Public Co. Boards - Think And Function Like A Raider Or Activist
Raiders and Activists Do Not Pursue High Performance Companies
There are numerous providers that work with public companies to develop defenses against shareholder activism. Yet the most foolproof way to avoid corporate raiders or activist investors is to position the company for value maximization and go about creating the same. It is axiomatic that raiders and activists do not pursue high performance companies.
For compliance laiden boards it may be far easier and safer just to hire a slew of legal and financial advisors to pull up the drawbridges and fill up the moats. But for those who want to take a walk on the wild side (relative to being compliance laiden) and really go to bat for their shareholders, you might consider the following steps:
Mindset Shift
Activist investors do not commit capital to a company in order to spend time on compliance issues, tick the right boxes, follow political correctness or to win “good governance” awards. They invest with the singular intent of maximizing their investment through the realization of the investment thesis they have developed. A board seeking to think and function like an activist must adopt the same high performance oriented mindset.
During activist Pershing Square’s proxy fight with Canadian Pacific Railway, the CP incumbent directors were touting the governance awards they had won and belittling Pershing Square CEO Bill Ackman. In a diametrically opposite manner, in a town hall organized by Pershing Square, the individuals who made up Pershing’s slate of director nominees were all talking about the value that could be created at CP. CP had been stagnant for five years and was the worst performing Class I railroad in North America. All seven of Pershing’s nominees were elected and in subsequent years the operating performance of the company and the stock price both soared.
Of all the steps involved this one is simultaneously the most important and likely the most difficult. The difficulty in shifting mindsets from what has been perceived as the function of the board to a new more robust and entrepreneurial model is one reason why activists nominate new director candidates. Yet for those that can make this shift, the odds are highly in your favor for generating new levels of longer-term performance and value.
Deep Dive Due Diligence
Private equity firms engage in very intensive and detailed diligence of target companies at various stages of the acquisition process. And, in many situations, some aspect of this diligence and analysis may continue for a period post-acquisition. Many of the best activist investment firms conduct the same basic processes.
While certain aspects of the process are focused on “red flag” risk issues, as much or more of the time and energy is put into learning what the full potential of the company is. In other words, this is not just an exercise in understanding the historical and present aspects the company but also a forward looking process designed to determine the full potential of the company and to identify value drivers to bring this potential into reality.
This is not an exercise that is all form and no substance nor does it follow a SWOT or other typical “strategic planning review” approach. Instead, it is the first step of the approach taken by PE firms to understand the company’s full potential and to develop a value maximization plan.
There is no reason why a public company board of directors, along with the senior management team, which has decided to pursue the maximization of value cannot take this same approach. For this to work optimally it is essential that the board engage one or more consulting/advisory firms with deep experience and track record in this type of diligence and identification of value creation levers. The company’s industry, size and level of complexity and other factors will determine exactly what is needed in outside advisory services. In some cases, one consulting firm may suffice; in others multiple firms may be required. As an example, in its diligence of Goodyear Tire & Rubber, Elliott Management engaged four separate consulting firms. In addition, they had over 90 conversations with former Goodyear and industry executives to further understand the company and its opportunities.
This type of diligence process should produce two major results:
First, the board and management, working together, will have the full understanding of the company’s potential which then leads to the ability to set a target equity value. This is typically set as a range rather than a single value. In keeping with the theme of value maximization, this target should be a stretch but should be supported by the data generated from the diligence process. The time frame for hitting this target will vary but typically would be over a 3 to 5 year period. Activist Starboard Value did this with their investment and campaign at Darden Restaurants. The Darden share price had languished in the $40 - $50 range for several years. Based on Starboard’s diligence and subsequent plan they set a target range of $67 - $86. Starboard and their director nominees took control of Darden’s board in late 2014. By the first quarter of 2017 the share price hit $85.55.
The second key result of the diligence process is the identification of a handful of core initiatives that have been determined will have the greatest impact on driving the company forward toward the three to five year equity target that has been set. These initiatives may cover different timeframes and with some having more sub-initiatives than others. But, the essential point is that the initiatives that have the greatest potential to achieve the highest value are selected. My experience and that of others is that there should be three to five, six at the outside, major initiatives. Other possibilities identified, while interesting, will need to be put aside as the realization of the company’s maximum potential over the three to five year timeframe will require a laser rather than a scattered focus. The decisions about which initiatives to pursue should be a joint effort of the board and management with input from the third party firm(s) leading the diligence effort.
Value Maximization Plan
The development of the Value Maximization Plan is the process whereby the major initiatives decided upon are converted into operating plans that spell out how and when they will be achieved and by whom. The actual work on this is the responsibility of management.
This will involve the translation of the major initiatives into detailed plans that can be executed and with the flow of information enabling progress to be measured.. It may involve the development of a number of sub-initiatives within one or more of the major initiatives. Each should include the naming of an initiative owner, resources (all) needed, timelines, key metrics and short and longer term targets.
Even though management has the responsibility to develop the Value Maximization Plan, as with all aspects of this governance model, the board will need to have far more engagement in vetting these plans. The board will want to ensure that the plans are in alignment with the equity target, that they (the board) are familiar with the details and that plans are developed in such a manner as to provide data and other information for the purpose of the board’s monitoring and assessment of progress.
Monitoring The Value Maximization Plan Progress
A few years ago the following quote appeared in a Wall Street Journal article about the poor performance of American International Group (AIG), “At this point every year, we actively review our past and future expected performance against our plan, and this year is no exception.” This comment from a company spokesman was supposed to reassure investors that even though performance had been abysmal, the company was on top of things. The idea that performance against plan would only be reviewed once a year would be anathema to a private equity portfolio company board. Yet, this is a perfect example of the lack of rigor, discipline and management accountability that results from the public company governance model.
For a board seeking to think and function like an activist investor, monitoring performance against plan resides in a totally different universe than that reflected by the AIG spokesman comment. Once the Value Management Plan has been signed off on by the board, the go forward primary item of the board’s agenda is an intense focus on monitoring the value maximization plan progress and the overall ongoing state of the business. This turns the agenda of most public company boards upside down as the performance of the business in the context of the plan takes center stage. But, this is also common sense when considering a governing objective of optimizing capital allocation and maximizing company performance and shareholder value. The three to five year equity target has now become the North Star for the board.
Board Composition Assessment
Just as the first step was assumed to be difficult, for many boards this step will also be tough but absolutely necessary. There is a very high probability that many incumbent members of the board will not meet the criteria for directors in the context of the board’s focus shift and the new initiatives. Thinking in this manner is exactly what activist investors do and is why so many activist campaigns include the replacement of some board members or in some situations the entire board.
If via an internal process as suggested in this article, a board has gotten this far, then a shift, albeit partial, to more robust and entrepreneurial governance model has commenced. But it will not hold without board members who can engage in and contribute to the value creation process going forward. There are a minimum of three types of directors that are needed in order for a board to reach its full potential as an asset:
Industry experience (recent) and value creation track record. The value creation track record is critical. It may be that one or more incumbent directors have industry experience (but more likely that there is no one with industry experience much less track record).
Specific experience and value creation track record related to one of the major value creation initiatives. Here are a couple of examples from a recent situation in which I was involved: At the company in question, there had not been any real emphasis on a cost reduction/efficiency program. One of our major initiatives was the development and execution of such a program. Within the company’s cost centers, distribution was by far the largest and also contained the biggest opportunity for improvement. We brought on a board member who had had big success restructuring and taking costs out of similar distribution operations at two major companies. Another major initiative was tuck-in acquisitions. A board member was added who had been involved in over 100 acquisitions in this industry and whose track record was stellar.
General value creation experience and track record. Successful and high level private equity partners are a great example of individuals who have this experience and typically have it over a wide range of industries (but not always). This type of ability and understanding is essential to ensure that the value maximization plan is being executed well and to determine when changes and updates are needed. In addition, they will typically bring a high degree of both rigor and discipline.
This has been a high level look at shifting a public company board toward a model that can move toward the development of the full potential of a company. The amount of change required is considerable but the results are worth the effort as the company is positioned to reach new performance and value levels.