Business Law Today - Shareholder Activism 2017: An Overview
By Pamela Harper
Shareholder activism, a catalyst for change in corporate boardrooms, is on the rise. According to FactSet's 2016 Shareholder Activism Review, there were 519 activist campaigns in 2016. Although this represents a 16-percent decrease from the 622 campaigns in 2015, it nevertheless reflected a 22-percent increase from, and the second-highest total since, 2009.
Of the total number of activist campaigns in 2016, FactSet identified 319 as "high-impact activism," defined as campaigns in which the objective is board control, board representation, the maximization of shareholder value, or removal of officer(s)/director(s).
This year has been a robust one for activism, as evidenced by the recent Proctor and Gamble proxy battle and ADP's ongoing battle with Pershing Square Capital Management. Among the most recent high-impact activist campaigns in 2017, three are particularly notable: Elliott Management's campaign against Arconic Inc.; Marcato Capital Management's campaign against Buffalo Wild Wings, and Jana Partner's campaign against Whole Foods Market, Inc.
Arconic, a $12 billion aerospace supplier, found itself under pressure from activist investor Elliott Management Corporation, Arconic's largest shareholder with an 11.6-percent stake, to cut costs and improve profit margins. Elliott, consistently recognized as one of the top ten activist investors in the United States by Activist Investing and FactSet, launched ten activist campaigns in 2016. The campaign against Arconic, launched in January 2017, called for the removal of the CEO due to underperformance as well as the addition of four, new Elliott-backed board members.
In response, Arconic indicated that nine new board members were added in the prior 16 months, three of which were proposed by Elliott. Independently, the CEO resigned in April after having sent an unauthorized letter to Elliott's founder that the board determined showed poor judgement and that Elliott deemed inappropriate.
Proxy advisers generally supported Elliott, with Institutional Shareholder Services (ISS) recommending two of Elliott's nominees and Glass Lewis & Company endorsing all four of Elliott's nominees.
On May 22, 2017, just three days before the scheduled Annual Meeting, Arconic and Elliott reached an agreement whereby Elliott gained three additional board seats (one of which would serve on the CEO search committee), thereby giving it major control with a total of six out of 13 seats.
Buffalo Wild Wings
Buffalo Wild Wings, a $2.3 billion restaurant chain with over 1,200 locations worldwide and with declining sales found itself challenged by Marcato Capital Management LP. Marcato disclosed its initial 5.1-percent interest in a 13D filing on July 25, 2016. Subsequently, it expressed concerns on multiple occasions regarding Buffalo Wild Wing's strategy and business model, specifically that the percentage of franchised stores should increase from 49 to 90 percent. On February 6, 2017, Marcato nominated four members to the board of directors. Two months later, Marcato called for the removal of the CEO.
As did Arconic, Buffalo Wild Wings noted that it had already implemented several of Marcato's recommendations, including adding five new directors (including one of Marcato's nominees), engaging a consulting firm, and increasing share buybacks. Not sufficient. Notwithstanding the months of discussion, unlike Arconic, a settlement was not reached prior to the annual meeting.
By May 2017, Marcato's stake in the company stood at 9.9 percent. ISS recommended three out of Marcato's four nominees to the board, after which shares increased six percent. Glass Lewis recommended that shareholders adopt the company's slate of directors. At the annual meeting on June 2, 2017, the CEO announced her retirement, and shareholders voted to elect three of Marcato's nominees, one of which included Marcato's founder. These seats, combined with the previous gained seat, gave Marcato control of four out of nine board seats.
On June 19, 2017, the company announced the launch of its franchise initiative with 83 restaurants in multiple locations including Canada, Pennsylvania, Texas, and Washington, DC.
Whole Foods Market Inc.
Whole Foods Market, the organic food pioneer, has seen a steady erosion in sales and a decline in shareholder value since 2013. Concerned with declining sales and a failure to remain competitive by adopting new technology and data analytics in an industry renowned for low margins, Jana Partners, LLC, Whole Food's second-largest shareholder with over eight percent of shares, and Investment Manager Neuberger Berman, with a 2.7-percent stake, independently of each other began to press the company to explore a sale in April 2017.
In May, Whole Foods announced a series of changes, including the appointment of a new CFO and a chairman of the board, as well as the appointment of five, new independent directors whose tenure would be limited to a 15-year term. Ponder whether a 15-year term represents board reform, but everything is relative.
Notwithstanding these changes, Amazon.com acquired Whole Foods in June for $13.7 billion, paying $42.00 per share and driving shares up 27 percent. In July, Jana sold its total position in Whole Foods, generating a profit of approximately $300 million.
Several themes emerge from these campaigns:
- Activism In each campaign, the activist prevailed. Elliott Management€”three additional Arconic board seats and the removal of the CEO; Marcato€”three additional board seats and the removal of the CEO; and Jana Partners€”sale of the business to Amazon.com.
- Prior acquiescence and adoption of recommendations will not insulate a company from further Arconic, Buffalo Wild Wings, and Whole Foods Market each adopted activist recommendations governing board composition. None were sufficient to address the fundamental issues underlying the activism: business strategy and governance.
- Activism as a catalyst for business strategy. Fundamentally, each activist (Elliott, Jana, Neuberger, and Marcato) recognized and sought to address the company's business In the case of Arconic, it was Elliott's focus on cost cutting, operational improvements, and product focus; for Buffalo Wild Wings, it was shifting the business model to decrease corporate store ownership and increase franchises; and for Whole Foods Market, it was Jana and Neuberger's concern about the company's failure to be more innovative by adopting new technology to maximize sales and profits. Elliott and Jana now have a controlling board interest and concentration of power that effectively allows them to drive their agenda.
- Settlement is the preferred Of the three companies, Buffalo Wild Wings did not prevail in this regard. It is ultimately in a company's best interest to settle and attempt to negotiate an agreement with an activist shareholder rather than wage a costly and protracted proxy contest. According to Fact Set, in 2016, the median cost of a proxy fight, including proxy solicitation and consulting fees, was $1 million for a target company, almost 100 percent more than in 2015.
Given this landscape, as a matter of good corporate governance, companies are well advised to do the following:
- Heed the directive of the Shareholder Director Exchange (SDX) Protocol. Established in 2014, the SDX Protocol arose out of "the shifting balance of power toward shareholders" and increased shareholder activism. From January 2010 through November 2015, shareholder interventions increased more than 100 percent. SDX, a blueprint for institutional shareholder-director engagement, recognizes that the power of communication prior, rather than subsequent, to an issue escalating into major public discourse or a proxy battle, cannot and should not be underestimated. Notwithstanding clear evidence of increased shareholder activism, PwC's Governance Insights Center found that in its review of 100 proxy statements, only 28 percent disclosed a process for shareholder engagement. This is staggering and particularly critical for small-cap companies, given that 75 percent of activist campaigns last year involved firms with market caps less than $1 billion, with the median target company market cap being $249 million, according to FactSet.At an absolute minimum and as a best practice, irrespective of market size, every publicly traded company should have a shareholder engagement policy that articulates who engages on what topics under which circumstances. A shareholder engagement policy will not insulate a company from investor activism; however, it is a risk mitigation tool that promotes communication.
- Embrace and adhere to the Investor Stewardship Group (ISG) corporate governance principles. Scheduled for implementation in January 2018, the six ISG corporate principles enunciate what ISG believes "are fundamental to good corporate governance at U.S.-listed companies." Key among these for the purposes of shareholder activism is Principle 3: Boards should be responsive to shareholders and be proactive in order to understand their perspectives.
Shareholder activism will continue to mount as investors seek to maximize shareholder value. The trend will not abate. One of the most effective strategies for companies to neutralize, but not eliminate, potential shareholder opposition is to engage strategically, thoughtfully, and consistently.
Reprinted with permission from the November 1, 2017 edition of the American Bar Association's Business Law Section.