Activists to continue to target European financially healthy companies to achieve better returns

• Well established brands to continue to attract activists’ interest
• Board and management changes remains top activist demand
• Activists expected to target spinoffs and break-up candidates

 
Financially “healthy” companies active in sectors such as industrials, chemicals, consumer and pharmaceuticals are expected to increasingly be targeted by activist investors in 2019, sector sources told Activistmonitor.

In 2018, activists launched 58 live campaigns, slightly down from 60 live campaigns in 2017, according to Activistmonitor data. The industrials sector has been the most active, with 23 campaigns launched, representing a 156% increase compared to 2017.

Europe has also seen a 41% increase in live and potential campaigns launched among small cap companies (below USD 1bn), while the mid and large cap markets have seen a decrease, of 64% and 6% respectively compared to 2017.

Activists tend to target specific corporate vulnerabilities rather than particular sectors, although these weaknesses do tend to emerge more readily in certain sectors that are struggling, the sources said.

Even “healthy” well-performing companies and global household names are expected to increasingly come under attack as activists are encouraged by their investors to continue hunting better returns and often larger positions to achieve those returns, said Greg Mulley, corporate M&A partner and company adviser on shareholder activism and corporate governance at Herbert Smith Freehills in London.

“What we’ve seen in 2018, and will see more of in 2019, is that it’s not just poorly performing companies or those in some sort of trouble that will be targeted,” Mulley said.

Activists are looking at well-established brands that have become a little complacent over time, leading to higher overheads and a style of management that does not push for change, according to Dhruv Sarda of Alvarez & Marsal in London.

Already in late 2018 there has been a flurry of activity in recognised large corporate names such as Pernod Ricard [EPA:RI] and Bayer [ETR:BAYN], both under Elliott Management, as well as Third Point’s ongoing interest in Nestle [SWX:NESN].

Whether the economy is buoyant or in crisis, activists will always have a role in providing that analysis for companies that don’t do it themselves, according to an activism defence advisor based in Germany.

Activists tend to articulate what the market wants to hear, and that approach will continue to pay dividends whether the market wants companies to simplify, diversify, grow, retrench, divest or consolidate, said the advisor.

“In the past investors have appreciated a lot pure-play and flexible companies and I see this [trend] continuing, at least until we get into the middle of a crisis,” the advisor said.

The trend goes in cycles – companies concentrate on specialising and being pure-play for a period, and then diversifying into a more conglomerate structure to be better prepared to face certain risks, the advisor explained.

Companies should conduct, or ask their advisors to conduct, an “outside-in analysis” much like an activist would do in order to be prepared for the eventuality of activism, said Sarda.

Corporate Governance change

A particular vulnerability that activists screen for in every economic climate and geography is corporate governance weakness, the sources agreed.

Although corporate governance laws, rules, and conventions differ in every jurisdiction, the dynamics of personal interactions are often similar across cultures and are therefore exploited by activists, they said.

Corporate governance issues at public companies can provide an easy target for activists to criticise the company if it is non-compliant with codes or guidance, and this will resonate with institutional shareholders, Mulley said.

In 2018, governance changes demands amounted to 19 in 2018, a 21% drop compared to the previous year, Activistmonitor data shows. However, activists have made a total of 52 board and management changes demands, a 16% increase compared to 2017.

“One tactic we have seen is for activists to sometimes targeting individual directors, either to cause some board friction or a split, or as part of a tactic to discredit the board’s strategy more generally,” Mulley said.

Non-executive directors can find it difficult and demanding when such specific attention is paid to them. They, and the rest of the board, need to be prepared for what can often be a long running campaign beyond the first demand or requisition, Mulley said.

“Make sure communications work well at the board level, that they are agreed lines of communication internally and externally ad board unity is maintained. What you don’t want is people second-guessing each other in an inappropriate way,” added Mulley.

Boards should have at least one non-executive director with a financial, activist mindset playing devil’s advocate at board meetings, said Sarda, adding that the CEO should definitely have such a forward-looking mindset and not just rely on status quo reporting.

Most listed companies have a takeover defence manual but are now more likely to have an activist situation arise than a hostile takeover, so it is only logical that they should devote resources to being prepared for an activist situation, said Mulley.

Activist hedge funds are increasingly forming relationships with more traditional investors, such as institutional shareholders, asset managers, and pension funds, said Mulley. Planning can help temper the company’s initial response which is key as this can set the stage for what follows, he continued.

Support from existing shareholders can serve to multiply an activist’s influence during a campaign so working out which investors are likely to support each other and maintaining good levels of communication with all shareholders is key for a company’s response strategy, he said.

Vulnerability screening

Some typical vulnerabilities of corporates include overhead costs getting too high, over-exposure to a particular geography where macroeconomic forces are negatively influencing the business, multiple profit warnings, or M&A situations which have become very public, Sarda said.

“Often, it’s the opportunity for potential carve-outs of underperforming divisions/segments that attract an activist,” Sarda said.

Industrial sector companies, including automotive and manufacturing businesses, will continue to be under intense pressure from market conditions, and therefore from activists encouraging efficiency, said Sarda.

Building products businesses are under intense pressure when it comes to commodity prices and are thinking about how to improve profitability when their margins are under pressure.

Chemicals companies are going to be actively targeted for potential break-up cases, according to EY’s Head of Chemicals EMEIA Transaction Advisory Services, Liana Logiurato, formerly Syngenta’s global head of M&A.

Pharmaceuticals and healthcare sectors are also attractive due to large firms having grown too large too quickly via acquisitions, and which are likely to have divisions that are underperforming, Sarda said. Activists could push for further carve-outs and separations.

In Germany for instance, where Bayer has recently found itself under the eye of Elliott, other conglomerates such as Osram [ETR:OSR] and GEA Group [ETR:GEA] would be seen – alongside “all the big automotive suppliers and OEMs”- as potential targets for break-up, the advisor said. Bayer has reacted by saying it is going to reorganise, be leaner, faster, and think about separating some businesses, the advisor noted.

by William Mace, with additional reporting by Myriam Balezou, and analytics by Prithish Ray, CFA.