Dealing with activist directors with an M&A agenda
This past year, more than ever, activist investors called for the companies they targeted to put themselves up for sale or divest assets. A record 99 campaigns launched in 2019 pushed an M&A-related agenda, according to Lazard’s shareholder advisory group. This represents 47 percent of activism campaigns launched last year, the highest proportion since Lazard has tracked this data.
According to Activism Insight, roughly 60 percent of M&A-related campaigns in 2019 called for a sale of the company or encouraged industry consolidation; around 20 percent called for a break-up or divestiture; and the remainder sought to intervene in an announced deal.
The true M&A implications of having an activist on your board are even greater. We examined 2019 data and identified 83 companies that added activist designees in 2017 or 2018. We then tracked how many of those companies were sold or divested significant assets over the two-and-a-half-year period from January 2017 to August 2019.
More than half were sold or engaged in a meaningful divestiture. Of the 83 companies we examined, 25 were acquired and 17 divested significant assets. Based on our experience, we can presume that a significant additional number of companies that added activist designees during this period explored M&A activity but did not find a suitable transaction.
Campbell Soup Company, for example, shed more than $2.7 billion in product lines after activist investor Daniel Loeb of Third Point gained two seats on its board in November 2018 having announced that the company should be sold. After Starboard won the right to add two directors to the board of Symantec Corporation in September 2018, the company looked to sell itself to Broadcom within 10 months. Although that deal fell through, Symantec later agreed in August 2019 to sell its enterprise security business to Broadcom for $10.7 billion.
Whenever an activist investor gains a seat, it can put a lot of pressure on management under normal circumstances. The activist’s success is generally viewed as a mandate to make changes to management’s plan or even to replace members of senior management. Adding an agenda to sell the company or divest significant businesses will raise tensions even further. These extraordinary situations will test any board and require focus, planning and careful deliberations.
Overall, activist activity levels remain relatively stable in the US. Continuing a pattern from the last several years, smaller companies tend to be targeted more frequently. Those with a market capitalization between $100 million and $500 million represented 43 percent of campaigns in the first eight months of 2019, while representing only 21 percent of Russell 3000 companies.
Of course, tallying the number of public campaigns in a given year doesn’t paint a full picture. A significant number of activist situations are resolved without any publicity. These silent campaigns raise the same issues as their public counterparts, and more.
Concerns around maintaining confidentiality can be used as leverage by the activist or can reduce a company’s flexibility in responding to the activist’s demands, such as by limiting the ability to negotiate contractually enforceable standstill provisions in any settlement.
A FAST-MOVING AGENDA FOR M&A
Adding to the pressure on target boards, activist campaigns have been moving more swiftly. According to our analysis, of those campaigns launched in 2019 through the end of August, 70 percent settled within two months. Only 48 percent settled that quickly during the previous year, and in 2017 only 20 percent settled within two months.
A notable feature of activist-linked M&A activity is how quickly it can unfold after an activist designates directors to a board. Less than two months after Nutrisystem agreed to give Legion Partners Asset Management two seats on its board in October 2018, the company announced its $1.3 billion sale to Tivity Health.
For a board, this rush to sell or divest following a fast-moving campaign poses special challenges, as directors may feel under attack and pressured to make decisions. M&A deals, by their nature, often must advance quickly, depending on the demands of the bidder and other factors that can limit the window to seal a deal. Still, directors must feel comfortable that they have all the available information they need to make an informed decision.
WORKING WITH AN ACTIVIST-AFFILIATED DIRECTOR
Activist-affiliated directors have a staff of financial analysts at their disposal to generate data and reports. As a result, a company needs to be prepared to respond to a series of detailed requests that may include raw data that senior management has not had the opportunity to vet. The incumbent directors, in turn, should be prepared to review new cuts of data presented in unfamiliar ways, which the activist-affiliated director may present in a board meeting without prior notice.
Some companies hire an employee to assist the corporate secretary with collecting and organizing responses to requests from activist-affiliated directors. In addition, some companies require that all materials be provided to all directors in advance of a meeting.
Practically speaking, attempting to marginalize an activist-affiliated board member who is pushing for an M&A deal can create a hostile environment that is counterproductive. This strategy may also be prohibited by the settlement agreement as activist funds often negotiate for membership on key committees. But companies should ensure that all M&A-related discussions are overseen by the board as a whole. Accordingly, companies that have not already done so often enhance their governance guidelines to ensure no lone director explores strategic alternatives without prior board consultation.
A CHECKLIST FOR BOARDS
Given the likelihood that the addition of an activist-designated director on a board could lead to the sale of the company or a significant divestiture, boards should be prepared if an activist gains one or more seats. Although there is no one-size-fits-all approach to working with an activist designee with an M&A agenda, a checklist for boards should include the following items for consideration:
- Preparing for detailed information requests, including staffing, procedures for quality control and safeguards regarding conflicts with other staff responsibilities
- Requiring all materials be provided to directors in advance of meetings
- Updating board policies to ensure confidentiality and to establish guidelines for stakeholder communications about potential strategic activities
- Opening a channel of communication between the activist fund’s general counsel and the company’s general counsel to address other topics relating to board policies, securities filings and insider trading policies
- Preparing for the activist to take a fresh look at the company’s strategic plan and to challenge key assumptions underlying management’s financial projections
- Periodic training on recent developments in the application of fiduciary duties in the context M&A activity.
With a strong foundation of preparation, a board will be equipped to deal constructively and effectively with an activist-affiliated director who joins its ranks.
Melissa Sawyer and Marc Treviño are partners at Sullivan & Cromwell