Carl Icahn, unhappy with the $13.65 buyout target proposed by Michael Dell and his partnering private equity firm, has recently taken a major stake in Dell. This investment strategy, shareholder activism, has become more and more predominant in today’s financial sphere. Billionaire investors like Icahn are more frequently taking large positions in corporations and then proceeding to effect change according to their investment theses.
A Response to the Classic Agency Problem?
The “classic agency problem” sets the premises for activist investment opportunities. The dichotomy between ownership (shareholders) and control (corporate management) confirms that those in control often don’t have the owners’ best interests mind. This void creates opportunity for a financial player to step in and see this gap closed.
At its core, activist investing is when an investor takes a large stake in a corporation in order put pressure on management to make a change. Equity markets are the most popular sites of shareholder activism, but it can occur in almost any financial market including distressed debt and convertibles. The typical timeline for this strategy is short to medium term (1-3 years).
Fundamentals and Events
Activist investment theses are structured from two distinct underlying themes: fundamentals and events. Much like other value investment strategies, activist investors conduct research on the intricacies of a corporation in order to identify strategic, financial, operational, or governance inefficiencies that stand to be rectified. Such fundamental opportunities can then be realized through different actions ranging from mergers and acquisitions (M&A) to restructuring to spin-offs of specific divisions.
Events can create asymmetric risk/reward relationships. In the past, the BP oil spill, the credit crisis and even healthcare reform have presented opportunity for activist investors to see value realized.
How the process works
Once an investment thesis is developed, the activist starts to pressure the target company using a spectrum of options ranging from friendly to hostile. First, the investor will send public letters to management and then communicate with the financial community and media. If the corporation is not receptive to the proposed changes, the investor can file a 13-D statement with the Securities and Exchange Commission, stating that they have acquired a position that exceeds five percent of the outstanding shares. This filing denotes an active investment and give credibility to the investor. Next, the investor can proceed and commence litigation against corporate board members for breaching fiduciary responsibility. It also allows the corporation to obtain official internal company documents to further substantiate their thesis.
Although the aforementioned activist tactics are effective there are actions that corporations take to prevent loss of control to activist investors. Corporations can use a staggered board election method, where only a fraction of board members are up for reelection every year, meaning that the investor must win multiple board election battles.
If an investor amasses a controlling position, the board can launch a “poison pill.” This is a scheme where shareholders are given the opportunity to buy more shares at a discount, thus diluting the value of the bidder’s interest and increasing the cost of the bid. Companies also use the public media to launch an offensive against the activist investor to invalidate the activist’s intentions. Finally, corporations will resort to extensive litigation against the activist.
Icahn’s Stake in Motorola
Founded in 1928, Motorola was renowned for being a pioneer in wireless handset devices. However, in early 2000s, Motorola began to lose market share, and shares hit an 18-month low on Jan. 12th, 2007. On January 30th, Carl Icahn announced he had accumulated a 1.4 percent stake in Motorola and demanded a seat on the board, pushing management to return more cash to shareholders through a leveraged $20 billion share buyback plan. Motorola rejected his proposal and claimed that Icahn’s success as an investor wouldn’t necessarily make him a valuable addition to the board. Icahn increased his stake to 2.5 percent and began submitting proxy materials for the upcoming annual meeting in May. Later in March, after posting lower earnings and forecasts, Motorola announced an accelerated share buyback program ceding to Icahn’s proxy demands.
In May, after increasing his stake to 2.9 percent, Icahn took his proxy battle to Motorola’s annual meeting. However, he failed to secure enough votes and was not elected to the board. By the next quarter in July, Motorola posted a loss for Q2 2007 and pressure for Ed Zander, Motorola’s CEO, to exit began to build from other investors. In November, Motorola announced that Zander would step down as CEO and would be replaced by the then-current COO Greg Brown. Icahn welcomed the announcement but demanded further action and a split of the company into three parts. In retort, Motorola announced that it may spin-off its handset business. Icahn then moved to elect three people to the board. In March of 2008, now holding 6.4 percent of the stock, Icahn sued Motorola to gain access to company documents.
Two days later, Motorola announced that it would spin-off its handset business. Motorola and Icahn reached an agreement to install two of Icahn’s nominees to the board. Motorola completed the split in 2011. By August, Icahn increased his stake above 10 percent for the first time. Motorola Mobility (handset and TV businesses) began to trade publicly and Motorola Inc. changed its name to Motorola Solutions (government and business enterprises). Icahn pushed for Motorola Mobility to realize the value of its patent portfolio believing it could worth ~$4.0 Bn. In August 2011, Google announced that it would acquire Motorola Mobility for $40 per share, a 63 percent premium. Icahn’s stake in the company was valued at $1.3 billion. Finally, in February 2012, Motorola Solutions announced that it bought back the majority of Icahn’s stake for $1.2 billion and one of Icahn’s directors resigned from the board.
Activism is about playing an active role in generating catalyst events to unlock shareholder value. As observed with Motorola, activist investing is often a lengthy and drawn out process that takes place under public scrutiny and doesn’t always deliver optimal outcomes. Bloomberg News hypothesized that Icahn likely broke even on his investment with Motorola. Despite this case, activist investing remains a valid strategy, delivering a cumulative 30 percent more than the S&P 500 returned over the past eight years.