In 2013, Elliott Management Corporation became an activist investor in the Hess Corporation (NYSE: HES). The activism focused on improved governance and a reconstitution of the board of directors with the ultimate goal of creating a more focused, efficient and streamlined oil exploration and production firm. The hedge fund was successful in motivating alterations to Hess's board and expediting asset divestitures, but the energy company has suffered in subsequent years due to falling oil prices.

Elliott Management Corporation

Elliott Management is a New York-based hedge fund that was founded in 1977 by its current chief executive officer (CEO), Paul Singer. Over time, the fund has pursued numerous strategies, one of which has been activist involvement with publicly traded companies. Elliott Management has gained notoriety for its activist involvement with BMC Software and NetApp, and it also one of the holders of Argentine government bonds that played a role in the country's financial hardships in 2015. The hedge fund has more than $23 billion in assets under management (AUM).

Time Line of Activist Engagement

In January 2013, Elliott Management took a 4.5% stake in Hess Corporation. In that same month, Elliott began a strong, public critique of the oil company's corporate governance and capital allocation decisions. The hedge fund alleged that poor board composition led to a lack of oversight for company management, keeping the company from maximizing returns on the most lucrative investments. Elliot estimated that Hess share prices could be 150% higher at $126 per share. The hedge fund showed that Hess shares lagged the performance of multiple benchmarks in recent years and throughout CEO John Hess' 17-year tenure, which Elliott noted is especially remarkable due to the company's lack of exposure to North American natural gas assets.

The hedge fund advocated separating some of Hess's international assets from its Bakken shale holdings, since the latter could yield a higher return on investment (ROI). Elliott also criticized strategic and capital allocation decisions in the Bakken operations, citing distractions from less lucrative assets and a lack of energy industry experience among board members. Elliot Management suggested that the company divest its midstream and downstream operations, such as refining, storage terminals and retailing. Rather than trying to compete with the largest diversified oil companies, Elliott hoped that Hess would become a smaller pure-play exploration and production company. This would also likely result in a higher valuation multiples based on market prices for different sorts of energy companies. Further, by divesting and monetizing downstream assets, Hess could generate cash flow that could be used to pay down debt, return capital to the shareholders and pursue operations in higher-yield areas. In response, Hess confirmed its intention to divest downstream operations, noting that the process to divest had already begun in recent years. Elliott countered that these measures still indicate a lack of urgency and that the divestiture plans were not broad enough, obscuring value from shareholders.

Proxy Battle

Elliot Management unambiguously criticized the composition of the board and called for new direction. In its January 2013 letter to shareholders, Elliott highlighted low voter participation and non-insider voting history on board declassification and executive compensation. The hedge fund claimed that the current board of directors received little support from independent shareholders, while independent shareholders also voted heavily in favor of removing the staggering of director elections. Finally, executive compensation was structured to reward mediocrity rather than supreme achievement. High insider ownership and a lack of board independence allowed these factors to persist, according to the hedge fund, and new board members were required to instill accountability on the part of company management. Elliott Management nominated five new board members, naming Rodney Chase, Harvey Golub, Karl Kurz, David McManus and Mark Smith as candidates.

While Hess announced its intention to meet some of Elliott's demands, the proxy battle continued as the hedge fund dismissed these efforts, still intending to get its nominees placed on the board. The stalemate continued for several months leading up to the May 2013 shareholder meeting, with Elliott sharply rejecting an offer by Hess to bring two of the proposed five nominees onto the board. On the night before the election, the two sides were able to reach an agreement in which nine of the 14 directors were replaced. Hess supported three of Elliott's nominees in exchange for the activist's support of five new directors. The CEO and chairman roles were separated, and two of the incumbent directors under fire from Elliott were replaced. The relationship between Hess management and the activists was cooperative following the deal, with CEO John Hess remarking that he was glad the proxy battle had ended and that he was looking forward to working with Elliott Management.

Results

Following Elliott's initial letter to shareholders, Hess share prices improved. After starting the year at $54.13, the stock rose to a high of $68.95 on February 1, outpacing the Energy Select Sector SPDR exchange-traded fund (ETF) by 18 percentage points over the first month of 2013. The market reacted positively to Elliott's involvement and suggestions, though further gains relative to the benchmark were negligible in the wake of the proxy resolution. In the years following the activist engagement, Hess sold its retail operations to Marathon Petroleum and also sold or spun off midstream assets. Hess created a master limited partnership (MLP) called Hess Limited Partnership, representing interest in the storage and processing facilities associated with the Bakken operations, and the company filed for an initial public offering (IPO) of the MLP in 2014. Hess's international and domestic exploration and production activities are still conducted by a single entity as of January 2016.

Since Elliott's involvement began, Hess shares climbed as high as $101, but they have fallen to current lows below $39. Judging the effectiveness of activist engagement has been complicated by a severe and protracted depression in oil prices, and the rise and fall of Hess shares through 2014 and 2015 closely resembled that of its benchmark index. Concerns over revenue, profit generation and creditworthiness have been the primary factors driving Hess share prices lower. These problems are pervasive throughout the energy industry, especially for producers of oil and natural gas. The timing of divestitures was fortuitous for Hess, given asset price dynamics in subsequent years. Hess also has a relatively strong balance sheet due to the cash generated from asset sales, which is valuable under the difficult circumstances brought on by energy price shocks. A strong balance sheet will also provide the potential opportunity to buy assets that are temporarily cheap. Though success of the implemented strategies is difficult to ascertain, there is little doubt that Elliott Management's aggressive campaign was successful in affecting substantial change in a large firm.

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