shareholders withdrew slightly from equities during the financial crisis but are coming back now to levels near 20 per cent. Their current voting rate is around 38 per cent, quite high for retail investors. Different legal initiatives to foster electronic voting and minority investors forums have not achieved the desired objectives, direct actions from listed companies having had more success in this sense.

FIGURE 1: SPANISH

SHAREHOLDER STRUCTURE

Foreign Investors 42% (voting 62%)

Strategic Shareholders 31% (v 95%)

Spanish Retail 17% (v 38%)

Spanish Institutional 10% (v 40%)

In Spain, foreign institutional investors follow similar patterns to those of other markets, with an average participation of 62 per cent, the highest of the free-float constituents. Depending on their country of origin, this participation ranks between around 70 per cent for US institutional investors and 10 per cent for their German counterparts. In Figure 2, right, we can observe the evolution over the last decade. The precipitous decline in participation rates among local institutional investors in Spain since 2013 is telling as current rates are dwarfed by those of US and UK investors. The message could not be any clearer: Spanish institutional investors have regrettably failed to effectively engage with issuers on their home turf.

As mentioned above, Spanish institutional investors do not play an active role in local AGMs. Representing less than 10 per cent of capital, only 40 per cent of them vote, just over the retail tranche and usually in favour of the agenda proposals, delegating their vote to the board. Their voter turnout and engagement at AGMs in companies they invest in outside of Spain is negligible, a behaviour which strongly contrasts with that of their European peers.

Spanish general meetings

Figure 3, below, shows the most contentious items during the last AGM season in Spain. We observe an increase in average opposition rates over the last three years. The higher dissent is due to an increased weighting of independent shareholders, but also to the creation of several Spanish boards. Unlike other European countries, the highest level of opposition is not about remuneration-related items, but is more related to the appointment of non-independent directors, in particular the ‘proprietary directors’ (13.4 per cent), a classic Spanish figure (‘consejeros dominicales’: directors representing a strategic shareholder, or more than three per cent of capital).

Remuneration-related items are also contentious, with an average opposition rate of eight per cent. In 2016, we saw a rejection of both the remuneration policy and report in an Ibex-35 company. Capital and voting limits are also of concern, due to significant opposition regarding the authorisation to issue convertible bonds and to increase the share capital without pre-emptive rights. These resolutions are almost standardised in Spain (up to 50 per cent of the share capital with the possibility to exclude pre-emptive rights in connection with 20 per cent of the share capital), with no or little reference to the actual needs of the company. Again, Figure 3 shows this behaviour in more detail.

Dissidence from voting recommendations of proxy advisors ranks from 10 per cent to 40 per cent roughly, depending on the companies and markets. Again, remuneration, board composition and capital are the most contentious topics. Actual opposition, albeit significantly increasing, is noticeably lower, ranging between less than one per cent to

FIGURE 2: INSTITUTIONAL INVESTORS’ VOTING IN SPANISH AGMs

80%

70% 72%

VOTING PERFORMANCE

60%

50%

40%

30%

20% 55%

40%

33%

France

10% 9%

Germany

0% 2011 2012 2013 2014 2015 2016

almost 10 per cent in some cases, with an average in European AGMs of four per cent. At Spanish AGMs, the average dissidence ratio was 2.9 per cent while in Portugal it held at a higher 3.6 per cent.

International investor codes

In the US, mutual and pension fund managers are obliged to exercise their voting rights since 2003. This rule has created a global practice that has spanned overseas. The Organisation for Economic Co-Operation and Development (OECD) Principles of Corporate Governance of 1999 were updated in 2004 to add stewardship duties to institutional investors. In Germany, France, Holland, Switzerland or Denmark, responsible investment codes have been enacted with strong recommendations to enhance transparency and apply effective governance criteria to investment decisions, disclosing their voting and engagement policies, under the ‘comply or explain’ principles.

Since 2014, the UK Stewardship Code of 2010 has been updated together with the UK Corporate Governance Code to show how

duties and interest of both issuers and investors come together to achieve sustainable profits and long-term growth for companies. As a result, participation of European shareholders has improved significantly, not only in their local markets but also in other European and international markets, in line with their portfolios. No such investment or stewardship code exists in Spain or Portugal. In Spain, only the Funds Regulation in 2015 sets up the obligation to vote for those shareholders holding more than one per cent of a (Spanish) listed company for at least 12 months, unless there are clearly explained reasons not to do so. As a result, since it is unusual to reach this threshold, asset managers have decided not to develop voting guidelines and engagement policies until it becomes compulsory. In addition to the lack of obligation (or strong recommendation), other reasons to remain inactive are processing costs, unwillingness to take on responsibilities, little ability to influence company decisions or reluctance to get involved in potential conflicts.

FIGURE 3: MOST CONTENTIOUS ITEMS IN SPAIN 2016

SAY-ON-PAY Remuneration policy Remuneration report Long-term incentive plans

CAPITAL Issuance of convertible boards Share capital increases without pre-emptive rights

7.9% 6.6% 10.1%

BOARD Proprietary directors Non-executive non-independent directors Executive directors Independent directors

2.0% 5.6% 13.4% 11.4%

10.2%

New regulations and obligations for investors

On 17 May 2017, we saw the adoption of the new 2017/828 Directive of the European Parliament and of the Council amending Directive 2007/36/EC regarding the encouragement of long-term shareholder engagement. The new requirements will help institutional investors and asset managers to be more transparent in their approach to listed companies. They will have to develop and publicly disclose a policy describing how they integrate governance criteria in their investment strategy and the engagement activities they carry out.

Major European markets have approved policies and codes to manage this regulation from 2007. Member states will have two years to transpose the directive. For those countries, such as Spain, Portugal, Italy and others, it will represent an excellent opportunity to get up-to-date, and a challenge for regulators. Institutional investors in these countries will have to adopt international standards and mirror their peers’ behaviour as to transparency and active engagement. invest in. After all, this is a dual responsibility; it defeats the purpose if companies improve but investors shirk their duty to monitor, more aptly put ‘it takes two to tango’.

Another survey among Spanish asset managers highlights some interesting points: one-third declared that they never vote, and in more than 20 companies only one-quarter vote. This implies that not even companies on the Ibex-35 are monitored regularly from a corporate governance standpoint by their domestic institutional investors. Furthermore, the use of proxy advisors’ recommendations is scarce or almost non-existent. And of those voting, the vast majority neither disclose their vote nor receive confirmation from the company.

Making matters worse is the fact that institutional investors have no structure in place to accommodate voting decisions, which are typically delegated to investment managers with other priorities or supporting staff. In a recent survey, 60 per cent of Spanish asset managers declared not to have developed a voting policy and 40 per cent not to have service coverage globally, while retaining in-depth local market knowledge and independence. Every year, their members analyse and discuss voting results and governance levels to prepare and publish the ECGS Corporate Governance Principles and Voting Guidelines.

CORPORANCE has just joined the alliance as representative for Spain and Portugal, to contribute with local knowledge of these markets and help institutional investors to adopt European best practices and international transparency standards, in order to improve corporate governance in the

Challenging times are ahead. Like issuers, Iberian investors will have to evolve in terms of transparency and stewardship. We may have missed out on a shareholder spring but we are prepared for a long and eventful autumn

SPANISH AUTUMN The fall will bring new activities for investors

There is no need for more corporate governance codes for issuers in Spain. The first Olivencia Code of 1998, was followed by the Aldama Report in 2003, the Unified Code (or ‘Conthe Code’, 2006) and the recent Good Governance Code of Listed Companies of 2015 (CNMV, the Spanish regulator), all underpinned by new rules under the revised Companies Act of 2014, completing the picture. However, there is a missing piece: not a single code for investors, other than the aforementioned soft obligations for mutual and pension funds.

Spanish investor behaviour

After more than a decade of efforts to strengthen the corporate governance of listed companies, Spanish corporations have reached international standards, even though there is still room for improvement in some aspects, such as board independence, remuneration and transparency (see Figure 3). Now it is time for the buy-side – the Spanish institutional investors – to manage their fiduciary role and act as responsible owners of the companies they carried out engagement activities with their investees. Almost 80 per cent, however, showed interest in corporate governance matters. It is time to convert desire into action.

Proxy advisors: CORPORANCE joins ECGS

The lack of a Spanish proxy advisor has not helped with this process. Most global institutional investors rely on the advice of these voting consultants to carry out their fiduciary duties. Otherwise it would be impossible to manage the voting process of thousands of companies in their portfolios. US advisors were the first to be created and are still the largest, following their asset managers’ obligation to vote. In Europe, Germany’s DSW, Proxinvest in France, Ethos in Switzerland, Frontis Governance in Italy and the UK’s Manifest were formed to help the needs of their local investors to fulfil their investment and engagement duties.

In 2001, they set up the European partnership ECGS, to join forces and extend Iberian markets. The Spanish proxy advisor will adhere to the Best Practice Principles for Shareholder Voting Research Providers and will publicly disclose its corresponding policies and activities.

The Spanish autumn

Challenging times are ahead. Like issuers, Iberian investors will have to evolve in terms of transparency and stewardship. We may have missed out on a shareholder spring but we are prepared for a long and eventful autumn. The evolution of the regulatory landscape in Europe, particularly with the arrival of the much-anticipated EU SRD II, has the potential to transform local investor behaviour, upending decades-old practices and ushering in a new era of shareholder engagement on a par with that of other markets. In Spain and Portugal, all players will work collectively for the sake of improved transparency and governance. Markets, regulators, intermediaries, proxy advisors and especially institutional investors must rise to the occasion.