Activist Investors: A Good Or Bad Thing?

By Glenn Curtis AAA

An activist shareholder is a large stakeholder who attempts to gain control of a company and replace its management. This generally occurs when the activist is dissatisfied with management. American billionaire investor Carl Icahn is one such example; he is known for buying large amounts of a company's stock and then pressuring the company to make significant changes to increase the stock's value.

This sounds like a good thing for shareholders, right? Well, not always. Let's take a look at the potential pros and the cons of having activist investors involved in a particular stock. (For background reading, see Nasty Shareholder Activist Battles And Why They Happened.)

The Potential Advantages to Activist Involvement

  1. Holding Feet to the Fire
    Individual shareholders generally don't have too much pull with management. That's because they may hold only a few hundred or few thousand shares, which is likely to be a relatively small percentage of the outstanding stock. However, activist investors often have more influence for several reasons.

    Because they often purchase, or have the ability to purchase, (or short) large quantities of stock, activist shareholders are powerful. They may also have a stated desire to replace the existing board. As a result, management and the board may be more willing to work with an activist. In addition, activist firms tend to garner a fair amount of press and often have a podium to air their grievances. (For more insight, see Can You Invest Like Carl Icahn?)

    The point is that activists often have the ability to hold management's feet to the fire and demand results. This in turn can make them work harder and cause them to try to find ways to enhance stakeholder value.

  2. New Faces May Mean New Ideas
    Clearly not every activist firm will bring fresh ideas to the table. However, those that do establish a large position over time often have ideas about how management should use the company's assets, improve operations or enhance shareholder value. To be clear, management may or may not be receptive to such ideas. However, the presentation of options and a dialog could end up being productive and may open doors of opportunity for the company that hadn't been there in the past.
  3. Demand For the Shares Could Perk Up
    Activists may snap up a large percentage of a company's outstanding stock in a relatively short period of time. In response, other firms and/or individuals might attempt to copy these activists by buying the stock as well in the hope of turning a tidy profit. This could push the stock price up and, by extension, benefit common shareholders.
  4. Management May Bend
    Activists can sometimes press for and/or demand certain changes from existing management. As an example, in 2006, Trian Partners pushed for fast food chain Wendy's (NYSE:WEN) to spin off its Tim Hortons (NYSE:THI) donut business as a means of increasing value. Some shareholders seemed excited by the idea, and Wendy's board reportedly decided to spin off the business. The spin off allowed Wendy's to focus more on its core business and on competing with its rivals, including Burger King (NYSE:BKC) and McDonalds (NYSE:MCD). (For more on spin offs, see Parents And Spinoffs: When To Buy And When To Sell.)

The Potential Downsides to Activist Involvement

  1. Selling Could Be an Issue
    In some cases, activists may purchase large blocks of stock. When that happens, the share price may increase. However, when the activist decides it is time to unload the shares, it may logically place a significant amount of downward pressure on the share price.
  2. Activists Look Out for Themselves
    Activist firms often try to convince existing shareholders and the media to understand and buy into their agenda, but at the end of the day, they may be looking out primarily for themselves and doing what is in their best interests. In short, it would be wise for investors (big and small) to keep this possibility in mind when listening to an activist's agenda in the press.
  3. Activists Aren't Always Right
    Right or wrong, many individuals perceive activists as being smarter than the average investor because they have extensive experience on the buy and/or sell-side. There is a belief that activists may have important industry contacts and access to solid research. However, activists aren't always right. Their timing can be off and they can (and do) lose money or become involved in situations that take an extraordinarily long time to pan out. Investors should to keep this in mind when the temptation arises to copy an activist's buying or selling.
  4. Activists May Have a Different Investment Horizon
    Activists can be a very fickle bunch. In some cases they may latch onto a position and hold it for years. In others, if it doesn't appear that they will win board seats or get the company to accept their agenda, they may bail at the drop of a hat. In short, it's important to note that activists may have a very different investment horizon from the average investor. They may also be more willing and financially able to accept a loss on the position. Again, investors who are looking to or are considering copying an activist (as some may do) might be wise to keep this in mind.

Bottom Line
Having an activist engaged in a stock you own may be a good thing or a bad thing depending upon the situation. Perhaps the most important things to understand is that sometimes activists have influence over companies that the average common shareholder would generally not have. In addition, they sometimes bring new ideas to the table that could potentially lift value and/or open doors. On the downside, they can be extremely fickle, and sometimes when it comes down to it, they may keep their financial interests above those of all others. (For related reading, take a look at Could Your Company Be A Target For Activist Investors?)

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