Elizabeth Judd, Writer
Until quite recently, an activist trying to wrest control of a Canadian boardroom was somewhat of an anomaly. Today, activist attacks are commonplace. “Some very mainstream funds are deploying activist tactics to achieve the kinds of returns they’re looking to achieve,” says Walied Soliman, Partner and Co-Chair of the Canadian Special Situations Team at Norton Rose Fulbright in Toronto. “Everybody’s an activist these days.”
And indeed, headline-grabbing forays by activists are occurring with increasing regularity in Canada. Agrium Inc. and JANA Partners LLC. Hess Corporation and Elliott Management Corporation. Genesis Land Development Corp. and Smoothwater Capital Corporation. Talisman Energy Inc. and Carl Icahn (in a campaign he announced via Twitter).
Increasingly, observers are noting that the number of Canadian proxy battles waged over board control is growing. By September 2013, for instance, public companies in Canada had seen 30 such proxy battles – the same number as had occurred in all of 2012, according to a December 16 article in the Financial Post.
Proxy battles in Canada are garnering such widespread global attention that a Cambridge professor, Brian Cheffins, published a paper last year entitled “Hedge Fund Activism Canadian Style.”
A Brave New World
Activists come in many stripes, but the overall strategy they tend to employ is roughly the same: to obtain a position in a company in need of a makeover. An activist puts forward a plan to significantly improve the value of shares in a public company, and if the board balks, the activist typically throws his or her weight around by asking that more congenial individuals be given board seats.
Almost all experts agree that the ‘watershed campaign’ that ushered in a new era of shareholder activism in Canada was that led by William Ackman, Founder of Manhattan-based hedge fund Pershing Square Capital Management L.P., to remake Canadian Pacific Railway. Although it has been widely reported that Ackman originally asked for two board seats, his 2012 campaign was so successful that he gained seven board seats and spurred CEO Fred Green to resign.
“For the first time, very large Canadian pension plans and institutional investors were prepared to line up and back an activist and effectively fire the board. That’s a very rare thing in Canada,” says Stephen Griggs, CEO of Toronto-based Smoothwater, and the former Executive Director of the Canadian Coalition for Good Governance (CCGG).
One of CP’s key management mistakes, according to Griggs, was that the board wasn’t listening to Ackman and other shareholders. “From an IR perspective that can be very dangerous. If you’re not carefully listening to your shareholders, analysts, and others talking about your company, you really are leaving yourself open,” he says.
William Ainley, Senior Partner at Davies Ward Phillips & Vineberg LLP in Toronto, believes that the CP campaign was different because of the high level of support it garnered. “You had a very thoughtful guy in Bill Ackman who was saying things that were not outrageous or seemed like short-termism, but seemed right about how the railway was operating relative to its peer group,” says Ainley.
If the events that transpired at CP spurred activists to think in new ways, one campaign alone couldn’t have spawned such a flurry of activist activity had Canada not been fertile ground. “Activists have the whole world as their oyster. Why would they go to Canada?” asks Soliman. “Because Canada is generally the most shareholder activist-friendly jurisdiction in the Western world.”
Canada has gained this reputation by having far fewer corporate and regulatory roadblocks to activism than the U.S. and other countries. For instance, shareholders in Canada can requisition meetings ahead of the traditional AGM. In addition, they can gain access to shareholder lists and find potential allies fairly easily. Soliman also points out that Canadian activists can literally run campaigns by press release through the Public Broadcast Exemption.
Finally, an activist doesn’t have to file an Early Warning Report until he or she has amassed a 10% position in a Canadian company; in contrast, in the U.S., a 13-D must be filed at 5%. Although Canadian regulators have proposed a lower threshold, no change has yet been made.
Meanwhile, public companies are using more aggressive tactics to gain support for their side. Richard Powers, a senior lecturer at the University of Toronto’s Rotman School of Management and academic director of the Directors Education Program, points out that only about 40% of shares are typically voted in a proxy campaign; therefore, Canadian companies keen to demonstrate strong support for their side sometimes pay brokers to deliver pro-management votes in what are known as “dealer-solicitation payments.”
Powers points out that when Agrium was fighting to keep JANA from getting five nominees on its 12-person board, Agrium paid brokers to get shareholders to vote – and in fact, many shareholders reportedly reversed their votes immediately prior to the deadline. In the end, JANA didn’t win a single seat.
The New Activist Agenda
Griggs, who is currently waging an activist battle at Equity Financial Holdings, defines his potential target universe as Canadian companies in the $100-to-$300 million market cap range.
“We’re value investors in the classic sense,” he explains. Ideally, he will identify a company trading at as much as 50% below liquidation value, which he feels provides a “good margin of safety” for moving forward.
The next step, he says, is to investigate why the company is undervalued. Often, he maintains, it’s because of poor management or because the company is in a badly performing industry. “If we think we can fix that by a change of the board and sometimes a change in management, the next step is asking: Can we implement that kind of a change?” When the answer is yes, Griggs usually seeks a material position in the 10-to-15% range, and would ideally like to find other dissatisfied institutional investors who also believe the company might benefit from an overhaul.
Having an activist show up at the door may not necessarily be a tragedy. Says Chris Makuch, Vice President of National Sales and Marketing at Georgeson: “Companies need to realize that when these folks come at you, whether it’s Icahn or Ackman or JANA, they’ve done as much – if not more – analysis as the company has. And they think, right or wrong, that they know as much about the company as the current management team and the board.”
Ainley agrees, pointing out that not all activists are cut from the same cloth. “Activist funds are establishing different brands. Some are more aggressive. Some are more cash oriented. And some are more long-term oriented,” he observes. “There are a lot more people being a lot more thoughtful about the different ways companies might run more efficiently from a return-on-equity perspective.”
Powers maintains that today’s activists are far feistier than in the past. “They’re more aggressive in pursuing their concerns and unwilling to settle for half measures,” he says. “They want it all.”
Honest disagreement over strategy is one thing, says Powers, but controversy arises when activists are pursuing short-term gains. He believes that hedge funds, in particular, are willing “to ruffle some feathers to get what they want.” Many boards, though, don’t see the changes activists are advocating as sustainable for the long term, “and that’s why they’re pushing back,” he says.
What the Future Will Bring
In this new environment, IROs naturally ask: Which company will become the next target? Ainley suggests that a red flag is poor performance compared to the industry peer group over a lengthy period of time. Another is having disparate businesses that don’t fit into a logical and overarching strategy. In addition, having lots of cash and very little debt on the balance sheet might attract unwelcome attention.
Beyond that, many experts advise jittery IROs to take a dispassionate look at their governance records. “Our assessment of the Canadian market is that midcap companies often have marginal governance,” says Griggs. He continues: “As an investor relations officer, the last thing you want is activists zeroing in on your company because you refused to have a majority voting policy or you’ve got a combined chairman and CEO.”
Although strengthening governance may be one way to preempt an activist attack, the trend for greater activism in Canada is almost certain to continue. For instance, a clear sign that more activism lies ahead is the sheer amount of money pouring into the shareholder activist asset class. With money from North America and Western Europe flowing into activist funds, there are more financial actors than ever “chasing activist situations,” says Soliman. An activist hedge fund like Pershing Square, for instance, has over $11 billion in assets under management.
Ainley explains that as M&A has dried up since the financial crisis of 2009, activism is viewed as a viable alternative. “Both approaches are similarly based on a change in how the target company is going to get run,” he says. “Instead of trying to acquire control of a company, activism costs a lot less money, and the returns can be very good.”
Data from the U.S. seems to confirm this assumption. The approximately 60 funds tracked by Hedge Fund Research that specialize in activist investing returned 16.6% in 2013 – far better than the returns for the average hedge fund, which were just 9.3%, according to HFR data.
“Institutional investors have now started to understand that investing in [companies targeted by activists] can be quite a lucrative approach to investing,” Ainley concludes. “And so we’ll definitely see more of this.”