Private Equity and Shareholder Activism
By Keith Fullenweider, Stephen M. Gill, Mark Proctor and Kai Haakon E. Liekefett
The tide of shareholder activism keeps rising. In 2013, there were 219 reported shareholder activism campaigns and 90 proxy fights, and the data in 2014 to date suggests that this year’s numbers will set a new record. Whereas activist investors initially faced acute skepticism, public opinion has turned around. Many institutional investors are now openly supporting activist hedge funds with funding and votes at the ballot box. Last year, 60% of proxy contests initiated by activists resulted in settlements or victories for activists, and this success rate has risen to 70% this year.[1] Most importantly, activism as an investment strategy enjoyed remarkable success. Activist hedge funds achieved returns of 16.6% on average for their investors in 2013 compared with an industry-wide average of 9.3%.[2] Indeed, many experts are speaking of a “golden age” of activist investing. In our view, there are manifold opportunities for private equity funds to profit from shareholder activism.
Use Activist Strategies: limited partnership agreements of most private equity funds include a prohibition on hostile takeovers and proxy contests. Many funds also have limitations on taking positions in public companies except for the purpose of acquiring the company outright. Therefore, the only way most private equity funds can openly engage in activism is to form a separate activist fund or a sidecar without these restrictions.
Invest as a “White Squire”: A private equity fund can also invest as a “white squire.” A board under siege will almost always be interested in placing a significant block of shares in the hand of a management-friendly third party. A significant stake in friendly hands can make it more difficult or even impossible for an insurgent to win a proxy contest. In addition, if authorized by the company’s governing documents, a board can use blank check preferred stock to create a new series of preferred stock with special voting, conversion or control rights for the “white squire.” The terms of these investments also often include the right to appoint or designate a limited number of directors to the company’s board.
Become a “White Knight”: Furthermore, there may be an opportunity for a private equity fund tobecome a “white knight.” Recently, activist investors have begun to collaborate with strategic acquirers in hostile takeovers. For instance, Pershing Square teamed up with Valeant in their hostile bid for Allergan, and Eminence Capital backed Men’s Wearhouse’s bid for Jos. A. Bank. Most boards prefer a friendly deal to a hostile takeover for a variety of reasons, psychological ones not the least. Management teams often prefer a leveraged buyout by a financial sponsor over an acquisition by a strategic acquirer because of the increased job security and appealing incentive compensation that a private equity buyout typically offers. For these reasons, many beleaguered public companies will consider competing friendly takeover offers from private equity funds.
Sell Out to the Activist: Lastly, a private equity fund looking to divest its stake in a public portfolio company may find a willing buyer in an activist hedge fund. In fact, activists sometimes approach private equity funds and ask them to sell them some or all of their remaining shares post-IPO because this enables them to obtain a significant toehold stake for their campaign in a single transaction. Activists prefer this approach for stakebuilding because the alternative, open market purchases, poses the risk of a leak and might drive up the share price of the target company, making the activist’s investment more expensive.
Conclusion
Shareholder activism has been very profitable and it is here to stay. While we do not expect many private equity funds to turn to activism strategies themselves, there are several opportunities for private equity funds to profit from shareholder activism.
Keith Fullenweider, Stephen M. Gill, Mark Proctor and Kai Haakon E. Liekefett are attorneys of Vinson & Elkins L.L.P. Mark Proctor focuses on structuring, establishing, and operating private equity funds. Keith Fullenweider, Stephen M. Gill and Kai Haakon E. Liekefett focus on mergers and acquisitions, private equity transactions and shareholder activism. The views expressed herein are solely those of the authors and do not necessarily represent the views of Vinson & Elkins or its clients.
[1] SharkRepellent, https://www.sharkrepellent.net (last visited August 7, 2014).
[2] Hedge Fund Research Industry Reports, Hedge Fund Research, https://www.hedgefundresearch.com/?fuse=products-irglo (last visited August 7, 2014).
