2015 06.11 Financial Engineering White Paper

7/23/2019 2015 06.11 Financial Engineering White Paper

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ACTIVISM REPORT

Contested Elections Resea

June 20

Dave Whissel

Director of [email protected]

+1 212 961 7506 x211

488 Madison Avenue, 23rdFl

New York, NY 100

+1 212 961 75

www.proxymosaic.c

Beware of Activists Bearing Formulas: Activist Investors

and the Success of Financial Engineering

Over the past several years, activist investors have grown considerably in

prominence and firepower. Since 2010, 15% of the members of the S&P 500 have

been the subject of an activism campaign,1 and in 2014, more activists targeted

more companies than ever before.2 Investors, attracted by the promise of strong

returns from this burgeoning asset class, have rushed in to the sector. During 2014,

activist stock holdings increased to nearly $250 billion,3and there is even more dry

powder available for future campaigns.4Despite its apparent explosion in popularity,

however, activism is hardly a new strategy. Instead, its basic tenets have shifted over

the years, to the point where there is now a fairly well-defined taxonomy5 of

activism strategies. Of these, financial engineering has been one of the most

popular.

According to Activist Insight, there have been 2,426 activist investments in North

America since 2010, more than a quarter of which have been concerned with some

kind of financial engineering. In the prototypical situation, an activist will take a

position in an underperforming company and argue that it is undervalued. This value

may be unlocked through a transaction that monetizes a portion of the companys

assets, typically via a divestiture or spin-off of a business unit. More exotictransactions, such as a sale-leaseback of a companys real estate assets or a

conversion from a C-corporation to a master limited partnership (MLP) or real estate

investment trust (REIT), are also possible.

At the other end of the spectrum, companies that have been performing well have

also found themselves in activists crosshairs. In the years following the financial

crisis, corporations had been hoarding tremendous piles of cash, making them

fodder for activists to enter the scene and advocate for that cash to be put to more

1"An Investor Calls." The Economist. The Economist, 07 Feb. 2015. Web. 05 June 2015. Available at:

http://www.economist.com/news/briefing/21642175-sometimes-ill-mannered-speculative-and-wrong-activists-

are-rampant-they-will-change-american2Black, Josh. "Editor's Foreword." Activist Investing: An Annual Review of Trends in Shareholder Activism (2015).

Available at: http://www.shareholderforum.com/access/Library/20150130_ActivistInsight-SRZ.pdf3Id.4Zagger, Zachary. "M&A Boom To Continue In 2015 With Deal-Friendly Economy." Law360. 05 June 2015.

Available at: http://www.law360.com/articles/599657/m-a-boom-to-continue-in-2015-with-deal-friendly-

economy5Levin, Michael. "A Taxonomy of Activist Investing Strategies." The Activist Investor. 05 June 2015. Available at:

http://www.theactivistinvestor.com/The_Activist_Investor/Blog/Entries/2014/6/17_A_Taxonomy_of_Activist_Stra

tegies.html


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Dave Whissel


+1 212 961 7506 x211


New York, NY 100

+1 212 961 75

www.proxymosaic.c

efficient use, such as via share buybacks or acquisitions.6The flow of cheap money

enabled by ZIRP has also fueled this phenomenon.

But amidst the proliferation of activist investing in general and its sub-strategy of

financial engineering in particular, few have stopped to ask what is, to us, an obvious

question: Do these financial engineering transactionsshare buybacks, divestitures,spin-offs, and acquisitionsactually create shareholder value like activists claim?

In many respects, there is an unbridgeable divide between activists and issuers.

Activists will claim that issuers and their management teams are too self-serving and

resistant to change; issuers will claim that activists have only short-term goals in

mind, and are hardly concerned with long-term shareholder value. However, we

believe that by looking at the data objectively, we can begin to bridge the divide. We

have examined a sample set of approximately 100 cases of activism campaigns

involving financial engineering over five years. Rather than having to rely on rhetoric,

our data-driven approach to this question can help determine whether claims of

unlocking shareholder value are just hot air, or whether activism truly does what it

says on the tin.

A Background on Financial Engineering

Financial engineering is somewhat of a pejorative term that refers to a sub-set of

activist investing that encompasses a range of strategies. There are two activist

investing taxonomies that we can use. One, posited by Michael Levin, includes

categories of social activism, governance activism, operational activism, and

financial activism.7 The second, used by Activist Insight, includes board-related

activism, balance sheet activism, business strategy activism, M&A activism, and

governance activism.

Source: Activist Insight

6Plath, Chris. Shareholder Activism: Impact on North American Corporate Sectors. Moodys Investor Service. 05

June 2015. Available at: http://www.law.harvard.edu/programs/corp_gov/activist-interventions-roundtable-2014-

materials/2014_03_shareholder-activism-impact-on-na-corporates.pdf7Levin, Michael. "A Taxonomy of Activist Investing Strategies." The Activist Investor. 05 June 2015. Available at:

http://www.theactivistinvestor.com/The_Activist_Investor/Blog/Entries/2014/6/17_A_Taxonomy_of_Activist_Stra

tegies.html

Balance SheetActivism

ShareRepurchase

Dividends

Recapitalization

Leverage

Board RelatedActivism

Gain BoardRepresentation

EliminateStaggered

Board

SeparateChair/CEO

BusinessStrategy

OperationalEfficiency

REIT/MLPConversion

Cost-Cutting

M&A Activism

Merger

Acquisition/Divestiture

Takeover

Spin-Off

GovernanceActivism

Compensation

BylawAmendments

Poison Pill


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Dave Whissel


+1 212 961 7506 x211


New York, NY 100

+1 212 961 75

www.proxymosaic.c

Broadly speaking, financial engineering activism represents a cross between purely

financial or balance sheet activism, business strategy or operational activism, and

M&A activism. Specifically, financial engineering activism deals with activist

campaigns where the primary goal of the shareholder is to pursue one of the

following:

Dividends Share

repurchases

Capital

restructuring

(e.g., increasing

leverage)

Acquisitions Divestitures Spin-offs

REIT/MLP

conversion

Pursue sale to

third party (e.g.,

private equity

buyout)

Mergers

Overall, financial engineering strategies are used in approximately half of all North

American activism campaigns. The reasons for the popularity of financial

engineering strategies within activism are manifold, but boil down to several factors

at both the macro and micro levels.


First, the return of a robust M&A market following the financial crisis has meant that

there are more opportunities available for activists to push for strategic acquisitions,

divestitures, or mergers.8

Second, many corporations have large piles of cash on hand that need to be put to

work.9With companies still somewhat reluctant to invest heavily in R&D and organic

growth, activists have sought to use that cash to fuel buybacks, dividends, or

8Black, Josh. "Editor's Foreword." Activist Investing: An Annual Review of Trends in Shareholder Activism (2015).9Plath, Chris. Shareholder Activism: Impact on NorthAmerican Corporate Sectors. Moodys Investor Service. 05

June 2015. Available at: http://www.law.harvard.edu/programs/corp_gov/activist-interventions-roundtable-2014-

materials/2014_03_shareholder-activism-impact-on-na-corporates.pdf

Activism Campaign Strategies

Balance Sheet Activism

Board Related Activism

Business Strategy

M&A Activism

Other

Other Governance

Remuneration


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www.proxymosaic.c

strategic acquisitions. Perhaps not surprisingly, this feature has made the cash-rich

technology sector a notable activist hunting ground.10

Third, the relative success of spin-off strategies have emboldened other activists to

try to replicate these and other financial engineering campaigns at a broader array

of companies. A report by Deloitte and Edge Consulting highlights the fact that theaverage TSR of parent companies one year after a spin-off is approximately 14%,

besting the S&P 500 over the same time period.11This figure rises to nearly 30% two

years after the break-up.12

With respect to real estate-related activism, such as REIT conversions and sale-

leasebacks, much of the popularity has been driven by the recovery of the real estate

market as a whole, which has restored lofty funds from operations (FFO) multiples

that provide for attractive monetization opportunities.13 And, the acceptance of

REITs as total-return vehicle for the masses14has meant that REIT conversions are

gaining traction among activists looking to unlock value through more exotic means.

Additionally, there are numerous other secondary factors such as the relative

strength of the dollar and tax reforms relating to inversions that have further

driven a rush of M&A activity, often at the behest of activists.

At the micro level, it is important to keep in mind that while many activist hedge

fund managers may lack the sort of operational experience that can form the basis

for a campaign centered on business strategy, they often find financial engineering

well within their zone of competency.15Portfolio managers are far more comfortable

building financial models that show the accretive impact of spin-offs than they would

be, for example, waiting tables to get a better understanding of the operating side

of the business.16

A recent study by FTI Consulting found that nearly 90% of those polled expected

financial engineering activism in general to continue to increase,17and a report by

Alliance Advisors suggests that, over the past few years, capital allocation (i.e., share

buybacks and dividends) and restructuring (i.e., asset sales and spin-offs) have

become the key issues in activism campaigns.18 But while the fundamental

10Id.11Black, Will. "Value of Companies Globally Undertaking Spinoffs to Hit US $664 Billion for 2014." Deloitte LLP. 05

June 2015. Available at: http://www2.deloitte.com/uk/en/pages/press-releases/articles/value-of-companies-

globally-undertaking-spinoffs-to-increase.html12Id.13Black, Josh. "Editor's Foreword." Activist Investing: An Annual Review of Trends in Shareholder Activism (2015).14Buller, Steven. REIT Stocks: An Underutilized Portfolio Diversifier. Fidelity Investments. 05 June 2015. Available

at: https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/REIT%20Stocks%20-

%20An%20Underutilized%20Portfolio%20Diversifier_Fidelity.pdf15Klingsberg, Ethan. Risks and Opportunities of Hedge Fund Activism. Cleary Gottlied Steen & Hamilton. 05 June

2015. Available at: http://www.clearymawatch.com/wp-content/uploads/sites/506/2015/04/1505Klingsberg.pdf16Giammona, Craig. Olive Gardens Hedge Fund Bosses Waited Tables to Aid Turnaround. Bloomberg LP. 05

June 2015. Available at: http://www.bloomberg.com/news/articles/2015-06-01/olive-garden-s-hedge-fund-

bosses-waited-tables-to-aid-turnaround17Balet, Steven. The Shareholder Activists View: M&A Activism to Rise in 2014. FTI Consulting. 05 June 2015.

Available at: http://www.fticonsulting.com/global2/media/collateral/united-states/shareholder-activism-views-

2014.pdf18Westcott, Shirley. Dealing with Evolving Activist Investor Strategies. Alliance Advisors, LLC. 05 June 2015.

Available at: http://allianceadvisorsllc.com/wp-content/uploads/2014/03/Alliance-Advisors-March-12-2014-

Webinar-Deck.pdf


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Dave Whissel


+1 212 961 7506 x211


New York, NY 100

+1 212 961 75

www.proxymosaic.c

conditions at the macro and micro levels support this kind of activism, many of these

recent reports and analyses have ignored a more fundamental question: Does

financial engineering actually create long-term value for shareholders, as activists

might claim?

Unlocking Value: eality or hetoric?

To answer this question, we used Activist Insights comprehensive database to

derive a sample set of 100 discrete instances over the past ten years where financial

engineering was one of the primary objectives of the activist, and where the activist

was successful in achieving this objective. We excluded financial engineering

situations where the corporate parent company did not survive (i.e., takeovers and

private equity buy-outs) as well as situations where the focus was on securing

dividends. We initially included situations in which the activist pushed for a merger

in our sample set, but ultimately excluded these situations from our analysis because

there were not enough discrete instances to make the data meaningful. We were

left we four broad activist objectivesacquisitions, share buybacks, divestitures, andspin-offs.

Buybacks were the most common objective of activists in our sample set,

representing about half of all campaigns. Acquisitions were the least common of the

four objectives.

Our data also revealed some interesting features about the activists themselves. As

one might expect, the big names dominated our list, with JANA Partners, Starboard

Value, and Blue Harbour occupying the top three slots in terms of number of

financial engineering campaigns. They were followed by other heavyweights such as

Relational Investors, Elliott Management, Third Point, Pershing Square, and Carl

Icahn. But the frequency of campaigns had little to do with performance, with some

of the most active players specifically Third Point and Elliott also among the

worst-performing.

Number of Campaigns

Acquisitions Buybacks Divestitures Spin-Offs


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Dave Whissel


+1 212 961 7506 x211


New York, NY 100

+1 212 961 75

www.proxymosaic.c

To assess whether financial engineering campaigns have actually created

shareholder value, we focused on two primary metrics: TSR and EPS. We measured

TSR over three primary time periods: during the 60-day window surrounding an

announcement, one year after an announcement, and from the announcement to

the present. With respect to EPS, we took the TTM EPS prior to the announcement

and compared it to the TTM EPS one year after the announcement. In addition to

looking at absolute TSR, we also looked at returns relative to the S&P 500, which

serves as an appropriate benchmark.

Overall, our data suggests that these types of financial engineering campaigns,

broadly speaking, do in fact unlock shareholder value, with one (highly important)

caveat. Across each of our four financial engineering verticals, the average TSR since

the announcement date has been more than 25%. Here, the fact that the average

TSR in these situations has been less than 1% on the announcement date and only

about 5% during the 60-day window around the announcement date suggests that

the value created during these campaigns goes beyond an initial short-term pop

in the target companys stock price. Instead, the fact that the average TSR is nearly

20% one year after the announcement and continues to rise past 25% past the one-

year mark indicates that the unlocked value is reasonably sustainable, which should

please institutional shareholders.

However, our results do not suggest that financial engineering transactions are

universally accretive to shareholder value. Instead, the data indicates that certain

types of financial engineering are considerably more successful than others. On

average, acquisitions have been the least successful of our four types of financial

engineering, with an average TSR since the announcement of -3.56%. The three

other strategies, are generally value-accretive. Buybacks, divestitures, and spin-offs

all have an average TSR since the announcement of more than 15%, with spin-offs

generating more than 50% TSR.

0%

5%

10%

15%

20%

25%

30%

TSR 1 Year After

Announcement

TSR On Announcement

Date

TSR During 60-Day

Window

TSR to Present

Average TSR - All Financial Engineering Campaigns


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Dave Whissel


+1 212 961 7506 x211


New York, NY 100

+1 212 961 75

www.proxymosaic.c

Interestingly, about half of the campaigns where the activist pushes for strategic

acquisitions have resulted in the destruction of shareholder value. This may suggest

that, although activists today are more operationally savvy than ever, management

teams are still in a much better position to assess the benefits of strategic

acquisitions. This is the clearest indication from our data that there are still certain

areas that lie beyond activists core competencies.

These results are reversed when looking at median returns over the 60-day window

surrounding an announcement. In that case, acquisitions seem to be well-received

by the markets, with a median TSR of more than 3%double that of the next-closest

strategy. Spin-offs have the lowest median TSR over the very short-term, which

should perhaps be expected given that the financial benefits of that particular

strategy (e.g., the re-rating of the Parent and SpinCo with higher multiples) take

longer to play out.

-10%

0%

10%

20%

30%

40%

50%

60%


Average TSR Since Announcement

0%

10%

20%

30%

40%

50%

60%


% Negative TSR Since Announcement


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+1 212 961 7506 x211


New York, NY 100

+1 212 961 75

www.proxymosaic.c

However, whereas financial engineering strategies have been largely conducive to

shareholder value in terms of TSR, these same strategies have often been dilutive to

shareholder value in terms of EPS. Of the four types of financial engineering we

examine, only onedivestitureshas produced positive median EPS growth. With

respect to the other three strategies, median EPS growth is slightly negative.

Interestingly, campaigns centered on buybacks have not been especially productive

in terms of growing EPS; which seems counterintuitive given the positive benefits of

decreasing the share count. It could be that the benefits to EPS produced by this

strategy are largely short-lived if the target company does not substantially alter its

operating efficiency.

Predictably, less than a third of spin-offs are actually accretive to EPS, which makes

sense given that the surviving parent company is left with a smaller earnings base

following the spin; for divestitures, this figure rises to about 60%.

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%2.5%

3.0%

3.5%


Median TSR During 60-Day Window

-15%

-10%

-5%

0%

5%

10%

15%


Median EPS Growth


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+1 212 961 7506 x211


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www.proxymosaic.c

Once again, we note that campaigns focused on pushing for strategic acquisitions

have been largely ineffective at creating longer-term shareholder value, and that

divestituresaddition by subtraction have been comparatively more successful.

Finally, it is important to note that, while our data indicates that financial

engineering activism does create value on an absolute basis, there is no evidence

that shareholders of these companies are necessarily better off than they would

have been had the activism never occurred. The median TSR of all types of financial

engineering trails the S&P 500 over a one-year time period and since the transaction

announcement.

Overall, financial engineering situations have trailed the S&P 500 since the

transaction announcement nearly 60% of the time. And while this paints financial

engineering with a fairly broad brush, we note that only one of these strategies

spin-offs has beaten the S&P 500 since the transaction announcement. As

mentioned above, the fact that acquisitions have fared so poorly reinforces the idea

0%

10%

20%

30%

40%

50%

60%

70%


% EPS Accretive

0%

5%

10%

15%

20%

25%

30%

TSR Since Announcement TSR 1 Year After Announcement

Median TSR

Financial Engineering Situations S&P 500


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+1 212 961 7506 x211


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+1 212 961 75

www.proxymosaic.c

that management teams (rather than activists) are likely best-suited to make those

types of high-level capital allocation decisions.

Conclusion

While we are hesitant to draw broad-based conclusions from a sample set of 100,

there are several interesting takeaways from the data. First, when examining the

merits of an activists campaign, the type of financial engineering matters.

Acquisitions have typically been dilutive to shareholder value over the long-term,

while spin-offs have generated strongly positive returns; this suggests that

shareholders should examine activist campaigns that push for strategic acquisitions

with a good deal of scrutiny.

Second, while managers like BlackRock CEO Laurence Fink may rail against the

short-termism inherent in activism,19 our data suggests that these kinds of

transactions may actually have moderate longer-term benefits to shareholders. The

short-term initial pop around the announcement of these transactions is minimal

compared to the value that is created in the next year and beyond.

Lastly, our data comes with an important caveat: Given the fact that shareholder

returns in financial situations typically trailed the S&P 500 over the same time

period, shareholders have legitimate reason to be wary of activists that advocate for

financial engineering transactions such as share repurchases, divestitures, and spin-

offs. The results from our sample set suggest that financial engineering has been a

valid and productive strategy on an absolute basis, but it is not clear that

shareholders are actually any better off after the activist intervention. In fact, our

data suggests that shareholders in activist-targeted companies may actually be

better-served by selling their shares in these troubled companies and following

19Sorkin, Andrew Ross. BlackRocks Chief, Laurence Fink, Urges Other C.E.O.s to Stop Being So Nice to Investors.

The New York Times. 05 June 2015. Available at:

http://www.nytimes.com/2015/04/14/business/dealbook/blackrocks-chief-laurence-fink-urges-other-ceos-to-

stop-being-so-nice-to-investors.html

48%

33%

40%36%

-4%

30%

18%

51%

-10%

0%

10%

20%

30%

40%

50%

60%


Average TSR Since Announcement

S&P 500 Activist Investments


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+1 212 961 7506 x211


New York, NY 100

+1 212 961 75

www.proxymosaic.c

Jeffrey Sonnenfelds advice by investing in broad index mutual funds.20While we

admit that the goal of most activist hedge funds is to achieve absolute, uncorrelated

returns, this is a troubling conclusion for those that claim that activism is generally a

force for good.

Ultimately, our message for shareholders is a simple one: In assessing the merits ofa particular activism campaign, shareholders should not assume that the

consequences will be positive, or even that the interests of activists are wholly

aligned with the shareholders they purport to serve. Instead, each activist campaign

deserves and requires a careful and thorough assessment of all the relevant facts.

Our data demonstrates that not all types of activism, and indeed, not all activists,

are necessarily equally adept at creating shareholder value. Some may be largely

beneficial, but others merit additional scrutiny.

20Sonnenfeld, Jeffrey. Activist Shareholders, Sluggish Performance. The Wall Street

Journal. 09 June 2015. Available at: http://www.wsj.com/articles/jeffrey-sonnenfeld-

activist-shareholders-sluggish-performance-1427929984


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+1 212 961 7506 x211


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+1 212 961 75

www.proxymosaic.c

Appendix: Sample Set and Aggregate Data


0 1 2 3 4 5 6 7 8 9 10

Livermore Partners

Luxor Capital Group

Audley Capital

Marcato Capital Management

California State Teachers' Retirement System

Meruelo Investment Partners

Engine Capital LP

Paulson & Co

Harbinger Capital Partners

Raging Capital Management

Kettle Hill Capital

Riley Investment Management

Western Investment

SpringOwl Asset Management

Carlson Capital

Steel Partners Holdings L.P.

Harry Wilson

The D3 Family Funds

Bulldog Investors

Third Avenue Management LLCAltai Capital Management

Trian Fund Management

Greenlight Capital, Inc.

Voce Capital Management

Lawrence Seidman

Eminence Capital

Engaged Capital

FrontFour Capital Group

Atlantic Investment Management

ValueAct Capital Partners

Clinton Group

Barington Capital Group

Corvex Management LP

Sandell Asset Management

Pershing Square Capital Management

Carl Icahn

Third Point Partners

Orange Capital LLC

Elliott Management

Relational Investors

Stilwell Value LLC

Blue Harbour Group

Starboard Value

JANA Partners

Number of Financial Engineering Campaigns in

Sample Set


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-100% -50% 0% 50% 100% 150% 200% 250% 300%

Kettle Hill Capital

Clinton Group

FrontFour Capital Group

Paulson & Co

Trian Fund Management

Marcato Capital Management

Voce Capital Management

Greenlight Capital, Inc.

Stilwell Value LLC

Bulldog Investors

Starboard Value

Pershing Square Capital Management

Harbinger Capital Partners

ValueAct Capital Partners

Carl Icahn

Orange Capital LLC

JANA Partners

Blue Harbour Group

Western Investment

Sandell Asset Management

Lawrence Seidman

Corvex Management LP

California State Teachers' Retirement System

Relational Investors

Engine Capital LP

Atlantic Investment Management

Elliott Management

Steel Partners Holdings L.P.

Third Point Partners

Raging Capital Management

Altai Capital Management

The D3 Family Funds

Engaged Capital

Audley Capital

Average TSR One Year After Announcement


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0 20 40 60 80 100 120 140 160 180

Adopt Majority Vote Standard

Amend Bylaw

Board Independence

Business Focus

Business Restructuring

Cancel Contract

Change Board Composition

Closure of Business Unit

Dividends

Elect Director

Eliminate Staggered Board

Equity Issuance

Excess Cash

Focus on Growth Strategies

General Cost Cutting

Lack of/Inaccurate information from Company

Nepotism

Operational Efficiency

Oppose acquisition of third party

Oppose Equity Issuance

Oppose merger

Oppose Proxy Contest

Oppose takeover terms

Oppose Terms of Merger

Push for acquisition of third party

Push for Company Division

Push for Merger of Company with third Party

Push for Sale of Company to third Party

Push for/Oppose merging of shares

Recapitalization

Redemption/Amendment of Poison PillREIT / MLP Conversion

Removal of CEO or other Board member

Remuneration

Replace Auditor

Replace Management

Restructure Debt

Return Cash to Shareholders

Sell/Retain Assets

Separate Chairman & CEO

Share Repurchase

Spin-off/sale of business division

Succession Planning

Takeover Company

Use Universal Ballot

Frequency of Activist Objectives Over Past 10 Years

(excl. Board Representation)

2015 06.11 Financial Engineering White Paper

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