Activist investing: Changing the corporate status quo for investors' benefit

Activist investing has gained traction in Australia for several reasons, although there are two that stand above all. The biggest of these is the amount of capital that is now behind activist investing. It numbers in the billions of dollars, which is far larger than it was historically.

Well-known Melbourne-based fund manager L1 Capital, via its L1 Capital Catalyst Fund run by James Hawkins, has raised around $1.6 billion in assets and outperformed the ASX200AI by 7% p.a. since inception in July 2021, increasing the profile of activist investing in Australia and helping the strategy break through to the mainstream.

Other smaller activist funds have been operating in Australia for some time, including the Sandon Capital Activist Fund, run by Gabriel Radzyminski, which has been involved in more than 40 campaigns over the past 14 years.

The second reason is that the media has begun to cover this space more frequently, enhancing transparency in this formerly under-reported investment style, as well as increasing the profile of activist investing campaigns and the value they can unlock. And the publicity goes both ways – journalists are focusing more on it, but fund managers and major investors are also increasingly using the media as a lever to help accomplish their specific activist aims.

But that’s not what this wire is about. This wire aims to shine a light on what activist investing is by sharing insights from two Australian-based activist fund managers – James Hawkins of L1 Capital and Gabriel Radzyminski of Sandon Capital.

What is activist investing?

Having watched too many movies about finance when I was a teenager, like Wall Street, Other People’s Money and Bonfire of the Vanities, I grew up thinking activist investing was all about corporate raiders intent on hostile takeovers; slicing up and selling off a company.

And while activist investing can be combative from time to time, the vast majority of activism happens behind the scenes and is quite the opposite of my idea of what it was in the heady days of the 80s. As Hawkins puts it:

“Activist investing is a fairly broad term but generally refers to shareholders who are willing and able to actively engage with publicly listed companies to unlock value for the benefit of all shareholders.”

Radzyminski adds a little more colour, saying;

“An activist campaign is all about trying to change the status quo.

Take the example of a stock trading at a big discount to its intrinsic value. Why is that? It could be because the company has a poor track record of executing on its strategy. It could be that the strategy doesn't work and management is not prepared to give it up. It could be that the business is confusing to the market because it's not a coherent or transparent portfolio of assets”.

In assessing all those things, the opportunity sometimes presents itself to change the status quo, do things differently, and perhaps better reflect the company’s intrinsic value.

The starting point…is not activism

Both Hawkins and Radzyminski point out that potential activism is the natural outcome of the investment research process – the investment manager analyses every aspect of a company, determines the intrinsic value of the shares, and what needs to be done to get there.

Hawkins highlights that the L1 Capital Catalyst Fund is a fund of best ideas based on quality and value, with a catalyst/activist overlay, whilst Radzyminski notes that Sandon Capital starts with value and, in determining that a company is cheap, then turns to the “Why?”.

The difference between traditional investors and activist investors is what they do next: activists commit the resources, planning and time to help companies realise that potential, rather than letting the company and the markets do all the work.

Why activism, why now?

As noted in the introduction, the major change seen in recent years is the amount of capital committed to activist strategies. That amount is only now starting to reach critical mass in Australia.

According to Radzyminski, who launched Sandon’s activist strategy in 2009, one of the biggest ongoing challenges had been garnering support for the strategy and attracting capital.

“That's what has changed in the last few years, there's more support from the broader audience. The L1 Capital fund has got off the ground and they've raised a meaningful amount of money in the two years since launch.

That’s the difference now… there is a lot more money flowing into the strategy from both institutional and retail investors, whereas previously the money wasn’t flowing.”

As well as the capital flows, Hawkins notes that market participants from all sides are seeing opportunities in Australia. He says:

“The market is maturing. And with the example of highly successful shareholder activism overseas, genuine activist funds of scale are now realising the potential in the Australian market. Companies are more receptive to it. And investors can see the return potential.” 

The shape of a campaign

Activism is not something that just happens. Both Hawkins and Radzyminski talked of the amount of work that goes into identifying a target, determining if there is an ability to move the needle, planning how to do it, and then being deliberate and patient to help it play out.

These are not overnight stories. Sometimes, things happen quickly, but often the outcomes are years in the making. So, what does a campaign look like?

Radzyminski notes that in the early days of activism, particularly in the US, if an activist appeared on the register the initial reaction from the target company was most likely fear, and a willingness to do what was required to make the activist go away – because they didn’t want a fight.

From his perspective, Radzyminski doesn’t think that's a good way to get an outcome.

“The way we operate is we're putting forward a proposal that will ultimately succeed because most shareholders get behind it. And shareholders will get behind it because they think it's a good thing for them, not because they think it’s a good thing for us.”

He goes on to add that if his pitch was merely about making money, he wouldn’t get anywhere.

“Whereas if we pitch the idea as a solution to their problem and it's plausible, suddenly we've got a conversation going.

The secret, in our mind, to successful activism is to be able to leverage your idea way beyond your economic interest in the company", says Radzyminski.

What outcomes are you seeking to achieve?

Hawkins notes that for the 10 companies in the L1 Capital Catalyst Fund portfolio, the team engages on a wide range of topics. These can be anything from structural separation and capital allocation, to board composition and ESG matters.

“A huge amount of preparation and planning goes into our campaigns, whether public or private, including the research and analysis behind our proposals. We also plan ahead for a full range of possible company responses and outcomes, and how we are going to react to those.”

Expanding on the comment from Hawkins, Radzyminski adds that one of the lenses through which Sandon looks at companies is that of a natural owner.

He explains that there are usually owners who are most likely the best owners of an asset. For example, “You could have a business that is highly cash generative with limited capital expenditure requirements in a stable, consistent industry that lends itself to being a dividend paying stock that attracts a certain type of investor. You've got other assets sometimes in one company that are highly cyclical and very capital-intensive but with lots of growth opportunities. That's typically attractive to a different kind of investor again”.

The question then becomes, “Is there someone who could be a better owner of the asset, for whom the asset could be more valuable than its current owner?

And that's the sort of question that you ask yourself that might lead to the argument that the company should sell a division or should sell itself.”

Testing the waters

Unlocking value for investors usually starts with private discussions with the company. Hawkins and the L1 Capital team find that companies are generally receptive to initial conversations and willing to listen, not only because they have a meaningful presence on the shareholder register but also because of the professional relationships the L1 Capital team has built with boards and management teams over the last two decades.

But that's not always the case and, as expected, some companies have a natural resistance. As Radzyminski puts it, "Nobody likes to be told what to do by an outsider”, adding that it is not typically a reflection of the quality of the idea.

What happens next?

If a company is receptive, conversations often continue behind closed doors – what Hawkins calls “small ‘a’ activism”. He acknowledges that for every example that makes it into the press, there are multiple examples of activism going on privately that will never be publicised. Alternatively, there are situations where publicly articulating the thesis (“Capital ‘A’ Activism”) has the benefit of stimulating discussion and debate amongst investors and analysts.

Radzyminski openly states that most of his and his team’s efforts “are not focused on persuading companies directly. It's persuading other shareholders”. 

He adds that if management isn’t receptive to their ideas, “That's where we pivot and focus on multilateral engagement with other shareholders and stakeholders to try and convince a majority of shareholders that it's a good idea in their interests to support change, which ultimately goes back to the board who will bend to the will of the majority”.

Some past examples

L1 Capital and Hawkins have been in the press recently, advocating for a breakup of Santos, claiming that demerging the liquefied natural gas assets into a separate company could create over 40% upside in the share price.

Hawkins notes that in this case, they wanted to socialise the idea with their investors in the Catalyst Fund and other Santos investors.

“A demerger of Santos would ultimately require a shareholder vote, and going public has enabled us and the company to openly seek valuable market feedback.”

Whilst that campaign is active, Hawkins highlights a historical investment L1 Capital had in Tabcorp (ASX: ASX: TAH) in 2021 as another successful campaign. 

It involved the manager, together with other Tabcorp investors, encouraging the company to separate its lotteries and wagering businesses.

This ultimately occurred, with Tabcorp demerging its lotteries business into what is now called The Lottery Corporation (ASX: ASX: TLC), unlocking value for all Tabcorp shareholders.

“The Tabcorp example reflects a theme we increasingly see overseas, known as ‘swarming’, in which multiple activist shareholders, typically acting independently, advocate for similar proposals at the same company.

We think swarming can actually be a good thing because it leverages the collective scale of shareholder capital and encourages open debate about what is the best way to unlock company value.”

Interestingly, and as an example of how activism can take time, Sandon Capital also conducted a campaign in early 2016 making the case that Tatts Group Ltd should demerge its lotteries business.

It published a detailed research piece that characterised the lotteries business as an “infrastructure-like” asset, and hence warranted a premium valuation. Ultimately, Tatts shareholders supported a merger with Tabcorp.

"Fast forward to 2020/21, Tabcorp had failed to deliver on its promises and investors had lost patience. During that time, Sandon had been quietly pushing the demerger thesis with a number of large Tabcorp investors. That was when those large Tabcorp shareholders, including L1 Capital, encouraged the company to separate its lotteries and wagering businesses", says Radzyminski.

As for a successful campaign from Sandon, Radzyminski highlights a company called A2B Australia (ASX: A2B) (the old Cabcharge) as an example of where the value in the opportunity overlapped with the ability to have an impact.

“We followed that company from a distance for several years and its share price was in decline. When COVID hit, it really knocked the taxi industry, like a number of other tourist-related industries, to the floor. We were able to buy a stake in A2B at a price that we felt represented good value and gave us a margin of safety over what we thought the company could be worth.

We already understood where the opportunity might lie. So sometimes you see one but not the other, and ideally, it's when you see both that you actually take a stab," says Radzyminski.

“We then conducted a campaign over about six months that led to the departure of the long-standing CEO and the Chairman.

The appointment of Mark Bayliss (former CFO of Fairfax and an ex PE operative) as executive chairman led to a significant change in strategy, including the sale of all the company's properties, abandoning its flawed fintech ambitions and has delivered a turnaround in the core taxi business".

Looking ahead

Beyond the current opportunities, L1 Capital’s Hawkins believes that the opportunity set for activism in Australia will continue to grow, “as companies struggle to grow earnings in a tough economic and operating environment. They are therefore becoming more open to value-accretive ideas from shareholders.”

He adds that “from an investor perspective, shareholder activism as an investment strategy has been one of the best-performing strategies globally.” As noted earlier, that is certainly reflected in the returns for both of the funds featured.

But as always, nothing is without risk. Both fund managers noted that activist investing takes time and, therefore, results can be lumpy. Hawkins adds “In terms of major risks, we think that investing with the sole criteria of seeking to change company behaviour or strategy is flawed and can lead to making poor investments.

This is why the L1 Capital Catalyst Fund only invests in companies that meet strict quality, value, and catalyst criteria, and has an investment team that collectively have decades of investing experience”.