Why COVID-19 is a gift to activist investors

Why COVID-19 is a gift to activist investors

Source: The Australian Financial Review.
By: Jonathan Shapiro.

Activist fund managers have the potential to create even more value from downtrodden companies as a result of the coronavirus turmoil, according to Independent Investment Research, because the timing is extremely favourable for a turn of fortunes.

Activist funds can increasingly guide equity recapitalisations, operational improvements and merger and acquisition activity in a bid to unlock value in oversold or overlooked listed companies, said IIR, which provides analysis of investment products.

There are three ways to unlock value in the current market environment, according to senior analyst Rodney Lay.

The first is to identify undervalued companies “with the divergence between value and growth [stocks] at generational highs”.

The second is to identify companies in need of recapitalisation and provide funds on favourable terms, and the third is via “corporate renovation” as low interest rates create “complacency amongst small and mid companies” that activist strategies can address.

Shareholder activism in infancy

While Australia has had its fair share of activist investor campaigns, shareholder activism is still in a stage of relative infancy compared to the US. Activity picked up after the famed raid by feared US hedge fund Elliott Management on BHP Billiton in 2017, but that has not yielded an anticipated invasion of US-style activism.

This is “partly due to antipathy among many Australian investors to sanction management, often exhibiting an unhealthy tolerance of under-performing management teams”, Mr Lay said.

The analysis also found that managers themselves “can be too cagey about transparency, information flow, and seem to exhibit little support for fellow activism managers”. “This manifests in little promotion of the investment strategy and segment.”

Research by Activist Insight found there were 72 activist targets in Australia in 2019, close to 2018’s record of 78 targets. At least two-thirds of the actions were board-related and were “predominantly protests against board handling of performance and pay”, according to IIR’s evaluation.

About 10 per cent of targets related to business strategy, but IIR believes the number understates the extent of behind-closed-door engagements between shareholders, management and boards.

The advent of Australia’s two strikes rule, which can trigger a board spill if more than 25 per cent of shareholder votes reject the remuneration report two years in a row, has forced directors to increase their dialogue with shareholders. 

But this has also blurred the definition and scope of activist investing. Remuneration campaigns do not constitute true activism because they are reactive and do not unlock material value, according to IIR.

“Remuneration campaigns are short term, typically settled by way of the shareholder rights provisions that exist in Australia.”

“In contrast, dedicated activism managers tend to focus on campaigns that are structural and/or strategic in nature and on account of which have significantly greater capacity to be value accretive for all stakeholders.

“They are proactive in nature and are almost invariably long-term campaigns that require a high degree of expertise and staying power.”

IIR identified five true activists in Australia: the Tenarra long short funds, the 360 Capital Active Equity Value Fund, Sandon Capital, Viburnum Strategic Equities and Armytage Micro Cap Activism Fund.

It also identified several “occasional activists that have a smaller component of a broader strategy to engage in value additive campaigns”, including Geoff Wilson’s Wilson Asset Management, Allan Gray, Perpetual Limited, Tribeca Investment Partners and VGI Partners.

Well-placed strategies

IIR’s Mr Lay said in an uncertain and volatile period where further material drawdowns in markets are possible, there are several strategies “well placed to generate outsized returns”.

Activist investing is one. Other strategies, he said, “include, but are not limited to, low to mid-market corporate private credit, distressed and special situations private debt, dedicated recapitalisation strategies – ideally partly through convertible note investments, and equity buy-write strategies.

“Equity activism strategies, which alternatively may be described as strategic equity strategies, offer arguably the purest form of active equities investment management,” Mr Lay said.

“They do so because activism managers provide significant input and direction to unlocking value within identified public companies through engagement with those companies’ management teams and boards of directors and other stakeholders to achieve a defined outcome.”

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