Activist hedge funds had a banner day on Feb. 7. Before the stock market opened, General Motors Corp. (GM) finally succumbed to months of pressure from billionaire Kirk Kerkorian and his Tracinda Corp. investment fund by slashing its dividend, cutting executive pay, and naming a Kerkorian adviser to the board. In the afternoon, an adviser to billionaire hedge fund manager Carl Icahn issued a 343-page paper detailing how to break up Time Warner Inc. (TWX) and release about $40 billion in shareholder value.
Boosting share prices rather than taking over underperforming companies is the name of the game, and any strategy to achieve that seems fair play. The new activists often band together and swarm all over the management. They seek new allies such as Wall Street's investment banks. Icahn, for example, signed up Lazard LLC to bolster his fight against Time Warner. And they garner support from shareholders by using savvy media campaigns and the Internet. Take William A. Ackman, founder of New York hedge fund adviser Pershing Square Capital Management LP, who was trying to force McDonald's Corp. (MCD) to restructure. On Jan. 18 he broadcast a standing-room-only PowerPoint presentation of his proposals at the Millennium Broadway Hotel in Times Square via Internet video and offered a free call-in number. Some 800 shareholders, analysts, and reporters attended or tuned in. "These were exactly the kind of people whose attention you wanted to get," says Ackman, who holds just a 4.5% stake.
Once they've got their teeth into a company, the new activists usually won't let go. "I stand up for all I'm entitled to and will accept nothing less," says Phillip Goldstein, founder of Bulldog Investors LLC, which fought a long battle to force Blair Corp. (BL), a Warren (Pa.)-based catalog retailer, to sell its $174 million portfolio of receivables. Such tenacity makes them formidable infighters. "Companies that still have a pre-Enron mentality are going to get swamped by this new activism," warns Ralph V. Whitworth of Relational Investors LLC, which has been instrumental in forcing restructurings at Waste Management (WMI) and Mattel (MAT).
The new activists are more dangerous to management than their predecessors. For starters, unlike mutual and pension fund managers, which often are trying to sell money management services to companies, the hedge funds are not tempted to pull their punches. In addition, they're so well bankrolled that they don't have to borrow money from others as the 1980s raiders did, and they can afford long-drawn-out fights with management. "With more than $1 trillion in assets controlled by hedge funds, they have credibility and capital," says Stefan Selig, global head of mergers and acquisitions at Banc of America Securities (BAC). "Companies have to take this threat seriously; the balance of power is shifting away from boards. You can't ignore them just because it's some hedge fund you never heard of."
The new tactics can produce faster results than traditional methods of pressuring managements through shareholder resolutions on the agenda at company annual meetings. For example, about a week after Ackman's audio-visual pummeling of McDonald's, the company unveiled a plan to sell 1,500 company-owned restaurants, buy back $1 billion of stock in the first quarter, and provide more financial disclosure -- all similar to the moves Ackman had called for. Last April, Blair announced it would sell its receivables portfolio -- as Bulldog wished -- at a 6% premium. Even before the transaction was done, Blair took out a loan to buy back the stakes of Bulldog and other investors at 42 a share.
NO HOLDS BARRED
That's not to say that the activists have abandoned proxy fights at annual meetings. Far from it. Hedge funds made use of last year's proxy season to do everything from pushing for a sale of the company (Siebel Systems (ORCL)) to demanding higher merger prices (MCI (VZ), Providian) to sinking deals (Mylan Labs (MYL), Johnson Controls (JCI).) They have come out swinging in 2006 as well. Hedge funds Pardus Capital Management LP and Liberation Investment Group sought additional seats on the board of Bally Total Fitness Holding Corp. (BFT). Ligand Pharmaceuticals Inc. settled a similar fight with Third Point LLC prior to its annual meeting.
In fact, the new strategies mean that such corporate battles are now year-round affairs. At any moment, an activist fund can take a position in a target company and quickly start agitating for change. The first move is often a salty open letter to management. When Icahn, who manages various Icahn Partners funds, wrote to Time Warner shareholders on Oct. 11, he let fly. "Unless this legacy of poor decision-making is fully recognized and the board is held accountable, the dismal record of mistakes and inaction will continue to the detriment of shareholders," he wrote. It was the official opening salvo in the war for the future of the company.
Activists are also recruiting new allies on Wall Street. In June, 2005, Pershing's Ackman hired Blackstone Group LP, a mergers and acquisitions advisory firm and money manager, to write a professional "fairness opinion" on the merits of his restructuring plan for fast-food chain Wendy's International Inc. (WEN). It was the first time activists had used such a tool. Wendy's adopted Ackman's proposal on July 29, just a few weeks after it received Blackstone's missive. The stock has since soared 28% to its current 58. "Wendy's did everything we asked," said Ackman. "I think this tactic will be used again."
In fact, it may have inspired Icahn to hire banker Bruce Wasserstein of Lazard to strengthen his arguments by coming up with recommendations for restructuring Time Warner. Richard Parsons, Time Warner's CEO, certainly took the threat seriously enough to hire Goldman Sachs Group (GS) and Bear Stearns (BSC) to help ward off the attack.
The activists sometimes have a far longer fight on their hands than they expect, especially if they take the battle to court. Consider the clash with Philadelphia-based Sovereign Bank (SOV). On Oct. 24, Sovereign bought Independence Community Bank (TCBC) of Brooklyn, N.Y., and financed it by selling a 19.9%, $2.4 billion minority stake of itself to Spain's Santander Bancorp (SBP). Relational Investors was Sovereign's largest shareholder and already had been fighting with the bank over governance issues, and demanding two board seats.
After the Santander deal, Relational's Whitworth asked the New York Stock Exchange to mandate a shareholder vote on the transaction. He also ran full-page ads in The Wall Street Journal, The New York Times, and The Washington Post to drum up public support. The NYSE ruled that since Santander was taking less than a 20% stake, no shareholder vote was needed. He took his case to the Securities & Exchange Commission, which, like the Office of Thrift Supervision and the Federal Reserve, has yet to rule on the deal. Each side has filed a couple of lawsuits on various issues. Sovereign's camp may have landed the ultimate legal weapon -- legislation. On Feb. 1 Pennsylvania lawmakers passed an anti-takeover bill to fight off dissidents. Institutional shareholders have lined up with Whitworth to urge Governor Edward G. Rendell to veto the measure, which he has to approve by Feb. 12.
Companies are often loath to admit that the activists do come up with eminently sensible ideas. Providing that management can save face, there's scope for the warring parties to find a mutually beneficial resolution. In the case of Blair, Bulldog and its supporters had to sign an agreement not to buy shares for five years. That suited Bulldog fine: Blair's stock had risen 70% since Bulldog started buying stock. At the same time, Blair's CEO, John E. Zawacki, got to keep his company. Even if the result was good for Blair, its managers are in no mood to say so. Says a person close to the deal: "They don't want to bring any attention to themselves again." With so many hedge fund activists swarming around, many managements can probably relate to that.
By Mara Der Hovanesian, with Nanette Byrnes in New York