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Activist investors have an image problem. Defined as a person or group that acquires an equity stake in a company in order to exert pressure on management to make changes, activist investors are often seen as a distraction from a long-term business strategy. Many think of them as unwelcomed guests at the wedding, taking the spotlight away from the bride and changing the seating arrangements without being asked. But new research from Wharton management professor Emilie Feldman debunks that notion by showing that divestitures prompted by activist investors often boost profits. Feldman and co-author Siwen Chen, a Wharton doctoral student, analyzed eight years of data from Fortune 500 companies and found that divestitures done under pressure from activist investors had more positive shareholder returns than comparable divestitures done voluntarily by managers. Feldman joined the Knowledge@Wharton radio show on Sirius XM to discuss her paper, “Activist-Impelled Divestures and Shareholder Value,” and why the enduring negative image of activist investors may be unwarranted. (Listen to the podcast at the top of this page.)
An edited transcript of the conversation follows.
Knowledge@Wharton: Some have a positive view of activist investors, while others have a negative view. Why are there such differing points of view?
Emilie Feldman: This is really what motivated us to start on this study and begin thinking about this question. We saw a prevailing view in the press and in talking to managers that activists were really a negative force, that they were troublemakers shaking things up, asking managers to do things that they didn’t necessarily want to do. We wanted to investigate this prevailing view within the context of corporate strategy and divestitures to see whether this held any water or whether this was just a sentiment that was not really at play.
Knowledge@Wharton: You looked at divestitures from Fortune 500 companies from 2007 to 2015, about 4,500 total. What did you find?
Feldman: We found that activist-impelled divestitures — the divestitures that activists were demanding that companies undertake — pretty substantially outperformed the ones that managers undertake of their own accord.
To put some numbers on it, we looked at announcement effects, which is the way that the stock market reacts on the day these deals were announced. The activist-impelled divestitures outperformed the manager-led ones by 2% to 3% on the announcement day. Then we tracked the differences in returns forward, in the months following the completion of the divestitures, and we saw that the activist-impelled divestitures outperformed the manager-led divestitures by about 1.5% in shareholder returns per month, which is pretty significant.
Knowledge@Wharton: But how far out does that benefit continue for the company after a divestiture?
“Our point was not so much to say activists are good/managers are bad, but to understand that activists are proposing strategies that are creating value for companies.”
Feldman: This is what was really surprising to us and what really counteracted the prevailing view that activists are troublemakers, negative, in it for a short-term gain, not really looking for long-term value for the company. What we ended up finding in our study was that these differences in monthly returns actually persist for up to two years following the completions of the respective sets of divestitures. Two years is a pretty substantial amount of time to see ongoing benefits from these activists. This is one of the things that was really surprising and compelling about this study: the fact that we were able to document these differences in returns over such a long period of time.
Knowledge@Wharton: Does that value increase come from spinning off a segment of the business?
Feldman: Just to be clear, we’re not only talking about spinoffs. We’re talking about divestitures in general. Spinoffs are a subcategory. Within the divesting firms, what we ended up seeing was that it could have been a lot of different factors. It could have been clearer analysts’ perceptions. It could have been undoing over-diversification that the company might have undertaken in the past. It could have been reducing managerial entrenchment or things along those lines. All of these problems that were getting rectified within the divesting companies were what’s contributing to the value differential that we’re seeing in terms of these activist-impelled divestitures.
Knowledge@Wharton: How frequently do you see interest from an activist investor who wants to buy into a particular company, but only if certain conditions are met?
Feldman: I think it’s important to be clear about what activists do when they take a stake in companies. They can come in with a lot of different demands. They can come in and say, “We want seats on the board,” or “We want you to rethink the way that your balance sheet is structured,” or “We want you to consider undertaking scope-changing transactions like divestitures,” or “We want you to think about compensation differently.”
We had some data to look at the breakdown of demands that activists were making. As it turned out, about half of the activists come in and immediately ask for board-related changes. But interestingly enough, over 20% of them start talking about divestitures as an appropriate strategy for the company to start thinking about in terms of what they should do going forward.
Knowledge@Wharton: Besides spinoffs, what else falls into the divestiture category?
Feldman: You can also think about sales to other companies. Companies could either spin off one of their divisions into an independent, publicly traded company, which would then operate as a free-standing entity. But they could equally sell one of their segments or one of their businesses to another company or even to private equity. Either of those would be viable modes of divestiture for companies to undertake.
Knowledge@Wharton: You’re talking about multimillion-dollar companies, so 1.5% per month is a pretty good return for a two-year period.
Feldman: Yes. What we ended up documenting in terms of these even longer-term effects is that there was no statistical difference between the activist-impelled divestitures and the manager-led divestitures, starting at two years after the completion of those deals.
In my view, this could be that the effect that we’re documenting disappears. But I think it’s also important to note that two years is a pretty long time. It becomes more and more difficult to say, “OK, these differences in performance are directly linked to the divestitures that companies are undertaking.” The connection between the strategy and the outcome becomes a little bit more blurry at that point.
Knowledge@Wharton: Does it seem like we are in a period now where there is more of this activity in general?
Feldman: Absolutely. There has been a huge uptick in activist activity in companies in recent years. I was looking at some statistics recently about the number of activist campaigns. In 2015, I think the number was something like 550 activist campaigns. By 2018, I think the number was 800 or 900. They were not necessarily all asking for divestitures, but certainly targeting these companies and asking for changes to happen within them.
Knowledge@Wharton: Do you think this research could persuade managers to consider changes such as a spinoff or a sale in advance, so they can avoid pressure from activist investors?
Feldman: Yes, I really hope it does. I think our point in this paper was not so much to say activists are good/managers are bad, but to understand that activists are proposing strategies that are creating value for companies. If companies were to embrace these ideas a little more proactively, they might end up being able to create some of the value that shareholders have to wait for the activists to come in and start demanding the changes in order to be realized.
I think there is absolutely a case for managers taking a page from the book of activist investors and maybe behaving a bit more proactively in terms of some of their structural decisions and strategy decisions.
Knowledge@Wharton: In January, it was reported that activist investors Elliot Management and Starboard Value LP want eBay to spin off or sell StubHub and its classified ads platform. What is driving that decision?
“Activist-impelled divestitures … substantially outperformed the ones that managers undertake of their own accord.”
Feldman: I think this is what ends up happening a lot of times and why activists start to target companies like eBay. They’ll have a core business that really drives 80% of the revenues, and then they have these other businesses that maybe are adding value, maybe not. Maybe they’re being managed well, maybe they’re not being managed well. But there is an opportunity to say, “Management, let’s focus on the core and get rid of all of these ancillary businesses that might or might not fit with this, or might or might not be creating synergies with this and adding value to it.” I think that mentality of really looking strategically at the composition of the portfolio is an important role that activists can play here in terms of identifying what’s really creating value for companies and what’s not.
With this eBay example, their core is this marketplace business. Is the classified business really adding value for them? Is StubHub really adding value for them? Is eBay’s management really the right management team to operate those businesses?
What’s fascinating about eBay as an example is that it’s not the first time that they have been targeted by activists. A couple of years ago, an activist came in and was demanding that PayPal be split from eBay. The payments business was far more competitive. The marketplace business was something with totally different characteristics, and they just didn’t belong together strategically. There was not a fit anymore. That demand ended up unlocking a huge amount of value for the two companies, and allowing them to trade publicly and independently was a huge step forward for both of them.
Knowledge@Wharton: The potential is that you make that company a stand-alone company, put it off on its own for a period of time, and then you draw the interest from another company that wants to acquire it because of the strength it has away from the original, parent company, correct?
Feldman: Yes, exactly. Part of it could be acquisitions — the stand-alone business could be acquired by another company. But part of it is that just the stand-alone company could end up being a more effective competitor on its own, with its own focus, its own capital allocation, its own management team that’s thinking only about the problems that it faces. PayPal is squarely focused on online payments, e-payments as its marketplace and dealing with the competition and the issues in that space. They’re not thinking about what eBay is doing, online marketplaces and all of these other things. That separation really aids strategic clarity and allows that company to function more effectively as a stand-alone competitor.
Knowledge@Wharton: Does it also change the view on governance?
Feldman: Absolutely. Maybe you don’t have board members who have the relevant expertise to govern a company in the online payment space because what you’re doing in the marketplace is totally different. If you think about who you choose as a board member, you might be able to structure your boards much more effectively to manage these two companies separately.
Knowledge@Wharton: Do you often see board members from the parent company going over to the company that has been split off?
“You hear activist investors, you see the way they’re written about in the newspapers, and it’s like Barbarians at the Gate. Something bad is about to happen to our company. But it’s exactly the opposite.”
Feldman: I’ve done some research on this in a separate paper. I’ve not looked at this specifically within the context of activists, but within the context of spinoffs in general. What was fascinating about that particular study is that in 40% of the companies in my sample, board members from the parent companies end up going to serve on the boards of the separated entities.
Knowledge@Wharton: But both companies at the same time?
Feldman: Both at the same time, which is pretty striking if you think about it from a governance perspective. Who are you beholden to? Who are you maximizing value for? What if the interests of those directors come into conflict? That’s a whole other boatload of issues to think about. But yes, there could be some value from the same people serving on both boards.
Knowledge@Wharton: Once an activist shows an interest in a particular company, it’s almost like an awakening for the firm that may be looking to be acquired or have a portion of it acquired.
Feldman: Right, and I think this is kind of the point. Whether the separated business that’s divested at the behest of activists stands alone, or whether it’s acquired by another company, the point is that it’s able to put itself into a better competitive situation.
To give an example of this, you can think about Nestlé. Nestlé has been under fire from activist investors to separate its entire company into three parts. They want them to separate groceries and nutrition and food products from one another. Nestlé hasn’t done this full separation, but they have divested the confectionary business. They sold it to Ferrero, which is a purely focused confectionary company. Can that company manage Nestlé’s confectionary business better than Nestlé can? Probably yes, because Nestlé has a whole bunch of other things going on that might or might not be relevant to this confectionary business. Once you put the confectionary business in a company, Ferrero, that’s purely focused on this particular issue — the competitive dynamics, how consumer tastes are changing, what the competitive landscape is like within that particular sector — that business could perform better.
Knowledge@Wharton: Do you think the push that activists are having right now is going to continue? Going back several decades, there were a lot of conglomerates like General Electric that have had pieces broken off over time.
Feldman: I would say within the past five or 10 years, there has been a huge push to focus on companies in general, and activists are contributing to this. We see a lot of activity right now where companies are really slimming down and focusing in on one or two core areas. I think GE is a great example. Many of the tech companies were doing this. Think of HP, Xerox, Symantec, eBay.
A lot of these companies are pushing towards focus as we’re looking at this. And yes, I think that activists are playing into this because, on average, if you look at the returns to divestitures and to focus increasing transactions more generally, you can see that investors react positively to them. The average investor response to a divestiture is about a 3% abnormal positive return on the announcement of a divestiture. By comparison, if you look at announcement effects to mergers and acquisitions, it’s about O.7% positive. It’s a huge difference, if we look at focus-increasing versus focus-decreasing.
Knowledge@Wharton: But there isn’t a ton of difference between the two. It’s almost a perception that makes that 2.3%.
Feldman: I think that’s exactly right. It’s a perception, but it’s a perception that translates into reality in the sense that we see that this transaction is happening. What does that imply in terms of how we expect the managers are going to run the remaining company? I think that’s the projection that investors are hanging that 3% return on when they look at divestitures.
Knowledge@Wharton: Are companies that have been enjoying success for a long time more hesitant to make changes? Is it the activist investor who pushes that change?
Feldman: That’s a great question, and I think there’s a number of factors that contribute to the inertia that companies and managers themselves exhibit against these kinds of changes, especially divestitures.
“We see a lot of activity right now where companies are really slimming down and focusing in on one or two core areas.”
One thing is that you can have enormous amounts of pressure from stakeholders to not refocus, not do divestitures. Think about how customers are going to respond, how suppliers are going to respond, how local communities are going to respond. Take the DowDuPont spinoff example. The local communities in Delaware were really unhappy about the announcement of that divestiture. Why? Because a lot of jobs were going to leave the region, maybe headquarters were going to close. Divestitures can have a very negative impact on various stakeholder groups. I think that’s one factor that promotes inertia.
This is much more of a negative story: Think about what drives managerial incentives. Managers are compensated based on the size of their firm, the profitability of their firm, so they want to grow. They want to do acquisitions; they don’t want to do divestitures. That’s exactly the opposite of where their incentives lie, especially in terms of compensation. I think that’s another big force that presses against divestitures.
The third one that I would point to is that you can imagine a stigma against divestitures. When you hear that, a company is sort of saying, “Well, we couldn’t really manage this business,” or “We weren’t able to be successful in this sector.” This is not exactly a vote of confidence for the management team. They’re portrayed fairly negatively, despite the positive reaction, which I think is so surprising. I think that inertia plays in from the way that divestitures are portrayed as signals of failure or problems that weren’t able to be managed within companies.
Knowledge@Wharton: When the average shareholder hears the potential of an activist wanting to tap into the company, what should they think?
Feldman: “Fantastic. Let’s see those changes.” I think that’s exactly what investors should be saying. I think they should be happy because a lot of these changes will shake managers out of their torpor and their resistance to undertaking these sorts of value-creating changes. So, I think it should be a really positive reaction when they see that. You hear activist investors, you see the way they’re written about in the newspapers, and it’s like Barbarians at the Gate. Something bad is about to happen to our company. But it’s exactly the opposite.