Activist Investor

Activist Investor Definition

Activist investor is an investor that purchases large stakes in companies to take control or get board seat/s with a view to bring about significant changes in the company to reduce costs, increase sales, improve efficiency and thus maximize profits and shareholders wealth, generally entering the company when the existing management is inefficiently managing the business and there exists a large scope of improvement.

Explanation

An activist investor hunts for companies that are mismanaged, and the investor believes that bringing about radical changes in how the company operates and can turn the fortunes of the company. These investors – which are typically wealthy individuals, hedge fundsHedge FundsA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques.read more, or private equity playersPrivate Equity PlayersPrivate equity firms are investment managers who invest in many corporations' private equities using various strategies such as leveraged buyouts, growth capital, and venture capital. The top private equity firms include Apollo Global Management LLC, Blackstone Group LP, Carlyle Group, and KKR & Company LP.read more –  pick up shares of such companies from the open market and bring their stakes to a level where they are entitled to a board seat.

Generally, the markets get to know about these acquisitions when these investors make necessary regulatory disclosures after acquiring a meaningful stake in the organization. In the U.S, investors file SEC Form 3D when they acquire more than 5% in a company. Shareholder activism takes many forms, including proxy fightsProxy FightsThe proxy fight occurs when all of a company's shareholders vote to remove the company's current management. This usually occurs when shareholders are dissatisfied with management. There could be a variety of reasons for this, including capital structure, performance, and poor decisions.read more, shareholder resolutionsShareholder ResolutionsThe term "shareholder resolution" refers to proposals submitted by shareholders to the management of a publicly traded company, whereby the outcome of the resolution is determined by voting at the annual general meeting.read more, and litigations.

Activist-Investor

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Role of Activist Investor

An activist investor’s role is to come up with ideas on how to prune losses or improve the profitability of the company. These investors generally come with an agenda and persuade other board members and shareholders to further their agendas on the future direction of the investee company.

When a company does not have a single significant majority shareholderMajority ShareholderA majority shareholder or controlling shareholder is an individual or a corporation that owns the majority of the company's stock (more than 50%) and therefore enjoys more voting power than other shareholders. These shareholders are in a position to influence the company's decisions.read more and is running inefficiently by the professional managers, the business starts losing out to due to high costs, lack of new revenue streams, declining existing revenue streams, and many other issues which might lead to the ultimate demise of the business.

In such cases, they play an important role in bringing back life to the company. They take over board seats, bring the necessary changes, and significantly enhance shareholder valueShareholder ValueShareholder's value is the value that company shareholders receive as dividends and stock price appreciation due to better decision-making by the management that ultimately results in a company's growth in sales and profit.read more.

How does it work?

Most activist investors look for excesses in a company. For example, one of the most common targets is the companies that are sitting on a large pile of cash. If they think that the company does not require that much cash and there is a possibility of large distribution, if the investor is able to convince the other stakeholders, he will start building ownership in the company to achieve his objective of sitting amongst the board members Board MembersBoard members comprise the individuals whom the shareholders elect as their representatives. They are responsible for taking crucial corporate decisions regarding the company's policies, dividend payouts, top-level managers' recruitment or layoff and executive compensation.read more and implementing his agenda, which could be a large dividend distribution or a buyback.

There could be other issues that the investor may think of fixing like high top management salaries, non-performing business units, under-productive workforce, or non-focused management. An activist investor ensures that the business becomes free from such inefficiencies and gets on the path of increased profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more.

List of Notable Activist Investors

Below is the list of some notable activist investors who have created a name in turning around businesses and creating shareholder wealth.

#1 – Carl Icahn

Carl Icahn is the founder and controlling shareholder of Icahn Enterprises, an investment holding companyHolding CompanyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary's directions and policies.read more. Icahn has been an investor in notable companies, including Apple, Yahoo, and Netflix. Carl’s net worth as $17.5 billion in 2019, and was the 4th richest hedge fund manager in America.

#2 – Bill Ackman

Bill is the founder and CEO of the hedge fund, Pershing Square Capital Management. He is known for his short in Herbalife and his soured bet in troubled pharmaceutical firm Valeant Pharmaceuticals. Ackman’s successful bets in many companies over his investment career have helped him shore up a net worth of $1.7 billion in October 2019.

#3 – Daniel Loeb

Daniel is the founder and CEO of Third Point, a hedge fund with around $11 billion in assets under management. Loeb started Third Point in 1995. His notable investments include Sony, Yahoo, Sotheby’s, and Nestle. Daniel’s net worth was $3.2 billion in 2018.

#4 – Barry Rosenstein

Barry is the founder of JANA Partners LLC, an activist hedge fund firm. Barry had a net worth of $1.3 billion in 2008 and is known for his bet in Whole Foods, in which he, along with other investors, owned 8.8%. He sold his investment for $300 million when Whole Foods got merged with Amazon.

Advantages

  • Fear of activist investors instills discipline and focus in the management teams
  • Their interest shores up the demand for shares of the target company
  • Activism often leads to the greater good of shareholders
  • They bring new ideas on the table

Disadvantages

  • Activist investors look out for themselves first, and there have been instances when they exit at outsized profits due to their arrangement with the other board of directors and management. These outsized profits are often elusive to other shareholders.
  • Activism does not result in greater good all the time as activist investors are also wrong at times. They bring about radical changes in the business just to realize that those changes were not at all required, leaving the company in a bigger mess than before.
  • They can be short-sighted, harming the company for the long-term while getting short-term benefits for themselves.
  • Selling from active investors might lead to huge price breaks, leading to significant losses to other investors.

Conclusion

Activist investors have been around for centuries and have gained popularity in the investor community and media for their ways of bringing about desired changes in the functioning of companies. They run campaigns and try sophisticated ways to get their way and force the management to pursue their agenda.

These corporate raiders have garnered appreciation and admiration for their contribution in bringing about a sparkling change in corporate boardrooms. Nowadays, their activism is more of a collaborative effort for the efficient functioning of the companies.

While the benefits of activism are debatable, and results have been mixed, the success of shareholder activism largely depends on the philosophy of the activist investor. A long-term value-investing philosophy generally benefits all the parties involved. A selfish, short-sighted philosophy generally does more harm than good.

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