Hedge Funds |
As Activist Shareholders
Gain Strength, Boards Surrender to Demands
Steven Davidoff Solomon
14, 2014 4:30 pm
Corporate America may try to hide from its shareholders, but two recent
shake-ups — involving the tech giant
Darden Restaurants, the owner of Olive Garden and other chains — show
that escape is no longer possible. Shareholder activism has rapidly changed
how corporate America thinks.
Hewlett-Packard, which is in Year 3 of
a five-year turnaround plan, finally did what some shareholders had been
demanding for years. The company said last week
that it would split in two: One company will be a printer and personal
computer manufacturer named HP Inc. and the other will be an enterprise
software company called Hewlett-Packard Enterprise. The Wall Street response
was to send the company’s stock up as much as 6.6 percent on the day this
was announced. Yet the New York Times business columnist James B. Stewart
suggested it might be a desperate maneuver that catered to shareholder
whims and the spinoff stampede rather than a well-reasoned strategic plan.
In the case of Darden, the activist
investor Starboard Value, after months of pressing for changes,
succeeded in unseating all of the company’s directors. Throwing out
every single company director is a rare and drastic event,
one I called an epic failure. This happened after the Darden board, in a
fit of chutzpah, decided to spin off its Red Lobster business just before a
shareholder vote on the issue, one that appeared to be heading toward a
rejection of such a sale. The Darden board thus sealed its own fate by
blatantly ignoring shareholder will.
So what do these two events — one where
a company appears to be catering to its shareholders and another where it
had been rejecting them — have to do with each other?
Looked at together, the events show
that the activist shareholders have triumphed. The two cases symbolize an
end to the war of aggression between corporate America and shareholders,
with a surrender driven by crusty breadsticks and a huge decline in PC
sales. Corporate America, previously ruled by chief executives and boards,
is racing to do shareholders’ bidding.
The Darden case in particular
highlights the seismic shift that can happen if a corporation ignores
shareholder demands. Indeed, Darden’s board members voted to sell Red
Lobster at a time when the activists were organizing to oppose this move in
part because they thought the seafood chain would be too small to survive on
That Darden’s old board would go
against the wishes of shareholders so stridently was puzzling. This was
particularly true in light of the fact that a similarly
hostile battle at the auction house
Sotheby’s had also ended in a loss for the company after the hedge fund
manager Daniel S. Loeb gained the three board seats he sought.
Wall Street chatter has attributed
Darden’s obstreperousness to its advisers (the chatter, of course, is mostly
coming from competitors). At both Sotheby’s and Darden, the advisers were
Goldman Sachs on the financial side, Wachtell Lipton for legal issues
and the firm Joele Frank for public relations advice. These firms are the
trinity of anti-activism, the experts that companies hire when they want to
oppose the activists. It is hard to blame the advisers for things going
against the Sotheby’s and Darden boards because those are the firms to hire
in a shareholder fight.
Goldman Sachs, Wachtell Lipton and
Joele Frank all declined to comment for this article.
In the wake of Darden’s upheaval,
strident opposition by boards is likely to disappear. It simply doesn’t pay.
Even the most ardent anti-activist firms know it.
This trend is already taking hold. So
far this year, activists had a success rate of 72 percent in proxy fights,
up from 60 percent in 2013, according to FactSet SharkRepellent, a research
Activists are gaining ground because
institutional investors are increasingly willing to side with them, and even
joining the fight (or ganging up, as some companies might say). These
shareholder forces are often given an assist by two prominent shareholder
proxy firms, Institutional Shareholder Services and Glass Lewis. But this is
not a surprise as activists tend to focus on struggling companies in need of
It all adds up to pressure-cooking
corporate boards. And as hedge funds have proved to be successful in their
activism, earning extraordinary returns as a result, billions more in money
is following. It is a virtuous circle, or a vicious one, depending on your
perspective. At least until the returns go away.
That is why the loss at Darden, coming
after Sotheby’s capitulation, is such a milestone. After the Darden fight,
companies are not going to want to go the distance. It is too much misspent
money on advisers in a fight that results in a loss of face.
If you needed more proof, you need only
see what happened at Hertz.
Carl C. Icahn popped up with an 8.5 percent stake in Hertz, and within a
Mr. Icahn was able to appoint three directors, two of whom are sitting
on the new chief executive search committee. Hertz quickly realized that the
easiest thing to do was give in.
This is where the Hewlett-Packard
spinoff comes in. As shareholder activists, backed by institutional
shareholders, grow stronger, no company is safe.
Microsoft have already been targets. It was only a matter of time until
would have again been the target of an activist.
In this respect, what happened at
Darden led to what happened at HP. HP’s spinoff can be seen as a
precautionary step to keep the shareholder activists happy.
From the perspective of activists,
every business that is even the slightest bit different from a company’s
core must be broken off. In Darden’s case, the activists argued for a
spinoff of Red Lobster and Olive Garden together.
A spinoff can be beneficial, as it
allows management to focus better on each separate business. But in other
cases, it pushes management to dump its worst-performing assets into the
newly formed company. The result though is that corporate America is slowly
being broken up, only to rebuild as these smaller companies again get
acquired or acquire others.
At HP, it is uncertain whether a
spinoff makes sense, but shareholders wanted it. And so the move by its
Meg Whitman, can be seen as responding to the market trend and the fact
that activist shareholders must be obeyed.
This is the way it goes these days in
corporate America. Corporations are running to reorganize and trying to
prevent the activists from coming. But the activists are on the prowl, and
there is nowhere to hide.
This is true even beyond activism and
in takeovers themselves. The Botox maker
Allergan (represented by the trinity of Goldman, Wachtell Lipton and
Joele Frank) is trying to fight off
Valeant Pharmaceuticals and the activist hedge fund Pershing Square
Capital Management. But barring a court ordering otherwise, shareholders
will soon get to vote on whether to unseat Allergan’s directors. Can you
guess where the trend is going?
The real winners here are the advisers,
who have seemed to figure out which way the wind is blowing. Guess who
advised Hertz on its quick deal with Mr. Icahn? The holy trinity of Goldman,
Wachtell and Joele Frank. For HP’s spinoff, it was Goldman and Wachtell. No
matter how contentious things get, the current shareholder atmosphere is
driving companies to break up and seek acquisitions. Wall Street will
continue to profit from both those trends.
Yet one has to wonder about the
corporations themselves. Shareholder activism can be a positive force and
certainly companies should listen to shareholders as in the Darden case. But
as companies run in fear to reorganize themselves, one has to wonder if fear
alone is a good way to run corporate America.
Steven Davidoff Solomon, a professor of law at
the University of California, Berkeley, is the author of “Gods
at War: Shotgun Takeovers, Government by Deal and the Private Equity
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A version of
this article appears in print on 10/15/2014, on page
of the NewYork edition with the
headline: As Activist Investors Gain Strength, Boards Surrender.
The New York Times Company