The rise of the activists

Monday, 01 August 2016


    No longer just the plight of international jurisdictions, shareholder activism is gaining significant ground in Australia. James Dunn explains why companies and boards should stand up and take note.

    Shareholder activism is on the rise around the world, and there are plenty of indications that Australia is joining the trend. We are starting to appear among the most-cited non-US jurisdictions for future shareholder activism. At the top of a list compiled by FTI Consulting were Canada and the UK, both of which were cited by more than half the funds surveyed, with Australia, France, Denmark, Switzerland and the Netherlands also highlighted by a significant number of investors.

    Clearly, a greater number and variety of companies than ever before will have to prepare for dealing with activists. But a distinction must be drawn between the different strands of activism – economic, and those that are environmental, social and governance (ESG) driven.

    Economic activism is the traditional form, where investors target underperforming companies, taking an equity stake in them in order to agitate for change that they believe will unlock shareholder value. Popularised in North America in the 1980s by the likes of Carl Icahn, T. Boone Pickens and Daniel Loeb, and funds including Jana Partners and Pershing Square Capital Management, the activist investors sought to change a company’s board members, businesses, operations, management, balance sheets, capital structure, dividend policies, indeed anything that they thought could be a catalyst for a significant re-rating in the company’s share value.

    The more recent offshoot is ESG activism, where investors place pressure on companies to improve their performance in a range of non-financial measurements. An example of this is environmental impact; “human capital” issues, such as gender and ethnic diversity in the composition of board, management and staff; and the social and health impact of the company’s operations. The major difference in the two is that ESG activists – often conducted by non-governmental organisations (NGOs) – are not investors themselves. More commonly, they seek to persuade investors to sell the stock, and dissuade anyone else from becoming investors.

    “Activism is definitely on the rise in Australia, we’re seeing a trend that follows what’s happened in North America in recent years,” says Michael Chandler, head of corporate governance at proxy advisory firm, Global Proxy Solicitation (GPS). “North America is a much more mature environment for activism, both economic and ESG. The distinction really is the support that it has in North America from pension funds.

    “Beginning in the 1980s, some of the huge pension funds really took activism to heart – the likes of California Public Employees’ Retirement System, California State Teachers Retirement System and Ontario Teachers Pension Plan,” says Chandler. “These funds have embraced activism for three decades, they’ve pioneered ESG or ‘sustainability’ issues, and with the money and scale they’ve got behind them, they’ve been successful in effecting change, and scaring boards into taking action.”

    Then there are the activist hedge funds, he says. “These are more in the Icahn tradition. They will look for economic opportunity, like a company that either has a lazy balance sheet or wads of cash; has not invested very well; has made a few bad moves in terms of acquisitions or investments; or has gone through a period of sustained financial underperformance. But layered on top of that you also have ESG considerations, where those risks can create more North American-style value opportunities – and that’s what ESG-oriented investors believe, that all of those ESG risks ultimately become financial risks,” says Chandler.

    The Australian way

    The Australian regime has a number of fundamental shareholder rights that “facilitate activism,” says Chandler. “Shareholders with collectively more than 5 per cent can call a general meeting and seek the removal of directors, that’s one. The ‘two strikes’ remuneration vote rule is another [where if a company’s remuneration report receives ‘no’ votes of 25 per cent of shareholders or more at two consecutive annual general meetings, it triggers a vote on whether all the directors will need to stand for re-election]. This is quite a blunt instrument that has occasionally been used by shareholders when there’s been absolutely no issues with remuneration – just as a protest vote to get the attention of the board that the shareholders aren’t happy with something,” he says.

    Research carried out by GPS shows that an increasing proportion of Australian fund managers and asset owners would support an activist campaign. “Two in three fund managers indicated to us that they would support an activist campaign, if the merits were there,” says GPS chief executive Andrew Thain. “I think definitely once the bigger funds formalise their strategies around activism, the age of activism in Australia will be here.

    “It’s on the back of the willingness of some of the larger global investors like the BlackRocks and DFAs of the world, and others like that, to actively get involved and usually their starting point is looking at it from an ESG point of view. As that grows, those larger funds will look to engage in an active campaign at board level,” says Thain.

    An important concept in the new activism is a company’s “social licence to operate,” which is increasingly being cited by activist groups. “We would define the ‘social licence to operate’ as the level of acceptance or approval that the community or stakeholders extend to your project or operation,” says Leeora Black, founder and managing director at the Australian Centre for Corporate Social Responsibility (ACCSR).

    “We’ve seen for at least a decade the rise of shareholder activism on ESG factors, and groups like the Australian Council of Superannuation Investors [ACSI] have been at the forefront of that. They’ve certainly been observing ESG-related shareholder resolutions being put at AGMs in the US, which has been the field where we’ve seen the most activity in this over the last decade or so, and they specifically pursue engagement by directors as a tactic.”

    Then there is the newer category of activist, social and environmental non-governmental organisations (NGOs) attached to specific causes. “Some of these cause-based activists are certainly relating their campaign to the social licence to operate, although they are looking more to influence the thinking of other investors. That kind of campaign is more around talking to big investors about their grievances, and I think we’ll see more of that kind of activism,” says Black.

    Examples of this abound in the resources space, with campaigns against coal seam gas (CSG) and coal, against the likes of AGL Energy, Santos and Whitehaven Coal; but also against industrial companies. An example can be seen in the ongoing campaign against Broadspectrum, related to human rights of people in Australia’s detention centres, and their treatment; and campaigns against companies with gambling operations, on the basis of the social damage that gambling can cause.

    Critical to this, she says, is quantifying the social licence to operate, and the potential for damage to the share price if it is lost. Black says there were two analyst reports put out by Credit Suisse in Australia in 2014. One was on AGL Energy (February 2014), which reviewed the (now discontinued) Gloucester CSG project, and the other, in July 2014, was on Santos’s Narrabri CSG project. The AGL Energy report suggested there was a 2.9 per cent downside to the company’s valuation, specifically over social licence issues at Gloucester, and that these problems were enough to cut the book value of that project from $347.5 million to $88 million. The Santos report lowered Credit Suisse’s value for the Narrabri project from 74 cents to 37 cents, enough to reduce the firm’s valuation on Santos by 30 cents, from $12.70 a share to $12.40.

    “That was the first time I saw in the Australian context that an analyst had put a dollar value on the damage to the social licence to operate, and made recommendations related to the company valuation based on these issues,” says Black. “It hasn’t become a mainstream thing yet for analysts to value the social licence to operate, and rate companies accordingly on it, but I think those reports were a sign of which way the wind is blowing, and I think we’ll see it becoming more commonplace in future.”

    Cause for alarm?

    For some companies, this wind is alarming, because they are unsure of the rigour of the analysis. When copper miner Sandfire Resources read in the media in 2014 that Australian National University (ANU) was selling out of its shares (and six other resources companies) because they were “not socially responsible, and doing harm,” according to the university’s then vice-chancellor, it was at first annoyed, and then – when the ANU’s decision was reported on the front page of the Wall Street Journal – it was angry.

    “A research firm, Centre for Australian Ethical Research [CAER], had been commissioned by the ANU to do proprietary research into the environmental, social, governance and ethical performance of companies in its portfolio, and it recommended that we be dropped,” says Sandfire Resources chief executive officer Karl Simich. “The nub of the issue from our point of view was that what CAER said about us was incorrect, out of date and misleading.”

    Sandfire brought a case against CAER in the Federal Court, which it discontinued in April 2015 once CAER issued a statement saying that the ESG ratings and reports on Sandfire it provided to ANU were “deficient and inaccurate,” and that “significant aspects of the research, conclusions and ratings were drawn from incomplete and out-of-date information”.

    Simich says many companies – including the six others publicly named by ANU – would be inclined to let such an event slide, but the stakes were too high. “It was a combination of a couple of thoughts. Number one was that if 1 per cent of your share register is saying that you’re ‘not socially responsible, and doing harm,’ you’re really obliged to the other 99 per cent to refute that. Number two was that if we’re looking to permit a copper project in the US, we couldn’t let that impression stay out there, because it could prejudice that.

    “But even more important was that we as a company take our ESG obligations very seriously, and we owed it to our staff and suppliers to strongly defend our ESG record,” Simich says. “We’re very passionate about our industry, we love it, we do it to the best of our ability, with the utmost of integrity and honesty, and that’s why we made a stand.” 

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