David Freedman:
Hello. My name is David Freedman, and I am the global head of shareholder engagement and M&A capital markets at J.P. Morgan. I'm very pleased to have with me today, two of my partners, Alfredo Porretti, and Darren Novak. We're going to be discussing some of the trends and developments we are observing in activism globally. And so, what I'd like to do is have each of Alfredo and Darren introduce themselves and we'll get into the discussion. Alfredo.
Alfredo Porretti:
My name is Alfredo Porretti, and I am the head of Shareholder Engagement and M&A Capital Market for North America here at J.P. Morgan.
Darren Novak:
This is Darren Novak. Great to speak to everyone today. I'm the head of shareholder engagement and M&A capital markets for Europe at J.P. Morgan. Alfredo, do you wanna kick it off?
Alfredo Porretti:
Sure. As we think about the year that has passed, the last 12 months, there has been a lot of activity in the activism space, and the levels have returned to pre pandemic standards, notably with a lot more activity in the large cap space, a lot of globalizations of activism and so activity both in Asia and Europe. ESG remaining prominent in the eyes of a lot of investors and also a number of factors which are very contingent, as the times that we are living today that play into the potential for activism to continue high levels. And I would note that those are volatility in the markets, which ends up creating a number of opportunities for companies across the board and then an opportunistic approach, from activists aside who have a lot of capital to deploy and are able to pounce on companies that they have been monitoring for a while, when the price hits the levels that they think are cheap enough towards an intervention. And I'll say there's somewhat of a parallelism with M&A, during tricky moments where the companies who do particularly well are those that are able to catalyze an event and a deal when valuations are subdued. And similarly, the activists who know how to deploy capital effectively tend to use these opportunities of volatility and stock dislocations very effectively. Darren, are you seeing similar things in Europe?
Darren Novak:
Absolutely. These moments at dislocation provide significant opportunities for funds. And the themes in some ways remain the same and the themes in many ways change. The activists are certainly able to adapt as quickly as possible to changing market conditions, but as we've seen, share prices for many companies go well below the intrinsic value of a very solid well performing enterprises, activists just can't help themselves. And while we may not be reading about as many headlines in the newspapers, in terms of campaigns at large cap companies, we were seeing a significant amount of activism outreach behind the scenes, certainly activists doing a significant amount of due diligence. And certainly, can expect that once we start seeing Q2 results coming out, there'll be any number of activists trying to determine whether we're close to the bottom, whether the bottom is near and when is the right time to actually make a position and start agitating at companies.
Darren Novak:
But we expect certainly in Europe, a very, very busy Q3 and Q4.
David Freedman:
Alfredo, do you want to talk about the activity we're seeing behind the scenes?
Alfredo Porretti:
There is a lot of activity behind the scenes. The proxy levels, which are as high as last year. About 33 campaigns in the US are only a small portion of what's going on. There is a lot going on in the background and notably the effect of that is that we all are very busy, but also that boards and management teams are either directly involved in dealing with activists or agitating shareholders behind the scenes. But also, don't forget a lot of these board members sit on multiple boards and a lot of members of management have friends at other companies. And so, they end up being even more focused these days because they're sensing an increased activity level behind the scenes.
Darren Novak:
I think that that very much mirrors what we're seeing here in Europe. Here's another question following up on that, Alfredo. What sort of activity are you actually seeing in the asks of activists?
Alfredo Porretti:
I would say that earlier in the year, there was a lot of M&A and transactional kind of asks. Now things have re-normalized and there's more focus on some degree of return of capital to shareholders and operational asks. But I think it is a bit specific to industries and depends on the circumstances and clearly as it is the case in many circumstances, ESG and governance themes tend to be coupled with value themes as companies are being targeted by activists. I don’t know how it's in Europe, but I'm curious to hear.
Darren Novak:
So, in Europe, what we're seeing is, especially as we get into this higher interest rate environment globally, the activists significantly focusing on cash flow, and companies that have strong balance sheets, high free cut cash flow yields, companies that are experiencing issues in terms of valuation, but are otherwise solid. And these activists coming in and basically making demand for a significant return of cash. And I think, we're gonna see more of this as the year progresses. Activists right now are positioning themselves to make the ask more aggressive as we get into the autumn season. Also, in the M&A front, we're seeing situations again, where companies could be very attractive to larger in particular, US strategics that wouldn't need to raise any equity or debt to be able to finance a transaction. Companies where private equity could be interested and could equitize fully a potential transaction.
Darren Novak:
These companies are in particular play at present. And overall, I think the activists aren't necessarily looking for a transaction today, they're looking at into the future. So, over the next 12, 18, 24 months, could this company, in fact, be vulnerable enough over the coming months that they could be put into play quite quickly?
David Freedman:
And Darren, we've seen some things similar on this side of the pond as well, where it's somewhat of a head I win, tails you lose. They invest knowing that a turnaround could happen in the market or in the stock. And they know that their downside is protected though, that if things don't go well, they can run a campaign to try and get the company sold and get at least some money out that way.
Alfredo Porretti:
And on the same note, I think the amount of capital in the markets is still staggering. So, there's a flood of cash, and that drives the forces of activists to some extent, private equity, to look at potential companies, as you both are saying down the road might be appetible in terms of being a purchase target. I would also add a third phenomenon, which I'm noticing, is that activists that might not have the pedigree of the usual suspects are becoming a little bit more eager to step up in terms of bigger leads and are doing more active maneuvers, notably around companies, where they can enormously benefit from the cache held by the company that they're targeting.
Darren Novak:
I think we're certainly seeing that here in Europe, where there are just a number of large names that were thought to be completely invulnerable to activism in the past, but actually getting hit because of their share price, their shareholder structure, because of, they are essentially being significantly, important companies in whatever jurisdiction they might be. And we see smaller activists in fact, going after them and going after them quite successfully. But I think another one of your points, which is very important, in terms of special purpose vehicles, here that for the activists, it's harder for many of them, especially the smaller ones, the mid-size ones, to in fact, raise money for their fund itself. Whereas they're able to raise SPV money, co-invest money much more easily.
Darren Novak:
And there any number of institutional investors, any number of family offices willing to do that quickly and allowing some of these funds to in fact, go after larger cap companies. So, the fund itself may have not particularly significant AUM, but companies shouldn't be lulled into a sense of safety. Those funds wind up going to other investors and are able to supersize their positions quite quickly. And it's important from a defense point of view.
Alfredo Porretti:
Ultimately as an activist, you need one or two wins to establish yourself as being a relevant player. And then you can raise capital on the back end of that. And so, as you're saying, Darren, if you can lower the cost of entry and make it appetible for investors to take the chance on your fund, you can then get those one or two or three wins. Assuming you can operate within the timeframe of your SPV and return the money at a higher rate to investors that will warrant them putting more money into your funds. So I predict there's gonna be more of that.
David Freedman:
And the impact of all this has been seen by the number of elephant size targets going up significantly in the past couple of years. And it's a combination of the ability to have marketing cache because you'll get that extra media coverage, cuz you've gone after a large cap, and you've been able to raise the money through the SPV. So, we have seen a lot more of the companies above 10 billion that's where you've seen more activity. And actually, the portion of campaigns for companies with market caps below 1 billion has decreased over the past couple of years, turning to the proxy season. Alfredo, which you just picked up, we had 10 proxy fights that went all the way to a vote this year. But the difference was this time managements were winning more than they did last year. You want to talk about how that's happened?
Alfredo Porretti:
Sure. It is a function of the types of targets and the claims and the defenses that management put in place. I do think that if you think about it in an aggregated basis, both from a proxy fight standpoint and a settlement short of the proxy fight, the results seem to be fairly equal on both sides. I.e., an activist is able to impact a company's strategic direction by getting board seats, maybe through a settlement versus a full proxy fight that goes to a vote. The other interesting trend there is that we've seen ISS, institutional shareholder services, increasingly siding with management teams, in the last turn.
And that might kind of be one of the bases of why, the results are a little bit more favorable, to management teams that is slightly different than in the past. And it's more substantial in the past. Whereas in the case of glass Lewis, they have kept their recommendations consistent with past practice.
David Freedman:
The stat that really interested me, Alfredo. Is that the change in where ISS was siding with management and improving it is, they didn't support a smaller number of dissident candidates. They either went all with the dissident on the dissidence card, or they were on management's card. And that seemed to be the difference in the stats, which leads us to the universal proxy rules. So, for the 2023 proxy season, that means there's only gonna be one card on which people will vote and it will be all the managements candidates and the dissidents’ candidates. This will enable more activists to have proxy fights because it lowers the cost to them. But when we look at it, Alfredo, what is your opinion as to how that impacts the actual win ratio as we get into next year?
Alfredo Porretti:
I think the smaller activist, as you hint to, who are more cost constrained are likely to use the universal proxy. And then the answer to the question there in terms of success will be how good of a stock picker and how good at timing their purchases are they. Clearly, having just one slate and not two slates is advantageous when you're thinking about it from a pure shareholder democracy and a challenge, that an activist tends to want to do against management teams and boards.
Darren Novak:
And aren't there some interesting incentives. So, if you have one universal card and the general sentiment is by many institutional shareholders and certainly an ISS and Glass Lewis that some level of change is warranted, that that really provides an increased risk for a company that an activist least obtains one or two seats. Whereas if an activist is looking for majority control and people are worried about that when you had two cards, there was a risk. So, there was a management card and an activist card, and many shareholders picked the activist card, but not necessarily pick all the nominees on the activist card, there was a risk that control could wind up going to the activist just because of the two-card system. Whereas with the universal card, there would be a lower, lower risk. There's a lot of game theory that could certainly be played out.
Alfredo Porretti
So definitely agree with that. In companies that have a broader retail base, it's gonna be interesting to see if people really do understand the mechanics of voting, because there's a chance that if you end up voting for more people than are up for elections in aggregates, because the card that is used by the investor will not be counted to the final results of the vote, and we'll have to see how pervasive a problem that is.
Darren Novak
Also very interested in your views in what you're seeing on the North American side, in terms of ESG. And this also relates back, certainly in the experience that we're having here in Europe is how funds, especially newer funds, smaller funds are trying to use ESG for their own fundraising purposes, quite frankly. But how are you seeing ESG being used in North America right now in campaigns?
David Freedman:
We did see a huge uptick in the number of proxy proposals in the past year, under the environmental and social sides. I worked with a lot of companies on how to deal with that this past year, but what's interesting is it did not receive the same percentage approval. We were hearing from institutional investors that they didn't wanna support it, even though they support the environment or social issues, they thought that these proposals were so specific that it would not help the long-term value of the company. Alfredo?
Alfredo Porretti:
Agree with that. Ultimately, they've gotta be thinking about ESG increasingly as they dictate the strategy of the company. Getting back to proxy, fights. It's interesting how there have been a couple of campaigns that I would say are pure play ESG campaigns and notably the McDonald's and Kroger campaign run by Carl Icahn this year, which were not successful, but pushed the envelope a little bit in terms of making ESG the center and the main fulcrum of a campaign.
Darren Novak:
And certainly, what we're seeing in Europe is there's a continued focus on governance. That's always been the case. Activists have always focused on governance in terms of these campaigns, regardless of jurisdiction, but the ENS has been substantially reserved for companies where activists can wrap themselves in the ESG flag, but it's really being used as a foundation to create a sum of the parts story where you can basically spin off. European shareholders, much more open to a broader transition story company, mixing old and new economies if you will in relation to ESG.
David Freedman:
So, given the trends that we're seeing and the activity that is going on and looking forward with the initiation of the universal proxy rules in America, Alfredo, what things do you think CFOs, CEOs and boards should be focused on as we head into the next year?
Alfredo Porretti:
Being prepared is a key part of doing well. Thinking like an activist, making sure you're well advised in terms of what you should be doing strategically. And at the very least, kinda revisiting the plans and thinking and stress testing, what your strategy is on a regular basis. Because ultimately if you do that, it's very likely that you're gonna be either making the changes that are necessary, which keep activists and investors happy, or instead if you end up, not deciding not to do them, you'll be in a position to very well explain to the market why those decisions are not the right ones for the business.
David Freedman:
Now, Darren, talk about Europe and what corporations should be doing from EMEA’s point of view.
Darren Novak:
Sure, absolutely. It is quite different in terms of how activists ultimately pursue their campaigns. For large camps in Europe, for companies with a market camp in, in excess of 10 billion euros, there have only been two companies over the last five years that have faced a proxy contest. The activists are using behind-the-scenes pressure, leveraging the support of other key institutional investors that are becoming more and more open and often favorable and even occasionally publicly favorable of activist thesis. And the activists are very clever and very conscious about trying to drive wedges between the independent directors and the inside directors and management teams. And that's why preparation is so fundamentally important to inoculate the board, to inoculate the management teams, to ensure that the management team is ahead of these issues. And very, very importantly, ensure that the boards understand that the management team has this under control and has a plan of attack, that's fundamentally important.
David Freedman:
So, I'd like to thank Alfredo and Darren for joining me today to discuss this topic of activism. It's terrific to be able to work with partners like this, and to be able to bring the best of what J.P. Morgan can bring for our clients to help them address these critical problems. Thank you very much.
