Bill Ackman and the State of Activist Investing, Part II

Despite a series of ongoing challenges, a variety of environmental effects have recently swung in the activists’ favor.  First, as mentioned in my previous blog post, stock prices have taken a tremendous hit over the past year.  Yet while the news media tend to tout the market’s recent resurgence, in reality the S&P 500 still remains more than 25% below its level of one year ago.  This has unlocked a variety of value opportunities for investors, and activist hedge funds have taken notice.  In Ackman’s case, it has allowed him to add considerably to Pershing Square’s stake in Borders Group (its current economic interest consists of 40% of shares outstanding), as well as earn him a seat on the company’s board.  In doing so, he has lowered his investment’s average cost basis by purchasing shares at lower prices, thus setting the stage for a substantial profit opportunity if and when the book retailer’s shares rebound.

In addition, activist investors are benefiting from a recent groundswell of support for corporate governance reform, following a rise in publicity over corporate excesses.  Corporate carelessness and excess, which includes outrageous bonus payouts and golden parachute provisions paid out to management, as well as the stacking of corporate boards with the close friends of leadership, essentially robs shareholders of their right to share in a firm’s success.  In one more egregious example, Robert Nardelli received a $210 million severance package from Home Depot in 2007 as its departing CEO; yet, during his six years with the firm its share price failed to appreciate in any meaningful way.

In response to such corporate excess, a variety of changes are in the works.  In July, the SEC enacted a series of proposals aimed at corporate transparency, such as allowing shareholders of companies participating in the Troubled Asset Relief Program (TARP) to vote on executive pay.  In addition, the SEC is now considering reforms intended to “remove impediments so shareholders may more effectively exercise their rights under state law to nominate and elect directors at meetings of shareholders.”

These new laws would directly benefit a company’s largest shareholders, and in the case of Pershing Square, it would allow the fund an easier means to influence a company’s management team.  For example, prior to Target’s annual shareholder meeting last May, Ackman’s fund spent $10 million fueling a failed proxy campaign aimed at educating Target’s major shareholders (pension funds, institutional clients) about a list of new board candidates the fund wished to nominate.  Ackman even went so far as to make guest appearances on the Charlie Rose Show and CNBC to get out his message.  Under newly-proposed amendments, shareholders would be able to have their nominees included on the official proxy ballot mailing.  As of right now, most can only formally announce their candidates at the annual meeting, on the same day as the vote.  By including shareholder nominees on the proxy ballot with the other board-nominated candidates, shareholder nominees will receive improved exposure, and this should in turn help their chances of winning a seat on the board.  For Pershing Square, this will make it easier for the fund to inform shareholders about its nominees, and should lower the overall costs involved in mounting a campaign.

Several distinct trends currently dominate the activist investor landscape.  While tightened credit markets, liquidity concerns, and market volatility pose significant challenges to the activist investor, a resurgence in value opportunities and mounting support for corporate governance reform should offer significant incentives moving forward.  As one of the most outspoken proponents in the activist hedge fund arena, these trends will certainly affect Bill Ackman’s activities over the next year.  In early May, at Target’s annual meeting, Ackman’s campaign hit rock bottom as his nominees were rejected in a shareholder vote.  Rightfully so, many will continue to question why he chose to mount an activist campaign against one of America’s most well-respected and successful retailers, especially given the current economic climate.

Nonetheless, in doing so, Ackman offered the casual observer a rare, refreshing glimpse into the activist arena.  By taking his campaign public, he put his own reputation at risk for the betterment of his investors (not to mention all Target shareholders).  If the recent multi-billion dollar bank and auto bailouts serve as any example, complacency amongst management is a disease that can destroy any business.  In Ackman’s case, yes, his efforts may have been misguided.  Yes, his campaign ultimately cost Target $11million to defend itself against his claims.   Yet, his intentions were in the right place.  In mounting his proxy fight, he offered Target shareholders a voice, a means to raise their (not to mention his) concerns directly to the company’s board and its CEO, Gregg Steinhafel.  The SEC, Congress, corporate leaders, and other activists would be wise to take note and continue the push for further corporate transparency, thus encouraging further dialogue between management and shareholders.  As one can see, activism is a painstaking and arduous process, and it faces several challenges in today’s uncertain environment.  However, as long as opportunities for creating value persist, the activist investor will continue to campaign on behalf of shareholders’ best interests.

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