Of all the demands that activist hedge funds make, one has emerged as a clear favorite over the past year: asking the management of a company they target to put up the “for sale” sign.
Heady valuations have made the windfall from a sale too hard to resist for dissident shareholders, turning what used to be a fall-back option in past campaigns into preferred strategy, and prompting a slew of takeovers in the process.
The uptick in activist-driven deals has helped boost returns of the dissident investors. However, campaigns to spur company sales could put activists at odds with some large and powerful investors and undermine their recent efforts to project the image of long-term value creators rather than quick-buck artists.
U.S. activist campaigns that called for companies to explore some type of sale process totaled 91 so far this year, more than double the number a year ago, Thomson Reuters data show. The data excludes companies worth $300 million or less.
For activists, the demands are increasingly turning into deals.
The number of activist investments that ended with a company sale jumped from seven in 2010 to 25 four years later and 36 last year, according to research and data provider Activist Insight.
“Most small to mid-cap companies eventually get bought. That’s the way the world works. There’s nothing wrong with that. It’s actually quite healthy,” said Daniel Plants, the founder and chief investment officer of Voce Capital Management LLC, a $100 million activist hedge fund.
Voce’s campaigns have contributed to the sale of several U.S. companies, including the acquisition of medical helicopter operator Air Methods Corp by private equity firm American Securities LLC for $2.5 billion, which closed in April.
More than 500 M&A-related campaign demands were made
by activists globally during the 2016 and 2017 proxy seasons, representing around 75 percent of the total number of demands, according to JPMorgan.
Driving the trend are struggling mutual fund managers who support the deal campaigns to lock-in a positive return, and the decreasing number of targets where a quick fix can yield results, according to Goldman Sachs Group Inc.
“The number of companies where a quick divestiture or capital allocation change will work is dwindling,” said Avinash Mehrotra, Goldman’s co-head of its shareholder advisory group, which advises companies on defending against activist investors.
The most high-profile example this year of activism prompting a sale was the nearly $300 million profit Jana Partners made on its three-month investment in Whole Foods Market Inc.
Jana disclosed last week that it sold its entire 8.2 percent Whole Foods stake, worth $1 billion at the time and around 40 percent more than what it paid, after the organic grocer agreed to Amazon.com Inc’s $13.7 billion acquisition offer.
Some activists also pile into companies already on the block, adding further pressure to seal the deal, a tactic applied in the sale of contract research firm Parexel International Corp.
Fueling the frenzy has been a surge in overall M&A volumes during the past several years, underpinned by cheap financing and lofty valuations.
Thanks in part to M&A, the performance of the HFRI ED Activist Index in the last 12 months is up 16.46 percent, the fourth best performer among all hedge fund strategies and a major turnaround from losses suffered last year.
“Activists are pushing for strategic review because in a lot of situations, selling the company today at current valuation multiples offers a better risk-adjusted return than waiting for the current strategy to play out,” said Waheed Hassan, who helps management teams defend against dissident shareholders as head of activist defense at advisory firm Alliance Advisors.
The M&A push is not without risks.
Powerful index funds such as BlackRock Inc. and the Vanguard Group, which control a growing share of the stock market, are pressuring managements and other investors to choose long-term strategies over a tempting premium from a suitor.
M&A plays can backfire when a company refuses to heed activists’ calls for a sale, or a buyer fails to show up.
Starboard Value LP, for example, suffered a 28 percent loss on its investment in Depomed Inc after the U.S. drugmaker explored a sale without success, according to research firm 13D Monitor.
Another concern is that the pace of of U.S. deals slowed down in the first quarter.
A slowdown in M&A would make activists revert to other strategies, such as seeking more operational fixes or share buybacks – though these demands usually yield smaller investment returns.
Voce’s Plants said activist hedge funds should avoid an investment strategy based solely on calling for company sales.
“It seems like a lot of funds are doing that now and I think it’s very risky,” he said. “You need a plan B and C and a long-term plan to own the business.”
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