Q&A: Shareholder Activism and M&A Deals in the Current Market

As the economy continues to crumble month after month, financial decisions made by U.S. companies are increasingly being met with greater scrutiny by shareholders, consumers, and the media. With the collapse of banks and lenders, more mergers and acquisitions falter one by one.

Page Davidson, a member of the Transactional Corporate and Securities Practice of the Nashville-based firm Bass Berry & Sims PLC, focuses his practice on mergers and acquisitions as well as a variety of other corporate and securities matters. He counsels private and public companies on how to control and leverage shareholder relationships to better ensure successful transactions.

In this interview, Mr. Davidson discusses the increased role that shareholder activists play in M&A deals, how corporate counsel can develop a productive working relationship with shareholder activists, and the current marketplace forces that have led to a chain of failed deals.

Q.: How have activist shareholders increased their influence on public companies? What tactics have they developed to do so?

A.: Shareholder activists are indeed exerting a greater influence on the strategic and operational direction of public companies. For example, pension and hedge funds often operate under relatively short time horizons during which they have to fund their obligations or deliver returns to investors. As a result, they often advocate transactions that can produce a quick increase in the stock price or a return to shareholders in a short amount of time.

Recapitalizations, special dividends and share repurchases are often part of the discussion. In some instances, activists take the view that a sale of the whole company is the best course of action. Activists have, in fact, developed an entire arsenal of pressure tactics. It frequently starts with corporate governance. In recent years, activists have utilized the shareholder proposal process to get many public companies to implement a majority-vote standard for director elections. And they have also used this process to force companies to declassify their boards of directors, so that the entire board comes up for election every year.

At the same time, the SEC's e-proxy rules and the Internet generally have made it easier for activists to wage media campaigns and build a consensus against incumbent management. The result is an environment where a takeover of the company's board of directors can occur much more easily than in the past.

Often, activists initially approach the company's management privately, before they have reached the 5% ownership trigger for reporting their investment with the SEC. If the activists don't think that these private discussions have been productive, they will “go public” by stating their criticisms of management in open letters to the SEC, attacking executive compensation as exorbitant, pushing shareholder proposals, and waging proxy fights to get representation on the board.

Q.: What are the best practices that in-house counsel can follow to cultivate a productive, positive relationship with activist shareholders? What would such a relationship look like?

A.: In-house counsel's job is to help management and the board communicate with activists in a productive, open manner while staying within SEC rules regarding shareholder communications. In an environment that can be emotionally charged and adversarial, it can be challenging.

It's important for a company to have open channels of dialogue with its shareholders. In many cases, developing a disciplined schedule of quarterly meetings between activists and management can be helpful. Especially with activist shareholders, companies should seek to avoid the perception that management is ignoring criticism about the company's strategic direction. The challenge becomes making sure that, in these meetings, management does not inadvertently disclose material nonpublic information that would constitute a Regulation FD violation.

Additionally, executives need to be aware that anything they say in meetings with activists can, and often will, be used as fodder by the activists to publicly criticize the company. It's important for management to do a lot of listening in these meetings, to hear what the activists have to say.

An activist attack can turn into a referendum on the strategic direction of the company. Is incumbent management utilizing the shareholders' capital effectively? Does it have a clear plan to increase market share and improve margins? Has the company been prudent in its acquisitions, both in terms of the types of businesses it has acquired and what it has paid for them?

Activists force discussion of these kinds of fundamental questions. Management must be prepared with clear responses and a coherent vision of the company's future. And it needs to communicate its message, not just to the activists, but to all of the company's shareholders, particularly those with large stakes in the company who could potentially align themselves with activists.

Q.: What impact can activist shareholders have in the success or failure of M&A deals?

A.: Before the credit crisis and the stock market downturn, forcing a sale of the company was often the end-game for activists. Private equity firms had access to cheap debt. And high stock prices meant strategic acquirers could use their stock as acquisition currency. So the market conditions really aided activist hedge funds that were agitating for sales and divestitures.

In that market, activists would often protest a management-led buyout (going private transactions), arguing that the sales price was too low, and would launch proxy campaigns against the takeover. In many cases these protests were dropped and, frankly, were probably just a tactic to push for a higher sales price, or at least ensure that the board was getting every dollar it could from the acquirer.

In the current M&A market, forcing a sale becomes much more challenging for an activist. On top of that, with depressed stock market prices, many funds are finding themselves underwater in their investments, such that the price per share, if the company were sold, would still be below the price at which they bought in. Activists, due primarily to market conditions, are thus finding that they are going to have to stay in some of their investments longer than they anticipated. As a result, they are becoming much more operationally focused to ensure survival until strategic alternatives are again available.

Q.: Other than a dearth of liquidity, what issues does an extremely distressed economy create for M&A deals?

A.: For the seller, deal certainty becomes paramount. So if we are representing a seller, our goal is to limit the circumstances under which the buyer is allowed to walk away. In this regard, the “Material Adverse Change” or “MAC” clause in M&A documents takes on heightened importance.

For instance, one client that our firm advised, Genesco, Inc., was able to prevail in litigation against The Finish Line, Inc. Finish Line tried to terminate the deal on the grounds that a MAC had occurred. But Genesco was able to point to language stating that The Finish Line couldn't walk away from the deal if “general economic conditions” caused the MAC. And the court agreed that the deteriorating economy, not factors specific to Genesco, had caused the MAC. So in today's market, you see more heated negotiation than ever over closing conditions and the “MAC” clause. The terms of the closing conditions are, more than ever, board-level discussions.

Q.: What other advice/insights would you offer corporate counsel with regard to shareholder activism in particular?

A.: Don't wait for the phone to ring. Responding to activists successfully requires a company
to be proactive. As much as anything else, it is an exercise in shareholder relations. When faced with pressure from activist shareholders, it's important to assemble a response team that includes management, investor relations, inside and outside counsel, and, depending on the circumstances, outside proxy solicitation firms.

Our corporate clients who have been most successful with activist insurgencies have tended to view the situation as an opportunity for the company to sharpen its message about its direction and future, and to get that message out to all shareholders.

Adam J. Schlagman, Esq., is Editor-in-Chief of this newsletter.

As the economy continues to crumble month after month, financial decisions made by U.S. companies are increasingly being met with greater scrutiny by shareholders, consumers, and the media. With the collapse of banks and lenders, more mergers and acquisitions falter one by one.

Page Davidson, a member of the Transactional Corporate and Securities Practice of the Nashville-based firm Bass Berry & Sims PLC, focuses his practice on mergers and acquisitions as well as a variety of other corporate and securities matters. He counsels private and public companies on how to control and leverage shareholder relationships to better ensure successful transactions.

In this interview, Mr. Davidson discusses the increased role that shareholder activists play in M&A deals, how corporate counsel can develop a productive working relationship with shareholder activists, and the current marketplace forces that have led to a chain of failed deals.

Q.: How have activist shareholders increased their influence on public companies? What tactics have they developed to do so?

A.: Shareholder activists are indeed exerting a greater influence on the strategic and operational direction of public companies. For example, pension and hedge funds often operate under relatively short time horizons during which they have to fund their obligations or deliver returns to investors. As a result, they often advocate transactions that can produce a quick increase in the stock price or a return to shareholders in a short amount of time.

Recapitalizations, special dividends and share repurchases are often part of the discussion. In some instances, activists take the view that a sale of the whole company is the best course of action. Activists have, in fact, developed an entire arsenal of pressure tactics. It frequently starts with corporate governance. In recent years, activists have utilized the shareholder proposal process to get many public companies to implement a majority-vote standard for director elections. And they have also used this process to force companies to declassify their boards of directors, so that the entire board comes up for election every year.

At the same time, the SEC's e-proxy rules and the Internet generally have made it easier for activists to wage media campaigns and build a consensus against incumbent management. The result is an environment where a takeover of the company's board of directors can occur much more easily than in the past.

Often, activists initially approach the company's management privately, before they have reached the 5% ownership trigger for reporting their investment with the SEC. If the activists don't think that these private discussions have been productive, they will “go public” by stating their criticisms of management in open letters to the SEC, attacking executive compensation as exorbitant, pushing shareholder proposals, and waging proxy fights to get representation on the board.

Q.: What are the best practices that in-house counsel can follow to cultivate a productive, positive relationship with activist shareholders? What would such a relationship look like?

A.: In-house counsel's job is to help management and the board communicate with activists in a productive, open manner while staying within SEC rules regarding shareholder communications. In an environment that can be emotionally charged and adversarial, it can be challenging.

It's important for a company to have open channels of dialogue with its shareholders. In many cases, developing a disciplined schedule of quarterly meetings between activists and management can be helpful. Especially with activist shareholders, companies should seek to avoid the perception that management is ignoring criticism about the company's strategic direction. The challenge becomes making sure that, in these meetings, management does not inadvertently disclose material nonpublic information that would constitute a Regulation FD violation.

Additionally, executives need to be aware that anything they say in meetings with activists can, and often will, be used as fodder by the activists to publicly criticize the company. It's important for management to do a lot of listening in these meetings, to hear what the activists have to say.

An activist attack can turn into a referendum on the strategic direction of the company. Is incumbent management utilizing the shareholders' capital effectively? Does it have a clear plan to increase market share and improve margins? Has the company been prudent in its acquisitions, both in terms of the types of businesses it has acquired and what it has paid for them?

Activists force discussion of these kinds of fundamental questions. Management must be prepared with clear responses and a coherent vision of the company's future. And it needs to communicate its message, not just to the activists, but to all of the company's shareholders, particularly those with large stakes in the company who could potentially align themselves with activists.

Q.: What impact can activist shareholders have in the success or failure of M&A deals?

A.: Before the credit crisis and the stock market downturn, forcing a sale of the company was often the end-game for activists. Private equity firms had access to cheap debt. And high stock prices meant strategic acquirers could use their stock as acquisition currency. So the market conditions really aided activist hedge funds that were agitating for sales and divestitures.

In that market, activists would often protest a management-led buyout (going private transactions), arguing that the sales price was too low, and would launch proxy campaigns against the takeover. In many cases these protests were dropped and, frankly, were probably just a tactic to push for a higher sales price, or at least ensure that the board was getting every dollar it could from the acquirer.

In the current M&A market, forcing a sale becomes much more challenging for an activist. On top of that, with depressed stock market prices, many funds are finding themselves underwater in their investments, such that the price per share, if the company were sold, would still be below the price at which they bought in. Activists, due primarily to market conditions, are thus finding that they are going to have to stay in some of their investments longer than they anticipated. As a result, they are becoming much more operationally focused to ensure survival until strategic alternatives are again available.

Q.: Other than a dearth of liquidity, what issues does an extremely distressed economy create for M&A deals?

A.: For the seller, deal certainty becomes paramount. So if we are representing a seller, our goal is to limit the circumstances under which the buyer is allowed to walk away. In this regard, the “Material Adverse Change” or “MAC” clause in M&A documents takes on heightened importance.

For instance, one client that our firm advised, Genesco, Inc., was able to prevail in litigation against The Finish Line, Inc. Finish Line tried to terminate the deal on the grounds that a MAC had occurred. But Genesco was able to point to language stating that The Finish Line couldn't walk away from the deal if “general economic conditions” caused the MAC. And the court agreed that the deteriorating economy, not factors specific to Genesco, had caused the MAC. So in today's market, you see more heated negotiation than ever over closing conditions and the “MAC” clause. The terms of the closing conditions are, more than ever, board-level discussions.

Q.: What other advice/insights would you offer corporate counsel with regard to shareholder activism in particular?

A.: Don't wait for the phone to ring. Responding to activists successfully requires a company
to be proactive. As much as anything else, it is an exercise in shareholder relations. When faced with pressure from activist shareholders, it's important to assemble a response team that includes management, investor relations, inside and outside counsel, and, depending on the circumstances, outside proxy solicitation firms.

Our corporate clients who have been most successful with activist insurgencies have tended to view the situation as an opportunity for the company to sharpen its message about its direction and future, and to get that message out to all shareholders.

Adam J. Schlagman, Esq., is Editor-in-Chief of this newsletter.