The ultimate impact of the coronavirus (COVID-19) pandemic on shareholder activism remains largely uncertain and comparisons with the surge in activism that followed the 2008 global financial crisis are tempting, but suspect as it remains questionable whether activists can continue to rely on the same forces that were driving activism prior to COVID-19. In any case, companies that have had their valuations recently upended should assume that they may be targeted by an activist investor, either alone or in concert with others, and take steps to prepare accordingly.
As much of the world’s economy has come to a standstill in the wake of government-mandated social distancing to stem the spread of the coronavirus (COVID-19) pandemic, global financial markets continue to experience unprecedented volatility and numerous public companies have seen their stock prices plunge to unfathomable levels. At first blush, with so many companies trading at more than 50% off of their 52-week highs, it may appear that activist investors may have an endless supply of potential targets to choose from. However, even looking back at the experience of the 2008 financial crisis and the surge in shareholder activism that followed shareholder activism is in unchartered waters and the ultimate impact of COVID-19 on shareholder activism is largely uncertain.
In recent weeks, global financial markets have experienced unprecedented volatility as heightened concerns about the ongoing COVID-19 pandemic take hold and its duration and ultimate impact on the global macroeconomic landscape remains unknown. From its record high, the S&P 500 has plunged as much as 35%, and companies in sectors that have had to reduce or suspend operations to comply with state and local government imposed social distancing mandates have experienced stock price declines of more than 80% from their 52-week highs. While the market has recently recovered some of its losses in anticipation of, and in response to, the US Congress reaching agreement on a $2 trillion economic stimulus package intended to alleviate some of the economic fallout that has resulted from the COVID-19 pandemic, it is likely that the financial markets will continue to be volatile until there is more visibility as to the duration and impact of the COVID-19 pandemic.
Given the large number of public companies, including numerous blue-chip large caps, that have seen their market valuations shrink to levels that were thought unfathomable only a few weeks ago, from a strict valuation perspective, there has never before been an opportunity when activist investors were presented with so many potential targets. While comparisons to the 2008 financial crisis and the surge in shareholder activism that followed are tempting, increasingly the 2008 financial crisis and the current COVID-19 pandemic are looking less comparable. Clearly, companies should expect and plan for the likely possibility that numerous activists will make new investments in light of the plethora of companies that appear to be trading at “bargain prices” and, as they have done in the past, often with great success, look for levers to access, whether through engagement with companies or a public campaign, to unlock value. What remains unclear is whether, at least in the near-term, there has been a change in the historical drivers of shareholder activism, including the strong encouragement and support that institutional investors have often provided activist investors.
Looking back at shareholder activism for the full year 2019, shareholder activism was top of mind in many corporate boardrooms. Consider the following statistical measurements of shareholder activism in 2019, which likely understate how widespread shareholder activism was in 2019 since they only reflect publicly disclosed activism campaigns:
If we were to believe that the period following the financial crisis is a fair comparison to the current period and, increasingly, that comparison is becoming highly questionable, we would expect to see a substantial uptick in the statistical measurements of shareholder activism cited above in the wake of the COVID-19 pandemic. In the wake of the 2008 global financial crisis, there were 126 proxy contests in 2008 and 134 proxy contests in 2009, the all-time record year for proxy contests. That was up from 109 proxy contests in 2007.
Prior to the COVID-19 pandemic, shareholder activism had many catalysts that combined to drive it and cause public companies around the world to be concerned whether they would soon be targeted and whether they were sufficiently prepared to respond to an activist investor. Among those catalysts were the following:
As noted above, if we look at the impact of shareholder activism in the wake of the 2008 global financial crisis, it clearly increased. There were 126 proxy contests in 2008 and 134 proxy contests in 2009, the all-time record year for proxy contests. That was up from 107 proxy contests in 2007.
With so many companies trading at more than 50% off of their 52-week highs, it may appear that activist investors will have an endless supply of potential targets to choose from. As some companies, particularly those in industries that have had to completely suspend operations in the wake of state and local governmental mandates intended to promote social distancing, have recently traded more than 80% off their 52-week highs, activists may consider this a unique time to accumulate equity stakes in premier, blue-chip companies at bargain prices. From a valuation perspective, activists may perceive that there are more potential activist targets than ever before and that their potential percentage gain, assuming that many of the companies with shrunken market valuations are able to weather the COVID-19 pandemic, is substantially higher than what they would ordinarily expect from an activist target.
With so many potential activism targets to choose from, and the widespread awareness that many companies are trading substantially below their peak valuations, activists may believe that now is a unique time to market activism as an investment strategy and raise capital for new investments. Activists may also believe that if they are successful in investing in the face of the current crisis, their performance records and reputations will be enhanced and, thereafter, they will be able attract more capital to invest.
Historically, activists have been value investors and were highly focused on smaller, highly challenged companies. In 2019, close to two-thirds of activism campaigns were at companies with market capitalizations of less than $2 billion.
Prior to the COVID-19 pandemic, some activists were already migrating to larger companies with strong performance metrics relative to others in its sector, even if they did not fit the profile of a “value” play. In the wake of the COVID-19 pandemic, many large, well-respected companies can potentially be thought of as “value” plays and activists that had already developed an interest in targeting larger, well-performing companies may now be able to invest in some of these companies at prices once thought unimaginable.
If many companies were “sitting ducks” prior to the COVID-19 pandemic and were reluctant to acknowledge how vulnerable they were to activists, the pandemic, while unprecedented and impossible for companies to anticipate, has only exacerbated such vulnerabilities.
For many companies, the obvious vulnerability to activists that the COVID-19 pandemic has exacerbated is stock price valuation. That vulnerability needs to be looked at in juxtaposition with the fact that so few public companies today have a poison pill shareholder rights plan in place. At the end of 2019, there were only 171 poison pills in effect at US-incorporated companies. That is the lowest number of poison pills in effect since 2002 when there were 2,220 poison pills in effect. While there has been a noticeable uptick in the number of poison pills adopted and announced in recent weeks, given the public sentiment that has evolved during the past decade that largely looks unfavorably upon prophylactic poison pills not adopted in response to a company-specific threat, it remains to be seen whether we will see a surge in poison pill adoptions in the wake of the COVID-19 pandemic.
Given that the primary focus of many companies in the near-term will be on preserving liquidity, staying afloat, being positioned to resume operations once the COVID-19 pandemic subsides, and the overall health of their businesses, it is likely that preparing for shareholder activism with any sense of urgency will not be a near-term priority for many companies.
Companies that have had their market valuations drastically reduced may be perceived as compelling targets for strategic and financial buyers, even if long-term shareholders may resist M&A transactions with prices that leave them significantly underwater.
Some activists may believe that, given the substantial impact that the COVID-19 pandemic has had on many industries, there is now a unique opportunity to push for the weaker companies in those industries, particularly those with liquidity challenges, to combine with the stronger companies.
It may also eventually become the case, once the COVID-19 crisis subsides and companies become more comfortable gauging their liquidity needs, that some companies may find that they have excess cash that can be put to use. If returning cash back to stockholders through stock buybacks becomes unfashionable or is prohibited, particularly for companies that benefit from governmental assistance, companies may look to use excess cash for M&A.
Some activists may attempt to portray themselves as “white knights” seeking to be helpful to the company in its time of need and offering to help the company overcome the crisis. Some activists, particularly those that see themselves as more constructivist in nature, may believe that their skillsets and experience at other companies, including those in the same industry, make them uniquely suited to help companies navigate through and emerge from the COVID-19 pandemic. In some cases, companies may welcome that assistance, particularly if the company needs additional liquidity and the activist can make such liquidity available.
While the optics of waging an activism campaign in the wake of the COVID-19 pandemic and related global economic shutdown may have horrible optics, particularly as the number of COVID-19 cases and related deaths escalate, some activists may believe that the COVID-19 pandemic provides them with a useful framework to highlight their case for change.
Even if the global pandemic and economic shutdown in response is an unprecedented crisis of such an epic scope that it would have been impossible for any company to anticipate and plan for, some activists may believe that they can use it to illustrate (i) a company’s lack of strong and competent leadership capable of navigating through crisis, (ii) flaws in a company’s strategic plan and business model, and (iii) the disconnect between executive compensation and share price performance.
Activists may attempt to drive the narrative that the company needs to enhance the composition of its board of directors and its leadership if it is going to have any chance of recovering all the shareholder value that had been lost during the COVID-19 pandemic.
In 2019, less than 40% of proxy contests went to a shareholder vote as many companies made concessions that caused the activists to withdraw their campaigns. In 2019, out of the 231 directors placed on company boards by activists, 210 were placed on boards pursuant to settlement agreements with the activists and only 21 were placed on boards via a shareholder vote. Activists may believe that, given that many companies are focused on staying afloat, addressing their liquidity needs, the overall health of their business, and their ability to rebound from the crisis, they may be more likely to settle to avoid a proxy contest and its related costs and disruption.
Regardless of whether activists are able to correctly identify targets with substantial potential upside and regardless of whether the traditional activist playbook is workable in the current environment, it is important to note that activists get paid fees to develop and implement activist strategies, not sit on the sidelines.
Activists may be reluctant to have to explain why they are not putting their clients’ money to use and have to answer the question, “If not now, when?” Activists, concerned with preserving their credibility as an activist, may also be reluctant to be accused of missing out on unprecedented investment opportunities, particularly if their competitors are willing to take positions.
Notwithstanding the numerous factors that would suggest that the COVID-19 pandemic could drive more shareholder activism, there are numerous countervailing factors that call into question the continued applicability of the historical drivers of shareholder activism, including, as discussed below, the strong encouragement and support that institutional investors have often provided activist investors.
As noted above, notwithstanding that shareholder activism had a significant upward trajectory following the 2008 financial crisis, it is increasingly becoming clear that, given the numerous complexities of the current COVID-19 pandemic, such period may not be a useful predictive model.
In the 12 years since the global financial crisis of 2008, activists have largely functioned in an era of global stability. Even the financial crisis of 2008 and related uncertainty it generated worldwide is looking less comparable as the COVID-19 pandemic continues to evolve. In the 2008 financial crisis, once the US federal government intervened and provided support to the banking, financial services, and automotive sectors, among others, and the US Federal Reserve used the various economic stimulus tools available to it, together with the other economic stimulus that was provided to state and local governments, we were on our way to “normalcy” and a 12-year bull market soon took hold.
One would likely have to look back to World War II, some 80 years ago, for the last time when so much of the world was engulfed with a shared sense of uncertainty across multiple dimensions. Given that most activists were born long after that time, none has had to operate in an environment of such widespread uncertainty. While many activists are extremely talented and often reluctant to show any fear, activists are not immune from the same fears and concerns that are currently impacting the rest of society.
The uncertainties that face activists today include the following:
Activists have not been insulated from the recent market volatility that has caused the S&P 500 to plunge as much as 35% from its record high and the valuations of other companies to shrink by more than 80% from their 52-week highs. As such, many activists may have their hands full in dealing with their current positions, some of which may be significantly underwater.
Depending on how an activist fund is organized and what types of investor lockups are in place to protect against redemptions, some activists, particularly those with short investor lockups, may be facing a significant uptick in redemptions.
As investors grapple with the fear and uncertainty that surrounds the COVID-19 pandemic, it may be more challenging for activists, as well as other investment vehicles, to raise money for new investments. Further, for some activists, their performance records in the wake of the COVID-19-driven market disruption, even if in line with the performance of the broader market, may make it harder for them to raise capital.
Further, it looks clear that activists making new investments in the wake of the COVID-19 pandemic will likely need to have a longer investment horizon than may have been the case in the recent past. It also looks clear that, unlike the period following the 2008 financial crisis, that market volatility will be with us for an extended period. As such, activists will likely need to be able to access capital with lengthier investor lockups to protect against redemption requests, which could limit the access of some activists to capital for new investments.
Prior to the COVID-19 pandemic, one of the driving forces of shareholder activism was the broad acceptance by institutional investors of activism as an investment strategy, the willingness of institutional investors to encourage and support activists and their efforts to pressure companies to enhance shareholder value, and the general belief by institutional investors that facilitating the ability to activists to make the case for changes in board composition, governance, and strategic direction at their portfolio companies was ultimately beneficial to them.
It is possible that institutional investors may not be as supportive of an activism strategy in the near-term as they were prior to the COVID-19 pandemic. In the wake of COVID-19, institutional investors may be more focused on seeing companies focus on the health of their business, their liquidity needs, their ability to stay afloat, and their ability to rebound from the crisis, rather than taking steps to enhance shareholder value. It is also possible that institutional investors become reluctant to see companies be more distracted than they currently are in dealing with the COVID-19 pandemic.
Further, institutional investors may have a near-term preference for stability and providing companies with more time and flexibility to regain their footing, rather than supporting activist-driven changes to a company’s board of directors and/or management team. In the near-term, it is possible that institutional investors will be more circumspect of pushing for companies to make changes, particularly if those changes do not directly address the company’s liquidity needs, its ability to stay afloat, its ability to rebound from the crisis, and the overall health of its business, and may demand much more specificity from activists with respect to changes being sought at a company.
Activists typically have an investment thesis that they believe shows the potential for unlocking value at a particular company. To that end, the activist identifies a lever to unlock shareholder value that they believe, through engagement with management or a public campaign, is accessible in the near-term.
As companies struggle to stay afloat and preserve their ability to rebound from the crisis, many of the strategies activists typically use to enhance value at their targets, such as unlocking the sum-of-the-parts value of company operations via asset sales or spinoffs, or seeking to monetize non-core assets may not be workable in the near-term.
Activists may also find it difficult to push some of the more popular activist-driven initiatives such as M&A, stock buybacks, cash dividends, or other changes in capital allocation. Returning cash back to stockholders through stock buybacks and/or special cash dividends may also become unfashionable in the near-term. For companies that benefit from the US government’s proposed $2 trillion economic stimulus package, companies will be prohibited from engaging stock buybacks and dividends through September 2020.
There are also few proof points for executing an activist-driven investment thesis in the wake of a global pandemic like COVID-19 and a related global economic shutdown.
Prior to the COVID-19 pandemic, activists often looked to M&A as one of their preferred ways for companies to enhance shareholder value. In the near-term, the ability of activists to rely on M&A as a path to value enhancement is uncertain.
As an initial matter, in the near-term, M&A processes, M&A due diligence, and the negotiation, execution, and closing of M&A transactions will face challenging logistics. In addition, acquirers and targets may want to focus their resources and bandwidth in the near-term on staying afloat, addressing their liquidity needs, being positioned to rebound from the crisis, and the overall health of their businesses.
In addition to bandwidth limitations, targets may opt to defer sale processes until markets stabilize and their market valuations recover at least some of the value that has been lost during the recent market volatility. Further, a target’s shareholders that are already significantly underwater may not be supportive of activists looking to be opportunistic and force a transaction that would still leave most investors significantly underwater.
Activists may look “tone-deaf” criticizing companies already facing unprecedented challenges due to the global COVID-19 pandemic.
While not impossible, activists may find it difficult to criticize company performance when the playing field and global macroeconomic environment had so radically and unexpectedly shifted in a way that no company could ever have anticipated and planned for. It would also be difficult for any activist to attempt to credibly argue that it has a better plan for managing through the COVID-19 pandemic than the company’s incumbent board and management.
The frequent demand by activists for companies to refresh their boards may not look so appealing when companies have significant need for institutional memory and experience to help them navigate through an unprecedented crisis. There are probably more than a few companies that wish they currently had on their board a veteran long-tenured member who left the board in the spirit of board refreshment.
Even among the most experienced and most successful activist investors, none can claim any experience targeting companies in the wake of a global pandemic of the scale of COVID-19 and the related global economic shutdown. While we see, and will likely continue to see, a number of activists continue to announce new investments in the wake of the COVID-19 pandemic, it is also likely that some may choose to keep their “powder dry” in the near-term.
In recent years, many activists have been successful in being able to constructively engage with company boards and management teams, at times outside of public view, and communicate a convincing argument as to why their ideas make sense for the company and would lead to enhanced shareholder value. In some cases, such constructive engagement has led to some activism campaigns ending before they even got publicly announced. To that end, as part of a company’s activism preparedness plan, companies are often advised to plan for that engagement and identify in advance who would be the most effective company representatives, and coached on how to make those engagements as constructive and productive as possible.
In the wake of the COVID-19 pandemic, notwithstanding that it remains advisable for companies to be open to engaging with their shareholders and listening to their ideas and perspectives, activists may have to confront the possibility that they will find it more challenging to engage with boards and management teams when much of the world is working from home. More problematic for such engagements will be that boards and management teams currently have their hands full focusing on staying afloat, ensuring access to liquidity, preserving the health of the business, and ensuring the company’s ability to rebound from the COVID-19 crisis.
Activists looking to pursue an activist campaign in the wake of the current COVID-19 pandemic and the numerous stay-at-home orders and nonessential business closures mandated by state and local governments would face very challenging logistics. These include, among others, those relating to (i) waging, and soliciting support for, an activist campaign when much of the world is working from home, and (ii) getting the attention of institutional and retail investors.
There are also logistical challenges in conducting activism campaigns at a time when so many companies are planning for virtual meetings to comply with the mandates in numerous jurisdictions that prohibit in-person gatherings of more than 10 persons. While Delaware already permitted virtual meetings prior to COVID-19, states such as Connecticut, Georgia, New Jersey, and New York have moved quickly in the wake of COVID-19 to facilitate the ability of companies incorporated under their respective state laws to hold virtual annual meetings. While activism campaigns at virtual meetings are certainly possible and may become the new “normal,” there is not much historical precedent to guide this.
In addition, an activist would have to contend with the broad control that companies generally have over the timing, place, and rules of conduct of an annual meeting, including whether the meeting is held in-person or virtually.
Further, an activist would have to contend with the uncertainty as to whether the laws and regulations over the frequency of annual meetings, such as Section 211(c) of the Delaware General Corporation Law, would be strictly enforced given current circumstances.
Shareholder activism is in unchartered waters and, for all of the reasons discussed above, the ultimate impact of COVID-19 on shareholder activism is largely uncertain. However, companies, recognizing that activists don’t get paid to sit on the sidelines, should expect that activists will look for opportunities among the numerous companies that have had their valuations upended by the COVID-19-driven market disruption. While the primary focus of many companies in the near-term will be on staying afloat, addressing their liquidity needs, their ability to rebound from the crisis, and the overall health of their businesses, companies looking to prepare themselves for the possibility that they will be targeted by one or more activist investors should consider taking the following actions:
For more information on shareholder activism and steps companies can take to prepare for activist investors, please consult the Morgan Lewis shareholder activism defense webinar series, which is available on demand. Read more about the Morgan Lewis shareholder activism defense practice.
For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
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 Section 211(c) of the Delaware General Corporation Law contemplates that Delaware corporations hold a meeting to elect directors no later than 13 months after the previous such meeting.