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Shareholder Activism & The Rise of Shareholder Value

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Describes shareholder activism factors, targets and strategies from an activist investor and shareholder value perspective.

Note: Confidential and proprietary information omitted from public version.

Publié dans : Business
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Shareholder Activism & The Rise of Shareholder Value

  1. 1. WSD Capital Management An Introduction to Activist Investors
  2. 2. Summary 3 Activism Targets 4 Activism Factors 6 Corporate Governance 7 Capital Market Efficiency 9 Shareholder Limitations 11 Activist vs. Acquirer 12 Activism Engagement 19 Shareholder Value 22 Conclusion 24 2
  3. 3.  While activist investors gained notoriety for their confrontational approach, they often aim for collegial if firmly “hands on” approach with incumbent management.  There is an overlap in investment philosophies between activist investors and the prototypical value investor.  Activist investors typically seek out undervalued companies where they anticipate shareholder value can be unlocked through intervention.  In other words, instead of speculating about future performance, activist investors aim to change future performance. Source: Institutional Investor (2003); Bruce C. N. Greenwald, Kahn, Sonkin, Biema (2004) 3
  4. 4. Governance Management Ownership Financial & Operational Event-Driven Major factors driving shareholder activism: 1. Undervaluation relative to peers, 2. Deteriorating share price performance relative to peers, 3. Low leverage/high cash balance, 4. Failure to execute business plan, 5. Multiple distinct business operations, 6. Takeover target in consolidating industry. Activist investors focus on shareholder value: 4
  5. 5. Governance • Limited board independence, • Insufficient attention to investor proposals or concerns, • History of reporting, accounting and/or governance issues Management • Diminished investor confidence, • Lack of accountability and strategic direction despite issues, • Excessive executive compensation Ownership • Heavy institutional concentrations, • Limited insider ownership, • Large founding family holdings potentially looking for exit 5
  6. 6. Financial • High cash balance, • Stable cash flow, • Low debt levels, • Low book-to- market ratio Operational • Underperforming line(s) of business, • Underutilized assets, • Uncertain or unclear strategy Event-Driven • Change in CEO, • Restructurings, • Cyclical downturns, • Consolidation 6
  7. 7.  They are supposed to prevent self-interested management from taking actions detrimental to shareholders.  They are not uniform across countries.  They are shaped by a variety of factors that are inherent to the business environment. Governance System Societal and cultural values Enforcement of regulations Reliability of accounting standards Protections afforded by legal system Efficiency of local capital markets Governance systems are complex: 7
  8. 8.  Governance systems are diverse because these factors combine in different ways in different countries.  Differences in factors impact prevalence of agency issues and control mechanisms needed to prevent them.  Governance debate is characterized by considerable hype but few hard facts. Managers Auditors Customers Suppliers Unions Media Regulators Analysts Creditors Investors Board Governance systems are diverse: 8
  9. 9. Efficient markets protect against: • One party in a transaction has an information advantage and uses this advantage to receive preferential pricing or risk transfer Adverse Selection • One party does not bear the full risk of its actions and so engages in excessively risky transactionsMoral Hazard  When capital markets are efficient, prices (labor, capital, and natural resources) are “correct”, which improves decision making.  Efficient capital markets “discipline” companies:  Poor decisions are punished  Stock prices decline  Cost of capital increases  Risk of bankruptcy or being taken over increases 9
  10. 10.  If a country lacks efficient capital markets, something else must take its place:  These institutions also “discipline” companies in order to protect their investment. However, their interests may be different from those of other shareholders and stakeholders.  Well-functioning markets require disciplining mechanisms that influence management to act in the interest of shareholders.  In efficient capital markets, the “market for corporate control” puts pressure on the CEO to perform or risk sale of company to new owners. Wealthy families Large banking institutions Other companies Governments 10
  11. 11.  Shareholders suffer from two primary limitations:  Free-rider problem. Shareholder actions are expensive. Although all shareholders enjoy the benefits, a few bear the costs. This provides a disincentive to act.  Indirect influence. Since shareholders do not have direct control over the company, they tend to exert influence via the following:  Communicating their concerns  Withholding votes from directors  Waging a proxy contest to elect an alternative board  Voting against company proxy items  Sponsoring their own proxy items  Selling their shares 11
  12. 12. Activist Investor Hostile Acquirer Objective Enhancing Shareholder Value Capturing Shareholder Value Avg. Investment Period 15 to 36 Months 5+ Years Control Ambition Aims for significant influence in cooperation with fellow shareholders Total Control Willingness to Partner with Others Yes, seeks often third-party support and consensus No Tolerance for Negative Publicity High Low Credibility with Investors & Public Depends on activist’s reputation and track record High Predictability of Strategy Low, can be creative and nimble High, due to influence of many constituencies Ability to Pressure Target Board & Management High Higher 12
  13. 13. • Acquiring firm believes it can increase profits through revenue improvements, cost reduction, or vertical integration. This is what drives strategic buyers. Financial Synergies • Two companies whose earnings are uncorrelated might benefit by relying on capital generated when one business is thriving to help the other when it is struggling. This is what drives conglomerates. Diversification • New owner group might have superior access to capital, managerial expertise, or other resources. This is what drives private equity buyers. Ownership Change 13
  14. 14. • Acquirer purchases target primarily for sake of managing a larger enterprise. Empire Building • Company pursues acquisition because its competitors have recently completed acquisitions. Herding Behavior • Management of target company agrees to acquisition primarily because it stands to receive significant windfall. Compensation Incentives 14
  15. 15. Research has routinely shown that public markets expect the incremental value of an acquisition to flow to the target rather than to the acquirer. Source: Eckbo (2009); Servaes (1991); Andrade, Mitchell, and Stafford (2001); Martynova and Renneboog (2008); Goergen and Renneboog (2004) The Target • Receives double-digit takeover premium offer • Experiences greater excess returns in hostile deals • Experiences greater excess returns in all-cash deals The Acquirer • Experiences no excess returns following bid • Experiences negative excess returns for hostile bid • Experiences greater declines if equity-financed bid 15
  16. 16. Research has also shown that acquirers realize less value following a merger than originally projected. Source: Martynova and Renneboog (2008); Krug and Shill (2008) The Acquirer • Underperforms peers on a one-to three-year basis • Performs worse if acquisition is financed with equity • Decreases investment in working capital and capex The Acquisitions • They are highly disruptive • They require significant management attention • The lead to elevated turnover rates for up to 10 years following consummation of deal 16
  17. 17.  Activist investors tend to get involved when company performance is falling short of competitors’ performance and market expectations.  A collaborative, negotiated, or settled response to activist campaigns tends to lead to higher excess shareholder returns than a combative one.  It is often more effective to get companies to change when in crisis.  Value investors who focus solely on share price may end up investing in value mines (i.e. stocks that are fatal to investor’s financial health). “Price is what you pay; value is what you get.” • Warren Buffett Source: Cyriac, Backer, and Sanders (2014) 17
  18. 18. • Activist investor acquires 1% to 10% of voting class equity; gains recognition as leading minority shareholder Stock Accumulation • Will include changes to corporate governance, strategic direction, operational execution, and/or capital allocation Shareholder Proposals • Certain activist investors prefer to engage privately before going public; other activists prefer to go public first Private Communication • Most activist investors have little trepidation to go public and are adept at making their case to the press Public Communication • May lobby third parties, including other shareholders, institutions, and proxy advisory firms Proxy Contest Solicitation Most Aggressive Least Aggressive Litigation: Expensive and utilized generally as last resort to protect investment 18
  19. 19.  Communication between activists and management remains most effective method to achieve goals.  Not only can it be less confrontational, but dialogue helps build relationships between management and shareholders in the future.  Staying out of media is best for both parties when negotiating. Achieving desired results: Source: Schulte Roth & Zabel (2012) 50% 32% 10% 8% Dialogue & negotiations Proxy contest & solicitation Publicity campaigns Shareholder resolutions 19
  20. 20. • Many activist investors advocate strategies that require substantial time to implement with durations measured in years rather than months. Strategy • Research shows that most target’s valuations, ROA, and operating performance improved in five-year period following activist engagement. Engagement • Three years after partial or full cashing out of an activist investor’s stake, long-term shareholders continued to have positive returns. Value Source: Enginalev (2014); Brav, Jiang, Thomas, Partnoy (2008) 20
  21. 21.  One of the key benefits of engaging directly with activist investors is that of getting another point of view.  Activist investors provide management with candid and educated perspectives from the investment community.  Appropriate engagement can achieve superior performance when dealing with activist investors. Responding to activist engagement: Source: Linklaters (2013) 60% 32% 26% 21% Compromise or Settlement Activists objectives partially successful Activists objectives successful Activists objectives unsuccessful 0% 10% 20% 30% 40% 50% 60% 70% Target Company Financial Results (Average Return Annualized) 21
  22. 22. Corporate Governance • Board Size & Independence • Shareholder Rights • Executive Compensation Business Strategy • Growth • Segments & Subsidiaries • Mergers & Acquisitions • Public vs. Private Decision Operational • Production Efficiency • Business Processes • Personnel Issues Financial • Capital Efficiency & Capital Structure • Dividend Policy • Share Buybacks & Cancellations Investor Relations • Analyst Coverage • Investor Interactions • Forecast Accuracy • Credibility with Markets Factors that impact shareholder value: 22
  23. 23.  Activist investors conduct thorough assessments of target company’s operations, incl. management, product strategies and capital structure.  Significant shareholder value lies hidden in many public companies that is difficult to unlock without commitment and proactive involvement.  Accounting consolidation makes many complex companies look simpler than they really are. This is important given that markets rely on consolidated data for valuation purposes.  Shareholder value can be unlocked by restructuring – changing strategy, operations, capital structure, capital expenditure plans – but overcoming status quo requires support from multiple stakeholders.  Activist investors specialize in fostering such coalitions through the quality of their analysis, their network of institutional contacts and the credibility of their reputation and track record rather than the size of their holdings. 23
  24. 24.  Activist investors act as important intermediaries in equity markets.  Activist investors, like M&A acquirers, aim to arbitrage the value gap between poor company performance and good company performance.  While an inherent bias in favor of management may once have existed among institutional investors, this is no longer always the case.  Open communications with activist investors can build credibility with shareholders and potentially enhance corporate strategies.  Shareholder activism can be costly and success is not guaranteed. 24
  25. 25. Proxy Warriors. Institutional Investor. January 2003. Bruce C. N. Greenwald, Judd Kahn, Paul D. Sonkin, Michael Van Biema. Value Investing: From Graham To Buffett And Beyond. 2004. B. Espen Eckbo. Bidding Strategies and Takeover Premiums: A Review. 2009. Journal of Corporate Finance. Henri Servaes. Tobin’s Q and Gains from Takeovers. 1991. Journal of Finance. Gregor Andrade, Mark Mitchell, and Erik Stafford. New Evidence and Perspectives on Mergers. 2001. Journal of Economic Perspectives. Marina Martynova and Luc Renneboog. A Century of Corporate Takeovers: What Have We Learned and Where Do We Stand? 2008. Journal of Banking and Finance. Mark Goergen and Luc Renneboog. Shareholder Wealth Effects of European Domestic and Cross-border Takeover Bids. 2004. European Financial Management. Jeffrey A. Krug and Walt Shill. The Big Exit: Executive Churn in the Wake of M&As. 2008. Journal of Business Strategy. 25
  26. 26. Joseph Cyriac, Ruth De Backer, and Justin Sanders. Preparing For Bigger, Bolder Shareholder Activists. March 2014. McKinsey Insights. Schulte Roth & Zabel. Shareholder Activism Insight. 2012. Ertan Enginalev. Is Shareholder Activism the Cure for the Common Stock. July 2014. Carried Interest. Alon Brav, Wei Jiang, Randall S. Thomas, Frank Partnoy. Hedge Fund Activism, Corporate Governance, and Firm Performance. May 2008. Journal of Finance. Linklaters. Activism Rising. 2013. 26
  27. 27. THESE MATERIALS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY INTERESTS IN ANY FUND MANAGED BY WSD CAPITAL MANAGEMENT, L.P. (the “Firm”) OR ANY OF ITS AFFILIATES. SUCH AN OFFER TO SELL OR SOLICITATION OF AN OFFER TO BUY INTERESTS MAY ONLY BE MADE PURSUANT TO A DEFINITIVE SUBSCRIPTION AGREEMENT BETWEEN A FUND AND AN INVESTOR. The information contained herein reflects the opinions and projections of the Firm and its affiliates as of the date of publication, which are subject to change without notice at any time subsequent to the date of issue, and serves as a limited supplement to a verbal presentation. The Firm does not represent that any opinion or projection will be realized. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. All information provided in this presentation is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. The "WSD" logo, "WSD CAPITAL MANAGEMENT", and "GROWTH THROUGH FORTITUDE" are registered and unregistered trademarks and/or service marks of the Firm or its subsidiaries and/or affiliates in the United States and elsewhere. All other trade names, trademarks, and service marks herein are the property of their respective owners who retain all proprietary rights over their use. This presentation may not be reproduced without prior written permission from the Firm. The information contained within the body of this presentation is supplemented by footnotes which identify the Firm’s sources, assumptions, estimates, and calculations. This information contained herein should be reviewed in conjunction with the footnotes. 27