The dynamics of active vs activist investment approaches

When anyone inside or outside of a listed company hears the words “activist shareholders”, there is generally an immediate reaction of fear. Think of the current high profile corporate raiders in the USA such as Carl Icahn, Daniel Loeb and Bill Ackman, whose reputations have been built around that fear and almost immortalised in Gordon Gecko’s character from the 1987 classic movie Wall Street. If you need a reminder of what it’s all about, sit down for an hour and a bit and watch the 2022 released documentary ‘Icahn: The Restless Billionaire’. It’s hard to forget a line like…

 “There are many good CEOs and Boards, but there are far too many terrible ones that are hurting our economy.” Carl Icahn

What is Activist Investing?

Activist shareholders have their origins more than 200 years ago, when corporations became more mainstream and provisions for corporate governance were being framed.

Broadly the aim of activist shareholders is to exert pressure on Boards and management teams in response to a perceived view that the business is underperforming or more generally that the share price is underperforming. Historically, and in many cases relating to complex amalgamated groups, the intention was to pull a group apart, identify the price arbitrage created by the market not considering the value of the pieces, hopefully sell individual parts for more than the collective value, and deliver that additional value created back to shareholders. Then move onto the next one!

In more recent times, activist shareholding has also come in the form of campaigns to oust Directors from their seats, stemming from a perceived view that they aren’t looking after the best interests of shareholders. Obviously, these campaigns can garner a lot of media attention for the larger capitalised end of town as well as those companies with widespread company/brand recognition.

Activism Down Under

At a local level, Australia is one of the most shareholder friendly regulatory environments in the world and according to the ‘Corporate Governance Australia 2023’ report prepared by Insightia, Australia ranked third globally in 2022 for shareholder activism, only behind the USA and Japan.

It was a non-stop campaign against Qantas Airways Ltd (ASX: QAN) last year, highlighting every indiscretion and ultimately it was the perceived threat from shareholders around remuneration report strikes that knocked over all the dominos resulting in an exit of the CEO and Chair. It’s safe to say Downer EDI Ltd (ASX: DOW) was a similar story.

Two Strikes & You’re… Out?

Introduced as an amendment to the Corporations Act in 2011, the ‘Two Strikes Rule’ is a shareholder voting requirement at any ASX listed company’s annual general meeting (AGM). It is a vote cast on the remuneration report, which if there is >25% vote of ‘no’ for two years in succession, can trigger what is known as a ‘Board spill’. The trigger is an additional resolution, which if >50% of eligible voters elect in favour of a spill occurring, then all directors will be required to stand for re-election.

We would argue this rule is a highly leverageable tool for shareholders. If you scour the ASX, there are plenty of 1st strikes (the first year in which there is a ‘no’ vote) being dealt to ASX listed companies but it is very rare for shareholders to follow through with not only the 2nd strike in the following year, but also the resolution to spill the Board.

The remuneration report leveraged activist campaigns tend to push these ASX listed companies to the brink of the deemed necessary change but stopping short of risk associated with the disruption to the business that would occur as a result of a full ‘Board spill’. After all, if you remove that Board, you need to find another one that will more actively oversee the strategy and management team. It can make activist shareholders stop and think “Is it worth it?”

The small cap sector is not immune to activist campaigns either and in recent times we have seen organisations such as Southern Cross Media Group Ltd (ASX: SXL) and Pacific Smiles Group Ltd (ASX: PSQ) under the spotlight. In most of these cases, Director resignations (and sometimes management too) have followed but it’s hard to tell whether this ultimately leads to a fundamentally better business in the years after - in SXL’s case it was primarily about the support for acceptance of a takeover offer from fellow small cap listed business ARN Media Ltd (ASX: A1N), which had teamed up with a private equity partner. It now appears as though this train has finally left the station, and SXL will sail off into the sunset as a private company.

In the case of PSQ, despite the infamous and dreaded notice received under Section 249D of the Corporations Act (calling of a shareholder meeting) and an ultimately fruitless campaign to oust all of the Directors of the business, private equity firm Genesis Capital has emerged with a bid (yes it took a couple of attempts) that appears to have gathered momentum and will be supported by the current Board, meaning it too will disappear off the public market.

It's safe to say time will now not tell whether these activist campaigns led to a brighter future for either of these businesses or whether these outcomes were merely ways for fatigued shareholders to get some kind of result. It’s also easy to conclude that, ok, this may be great for some shareholders, but what about everyone else? What about the many other stakeholders associated with that business? Is it fundamentally creating more sustainable long-term value for all stakeholders? In today’s environment, the measure of success is not just financial returns but also the impact on its staff, the environment itself and positive social contribution.

The Era of Sustainability

Sustainability has become a key investing and transacting decision for businesses and consumers. We are clearly seeing this angle also being used by activists in the campaign for change. While it played out in a polarising way for many, the Mike Cannon-Brookes activist-led campaign to oust multiple Directors of AGL Energy Ltd (ASX: AGL) was on the basis that there was a belief the Company was not doing enough to transition away from high emission energy production which resulted in an enormous amount of carbon emissions, to a cleaner energy company and (theoretically) a more profitable one too. For the record, Cannon-Brookes described AGL as “one of the most toxic Companies on the planet”.

One suspects now that he succeeded in having his nominees appointed to the Board, they will need to start doing more active investing rather than just activist campaigns if they are going to help make the necessary changes for AGL to evolve into his vision. That subtle difference between “active” investing and “activist” investing clearly requires a different approach and skillset.

Active Investing

Active investing is about being active in the investment which includes partnering with the company through positive and negative cycles, changes in strategic directions, changes in management and potentially changes at Board level. Plenty of CEO’s will admit operating an ASX listed company is not a straight-forward exercise and rarely travels in a straight line.

Active investing should facilitate the journey to success by reacting to the circumstances that present themselves at the time and helping to provide the guard rails against poor decision making and burning unnecessary capital. For example, it will always be economically smarter and fundamentally easier to actively ensure a business doesn’t leverage up their balance sheet beyond their means at the outset, rather than wait for the crisis moment and participate in a highly dilutive re-capitalisation.

Alternatively, making the right connections and introductions within an active investor’s network either to a potential customer, supplier, or advisor, may ultimately be the difference in success or failure for that business. Active investing can take different forms, whether that be from the sidelines or from being on the Board but whichever way it is approached, common goals between shareholders, Boards and management teams go a long way to alignment and ultimately success.

At NAOS Asset Management, we have a high conviction approach to investing and our significant minority positions in our investee companies gives us a unique position to embrace that philosophical active investing approach. Their success is our success, and we never forget that.