| Small & micro cap project / Activism insight

Thoughts on academic studies on activism: Activists are not Ben-Hur heroes

 

by | Dec 15, 2019

The Debate

Quite often, someone publishes an article or study that analyses the performance of shareholder activists.

There are multiple studies on activism, but differing conclusions. Some studies conclude that activists have little impact on improving performance, whereas other studies conclude that activism helps to improve returns.

So, which is correct?

Assumption #1 Activists have power to influence the company

Let’s consider a hypothetical situation: A group of students are given a nail and a hammer. Each is given a different object and the task is to hammer a nail into the object. The objects are as follows: hard wood, plywood, brick, concrete and rock.

Is it fair to measure the outcome of the test?

Similarly, by including all activist situations, the researchers automatically assume that all activists have an “equal” level of power in influencing all the companies targeted, and it is fair to assess how the activists performed as a group. Similar to rock and concrete in the above example, companies with higher insider ownership and tough by-law provisions are extremely hard to deal with. Moreover, even a board membership doesn’t guarantee any significant influence on the company’s strategy.

Case study: Bandera Partners

In 2019, Jeff Gramm lost the election at Luby’s Inc. The company’s management won primarily due to their ownership – insiders own 40%. Moreover, 68% of shareholders (excluding insiders) overwhelming voted for Jeff Gramm. To read more about the analysis of the proxy outcome, click here.

Given the fact that insiders own 40%, it is hard to win the election. So, why did Mr. Gramm launch a costly proxy campaign, funded from his pocket?

Jeff Gramm did not launch a proxy campaign just because the company had one terrible quarter, and neither did he see an opportunity to make quick money. He has been a shareholder of Luby Inc. for more than a decade, and he got fed up with the consistent 5-year decline in the stock price.

What were his choices before the proxy campaign?

a) Continue to have a ‘hope strategy’, that one day the stock price would eventually increase.

b) Sell the stock at a loss.

c) Even though the odds of winning a proxy fight are terribly low, fight and make a serious attempt to bring about changes.

Jeff chose (c).

There are two possible outcomes: a) The board and management get a clear message that the problems flagged by Jeff Gramm should be addressed, and they take action; b) The management team continues to run the show ‘as usual’ and poor performance continues.

Jeff Gramm is not able to influence either of these outcomes.  In fact, he doesn’t have a single board seat to voice his opinion. He gave it his best shot.

The Luby situation is pretty much like a student being given a rock and asked to hammer a nail into it. Now, ask yourself; it is fair to judge Jeff Gramm’s effort?

Assumption #2: All activists are the same

You can broadly group activists into three categories-

(a) Long time shareholders who are upset with the incumbent board/management.

(b) Shareholders who buy a stake with the intention to use activism to unlock value.

(c) Others: Those who don’t fall under (a) or (b). Typical 13D filers include a former CEO who was terminated, a company that tries to acquire a target company, etc.

From a track-record perspective, some activist investors have a long history and most filers are “first time” filers.

On the top of this, some are “hit and run” activists. On a few occasions, some activists have accepted the company’s offer to buy their shares at a premium, a deal that is not available to other shareholders.

Unfortunately, most studies assume that all activists are the same. In order for a study to be effective, the samples should undergo some filtration process. Unfortunately, as soon as some have filed a 13D, the studies include it – a very poor admission criteria.

Wrong question and unfair conclusion

PayScale, a Seattle-based compensation data software company, surveys institutions that grant bachelor and associate degrees. They study how much alumni earn after graduation and how much it costs to finish the degree.

The objective of the PayScale report is not to determine whether or not a college degree is useful, but rather to give insights into the potential for students to make informed decisions.

Unfortunately, the studies/articles on activism try to conclude whether or not activism is useful – the study analyzes the “collective” return of activist investors and expresses an opinion on the entire activism space. From an investing point of view, this doesn’t make any sense.

A recent academic study explained why value investing generally fails. I was curious as to how they measured the performance of a strategy. The study relied heavily on book value and P/E ratios. I have never believed that value investing means a low P/E.

Final note

Many investors run several screens to narrow down the list – negative EV, stocks owned by value investors, stocks trading near 52-week lows, etc. No one believes that “all” the companies on the screen are investible. The screen helps to narrow down stocks.

It is wise to take a similar view with activist investing.

The discovery of truth is prevented more effectively, not by the false appearance things present and which mislead into error, not directly by weakness of the reasoning powers, but by preconceived opinion, by prejudice. – Arthur Schopenhauer.

The problem with opinions and studies of activism is that investors develop some sort of preconceived notion over a period of time. This can result in lost opportunities for investors.

As Buffet puts it, “The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot.”

Each 13D filing is a pitch. There is no reason to react to every pitch.

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