A proxy vote is a vote cast by an entity or person on behalf of another. As many shareholders find it difficult to physically attend a company’s annual general meeting or other meetings, the company permits them to vote on certain issues - such as electing directors to its board or approving an acquisition - through proxy votes. Proxy votes thus become invaluable instruments when radical change is sought to be effected in a company, because such change is quite likely to be resisted by the incumbent directors.
This sets the stage for a proxy fight wherein the current directors and management are pitted against the group trying to usher in change. While it is also known as a proxy contest, the term “proxy fight” may be more appropriate in light of the Machiavellian tactics occasionally employed by both sides. Regardless of what one calls it, investors would be well served to stay abreast of proxy fights, since they can often have a significant bearing on a company’s stock price.
Parties in a proxy fight
The contestant on one side of a proxy fight is always fixed - a company’s incumbent directors and management. The contestant on the other side of the ring is generally one of the following:
- Dissident shareholders: Disgruntled shareholders in a company who are dissatisfied by a corporate governance issue or other concern such as excessive executive compensation may attempt to stage a revolt by banding together and trying to replace some or all of the company’s directors. But these efforts are seldom successful unless the dissidents win support from major shareholders in the company.
- Activist shareholders: This group has attracted a great deal of attention in the present decade, thanks to proxy fights involving a number of high-profile companies in the U.S. and Canada. U.S. activist funds grew faster than the broad hedge fund industry in 2013, with total assets at the end of the third quarter up 36% year-over-year to a record $89 billion. In Canada, a January 2013 study found that proxy contests had increased 84% in the five-year period from 2008 to 2012; the number of contests focused solely on changing the board of directors almost doubled over this period.
- Acquiring companies: In the case of a hostile takeover, if the target company’s board steadfastly rebuffs the acquirer’s overtures, the latter may decide to engage in a proxy fight so as to force the target to acquiesce to its proposal.
Objectives and Tactics
Since the recent increase in proxy fights has largely been driven by activist shareholders, let’s look at some of their objectives and tactics.
Typical objectives of activist shareholders include the following:
- Management change: A classic example of this objective is the 2012 proxy battle waged by Bill Ackman’s Pershing Square against Canadian Pacific, the second-largest Canadian railroad that was facing operational challenges at the time. Pershing Square won the proxy fight in mid-2012, and promptly ousted a number of Canadian Pacific’s directors and replaced its CEO with legendary railroad executive Hunter Harrison. Harrison executed a remarkable turnaround at Canadian Pacific in 2013, as a result of which the stock was one of the best performers on the blue-chip Canadian TSX-60 index that year.
- Spin-off: This is another favorite objective of activist shareholders, who believe a spin-off of certain assets will unlock a company’s value. An example is provided by Jana Partners’ attempt to shake things up at Canadian fertilizer major Agrium in 2013. Jana had accumulated a stake in Agrium that made it the company’s biggest shareholder by mid-2012. Jana then proposed that Agrium split its fertilizer production operations from its farm products retail unit, a proposal that was rejected by Agrium’s board. Jana lost its nearly year-long proxy fight after it could only get two of its nominees elected to Agrium’s board, instead of the five it had sought. A more recent example is the proxy fight that Carl Icahn has said he will undertake if required to win two seats on eBay’s board of directors. In January 2014, Icahn accumulated a 0.82% stake in eBay and released a proposal for a spin-off of the company’s PayPal unit.
- Return cash to shareholders: Activist shareholders sometimes get involved with a cash-rich company to prod it to distribute some of its cash hoard to investors. In April 2013, Apple raised its quarterly dividend by 15% and boosted its share buyback program by six-fold to $60 billion, amid increasing pressure from hedge fund manager David Einhorn - who owned 1.3 million Apple shares as of end-2012 - and other large shareholders to return cash to its investors. Carl Icahn - who had a $3.6 billion stake in Apple - also urged Apple to buy back $50 billion of its shares, but dropped this proposal in February 2014 after the company came close to this target with $40 billion in repurchases over the preceding year.
A favored tactic of an activist shareholder is to amass a stake in a target company, and then announce its shareholding with a great deal of fanfare. The announcement sometimes also contains details of the activist shareholder’s plan to unlock value or drive change at the target company, and often states its intention to engage in a proxy fight if required.
This highly visible drawing up of battle lines between the activist shareholder and a company’s existing management often makes front-page news, and increases investor interest in the stock. While the stock may often surge on the news of an activist investor’s involvement, these gains are not sustainable in all cases, with subsequent moves influenced by the company’s fundamentals more than anything else.
How can an investor benefit?
Activist shareholders are some of the smartest investors around, and their involvement with a company is a strong signal of their belief that the stock is undervalued. While the monetary value of their stake in a company is proof that they are putting their money where their mouth is, their willingness to engage in a proxy fight is a concrete indication of the courage of their convictions, i.e. they are willing to go the distance to drive positive change.
Although the participation of activist shareholders cannot and should not be the only yardstick for measuring the attractiveness of an investment, it is a definite plus point. Apart from pressuring management to take measures to improve efficiency and drive value, activist shareholders can also urge the company to follow sound corporate governance policies.
While a proxy fight that is resolved quickly may benefit shareholders, a nasty and long-run proxy battle is in no one’s best interests, as it distracts management and may lead to less than optimal operating performance for the company.
Investors can stay tuned to the investments made by activist shareholders with the best long-term record by scouring their regulatory filings. These include the Schedule 13D in the U.S. - which must be filed with the SEC within 10 days by anyone who acquires more than 5% of any class of securities of a publicly traded company - and the “early warning” report in Canada, which has to be filed if an entity acquires more than 10% of any class of equity or voting securities of a company.
The Bottom Line
Activist shareholders are not always successful in winning proxy fights, and even if they do, the target company does not always flourish. In August 2013, Bill Ackman’s Pershing Square sold its entire 18% stake in struggling retailer J.C. Penney, after failing to turn it around; Pershing lost an estimated $700 million on the investment, according to unconfirmed reports. Despite Ackman’s many winners over the years, this was his third failure in the retail space, after previous failed investments with Borders Group and Target. The moral of the story is that while the involvement of an activist investor and the subsequent proxy fight may improve the chances of a stock’s success, as with any other investment, profits are not guaranteed.