Starboard's 100 percent replacement of Darden
Restaurants' board is a landmark activist event. Never before
has any board been wholly thrown out of office absent a fundamental
financial or operational meltdown. There is little doubt this will
embolden activists, and likely stimulate one-upmanship among
Starboard competitors. In fact, one can credibly argue that
activists were emboldened even before the outcome of the Darden
imbroglio was known. Following Labor Day, an abnormally high number
of companies across all spheres of size and success received
private overtures from activists. Many of these requests contained
the same essential message: Undertake to return cash to your
shareholders right away, or break up your company or we will take
our message public. The timing of this type of request—and
the embedded threat—is that if the company fails to respond,
the activist has plenty of time to present a competing slate of
directors before the target's next annual meeting.
More fundamentally, activism has become a major, permanent
investment asset class, and activists no longer target only
underperforming or mid-cap companies. In fact, it is not hyperbole
to say that almost any company is a potential activist target
today.
And so, in all meaningful respects, the annual meeting season has
already begun.
The question is, what to do now?
The Darden situation is not alone in teaching that the
conventional holy war defensive playbook is ineffective and out of
touch. Instead, a more nuanced approach can often be orderly,
constructive, and even insightful. Here is our perspective on
pursuing a more thoughtful approach:
First and foremost, know thyself. You and your
advisors should spend real time looking at your company through
activists' eyes. It has been said that activists are
"value investors on steroids," ruthlessly economically
rational. (They have egos, too.) Assess your company against its
peers, and then assess it in isolation. Have you truly achieved
organic growth? Has your capital investment strategy paid off as
expected? Are you fully putting your balance sheet to work? Once
you've done this, schedule time—lots of it—with
your board. More on this later.
Second, take a fresh look at how you present your
company. Does your road show stump speech really precisely
reflect your company and its opportunities, or has it become rote?
Do your disclosures do your company justice? Most critically, are
you taking on key activist themes—most importantly, smart
capital allocation?
Third, cultivate the right shareholders. There
are two important points here: that you do in fact cultivate, and
that you should be clear-eyed and plainspoken about who
should be your shareholders. Reach out to your
shareholders, and not just at the IR level. Senior-most management
and, in the right circumstances, board leaders should spend quality
time with your most significant shareholders before you
ask for their vote. Don't let your lawyers thwart prudent
engagement by reflexively pulling out the Regulation FD yellow
card; it is not a barrier to engagement, and particularly not a
barrier to actually listening. Also, if someone has entered your
stock with an investment theory that doesn't fit, you should
say so. Over time, you can influence who's invested in your
company.
Fourth, eliminate governance issues that invite unwelcome
scrutiny. If you have underperforming directors (low
meeting attendance, long tenure, underwhelming
résumés) or governance practices that are outdated,
clean them up. Any perceived governance "foot faults"
will be used by activists, with the support of proxy advisory
firms, to gain traction on the theme that your board just
doesn't get it. This does not mean that you should immediately
embark on dismantling every defensive measure you have in place,
but it does mean you should retain only those as to which you have
a principled—and recently assessed—view.
Fifth, maintain a pool of well-qualified, independent, and
available potential director candidates. This is hard.
However, our experience has been that when an activist comes
calling seeking board change, companies often can achieve a private
resolution by not only considering the activist's candidates on
the merits, but also by creating a successful compromise that
includes one or more of its own new director candidates. Activists
want change, and may be agnostic about who embodies that change, as
long as it is scored as a win for them. It is important to note
here that activists have substantially lifted their game in terms
of the caliber of board candidates they nominate. (Witness the
Darden slate—the dissident nominees had credible senior-level
industry experience, as well as significant diversity.) Often,
activist candidates who hail from the corporate world prove to be
hardworking, properly motivated directors and even committee chairs
at the invitation of their fellow board members. But again, just in
case activists nominate candidates who are of a lesser caliber or a
wrong "fit" with your board, you should be prepared to
counter with a few names of your own.
Last, and most important, actively engage with your board
on activism. There is, of course, a meaningful risk that a
divide will open up between management and the board in an activist
situation because the board will inevitably feel that it is, or is
likely to become, a target at the very time that it is important
that management and the board work together for the long-term
benefit of the company. Management has to be mindful of this and be
responsive to director requests but, most important, have laid the
foundation so that the board is not thinking through how to respond
after the activist has shown up. That's too late. Open dialogue
and the introduction of PR and other appropriate advisors to the
board are critical to avoiding an urge that directors need to take
control of the situation.
When the activist reaches out, remember the adage "Kings to
Kings." Do not poke the activist in the eye with a sharp
stick, as it will have the expected reaction. This is the ego point
already mentioned. Instead, implement a cordial but escalating
series of interactions: IR to analyst, CFO to managing director,
CEO to principal. There are, or should be, no hard and fast rules
regarding meetings with board members, other than that they are not
casual events. Ideally, they should be used to bring to closure any
preliminary agreements between the activist and the company. In any
event, all of these meetings should be characterized by ample
preparation, good listening, and a lack of defensiveness.
Moreover, we urge companies to use caution and restraint when
considering activists' requests to appoint new board members,
return cash to shareholders, or take other significant actions. We
agree with the statements made by Ken Moelis, whose advisory firm
has represented both activists and targeted companies, in that some
companies may be acting too hastily in acceding to activists'
demands, which demands may be buttressed by premature or
ill-considered advice from investment bankers. But that only works
if other steps of a type outlined above have been taken.
We may decry the short-termism inherent in the activism worldview,
but the reality is that the market has spoken. Activist investors
are here to stay. They have lifted their game. It is time for
Corporate America to do the same.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
