"The New Barbarians — Shareholder Activists Have Europe in Their Sights"

by Skadden, Arps, Slate, Meagher & Flom LLP
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Shareholder activism has risen significantly since the start of the financial crisis, with global shareholder campaigns increasing by 62 percent since 2010.1 This growth is partially driven by activist hedge funds, reaping outsized returns of 19.9 percent compound annual growth rate on investments since 2009 versus 12.7 percent CAGR for S&P and just 7.6 percent for all hedge funds.2 Shareholders have engaged companies in all sectors — although in certain geographic areas, activists have focused principally on a limited number of industries — and are targeting increasingly larger companies.

This wave of activity has hit the shores of the old continent, resulting in the creation of Europe’s own mix of shareholder activism. Before the global financial crisis, shareholder activism in Europe could be characterized by spurts of activity in a handful of EU member states and complete absence in most others. Shareholder activism now is on the rise across the continent, with activity increasing in the more than $100 million category from 22 campaigns in 2010 to 60 in 2012 (45 as of October 2013) and in the more than $1 billion category from 12 campaigns in 2010 to 42 in 2012 (21 as of October 2013).

Activism has been most prominent in the United Kingdom, partly because of the size and structure of U.K. capital markets compared to the rest of Europe, enabling activist shareholders to leverage their knowledge of and expertise in the United Kingdom. There have been more than 80 campaigns (of any size) in the U.K. from 2010 to 2013, representing more than one-half of all activity in Europe during this period. France, Continental Europe's second-largest economy, has had more than 20 campaigns. Smaller economies with relatively dynamic capital markets and large listed companies have seen disproportionate levels of campaigning, relative to their economic size, including Switzerland, with 14 campaigns, and the Netherlands, Belgium and Finland, with 20 campaigns combined. Germany and Italy, the other two large European economies, have witnessed only 10 campaigns, but activism appears to be on the rise in these countries, despite the fact that many listed companies have concentrated ownership structures.

Increased Support of Activist Campaigns

European markets’ prolonged weakness since 2009 and the poor performance of large European strategic players during that period has laid the groundwork for the recent rise of shareholder activism. U.S. hedge fund activists turned to Europe, seeking opportunities outside North America to replicate their successful U.S. campaigns. At the same time, European hedge funds and other players analyzed the success of prominent activist investor campaigns across the Atlantic, particularly those supported by more traditional institutional investors, and realized that they could leverage their knowledge of European mechanisms and dynamics through their own campaigns.

While activists face numerous structural challenges in Europe, such as a lack of common proxy rules and limited regulatory precedent in some jurisdictions, and thus often do not have the tools available to them in the United States to carry out their campaigns, the number of players in the market that are prepared to hear activist shareholders out and support their campaigns has grown in recent years. Corporate governance matters and, specifically, executive pay, have been at the center of attention of lawmakers, regulators and shareholders since the beginning of the global financial crisis, resulting, for example, in binding and nonbinding say-on-pay regulations being adopted in several EU member states. Influential proxy solicitors, such as Institutional Shareholder Services (ISS) and Glass Lewis, generally are supportive of executive pay and corporate governance campaigns brought by activists. A momentous shift in the composition of the shareholder base of large EU companies also has occurred, with the proportion of U.S. institutional investors with a sympathetic ear for activist campaigns increasing significantly in recent years. Additionally, European institutional investors have been supportive of campaigns. We believe these are lasting factors that will cause shareholder activism to continue to expand in Europe.

The resulting landscape is a mixed bag of U.S. and European activists campaigning for changes to board composition, executive pay and richer consideration in takeover transactions, and fighting against strategic plans as well as management-proposed disposals or purchases.

Activist Strategies: Navigating the EU Landscape

Activists generally target large strategic players with diffuse and/or high institutional ownership, because the absence of a controlling shareholder increases the probability of a campaign’s success. So far, the principal sectors targeted by shareholder activists have been financial institutions, which have been particularly weak in the European recession, and industrial and telecommunications groups.

Specifically, activists have targeted companies that have been underperforming significantly compared to their peers, are pushing controversial transactions or strategic plans, or have a diverse set of assets but for which a split-up to improve strategic focus could bring stronger returns. Other typical features of targets include perceived poor governance, low leverage and significant debt capacity, and/or steady cash flows but low distributions to shareholders.

Shareholder activists, however, continue to face an uphill battle against established European strategic players. Europe remains a very fragmented market, with 27 member states and rules, regulations and practices that largely require harmonization by EU institutions. Europe lacks a common set of proxy rules or rules on corporate governance. Europe’s securities markets do not rely on disclosure and related judicial scrutiny as much as such markets do in the United States; as a result, European markets generally suffer from lower transparency than those in the U.S. with regard to board/company actions and shareholder transactions and intentions. The European system generally is more reliant on intervention by securities regulators. At the same time, the sophistication of regulators in Europe varies dramatically from country to country. In the U.K., where approximately 20 to 30 cases are regulated each year, regulatory action is largely consistent and reliable. In several other jurisdictions, however, regulators see one or two activist campaigns annually and have not yet built up sufficient regulatory history upon which market participants can rely.

Activists also face material challenges borne out of the structure of capital markets in much of Continental Europe. In several European countries (including Germany, France and Italy), the ownership structure of listed companies is concentrated — for example, listed companies are controlled by founding families or their foundations — and, therefore, not favorable to shareholder activism. Also, shareholder activists favor liquid stocks; the absence of a liquid derivatives market, which is not a consistent feature across Europe, is a significant hurdle for activist shareholders.

Other than in the U.K. and France, where the largest proportion of campaigning in Europe occurs, activists seldom resort to the courts. In most EU member states (other than the U.K. and France) the court system is slow and/or relatively untested in shareholder matters, and it is impractical for shareholders to consider litigation as an effective tool to obtain an immediate result in a campaign.

As a result, hedge funds and other players must structure and cater their campaigns in a different manner in each EU member state. For example, activists generally will approach targets privately first, and a significant proportion of campaigns never make it to the public domain in Europe. Public campaigns are rare outside the U.K. and, at face value, often unsuccessful, as the proxy and corporate governance rules heavily favor target companies and incumbent boards.

The European Players

The principal activists in the European landscape include some of the usual suspects from the United States, such as Elliott Management and its affiliates, which recently was active in opposing McKesson's bid for Celesio (Germany), Vodafone's takeover of Kabel Deutschland (Germany) and DuPont's offer for Danisco (Denmark). Additionally, a number of European players have emerged in the past few years.

In the U.K., the increased presence of shareholder activism was apparent in the recent public offering of Royal Mail, where The Children’s Investment Fund (TCI), a large London-based hedge fund and established activist, positioned itself as the largest shareholder with a nearly 6 percent stake in the postal service company. Hedge funds wasted no time, ratcheting up the pressure on Royal Mail to increase cost savings.

TCI also has been increasingly active in France, particularly in relation to both EADS and Safran. Following its acquisition of EADS (now Airbus) stock, TCI first demanded that the European aerospace giant sell its €4 billion stake in French jet maker Dassault Aviation, alleging that EADS was making poor use of its capital and that the sale proceeds should be given to shareholders. Having failed in its attempt to force a sale of Dassault Aviation, TCI now is demanding that EADS implement cost-cutting measures and focus on profit growth; it also is demanding that management announce further cuts in its defense unit in short order. No significant changes have made public, but TCI continues to hold talks with other key shareholders and to eye EADS’ annual meeting in April. TCI also recently launched an attack on Safran, the French aerospace manufacturer, heavily criticizing the company's track record for acquisitions outside civil aerospace and requesting the appointment of new independent board members to review all proposed merger and acquisition transactions. TCI continues to hold a stake in Safran and exert pressure on the manufacturer.

Recent events involving ThyssenKrupp also serve as a reminder that the new culture of shareholder engagement may be here to stay. Even before say-on-pay came to its first vote, Gerhard Cromme, chairman of ThyssenKrupp, scheduled a meeting with investors to discuss executive compensation. The gesture was called “extraordinary” by investors. However, it was not enough. The dilution of the Krupp Foundation's stake resulting from recent capital increases opened the door to potential investment by shareholder activists. Anglo-Swedish fund Cevian, which acquired stock in ThyssenKrupp, recently increased its stake, is seeking board representation and likely will push for significant changes to the company.

Telco, a joint venture company owned by Telefonica and certain Italian institutions, which is the largest shareholder in Telecom Italia and controls its board, faced the last high-profile campaign of 2013 from Findim (the holding company of Italy's Fossati family and owner of a 5 percent stake). Although Findim’s proposal to replace the entire board of Telecom Italia failed to pass at the shareholder meeting held on December 20 (50.3 percent voted in favor of the incumbent board against just more than 42 percent for Findim's list), the close vote shook Telecom Italia, causing two Telefonica representatives to resign from the Telecom Italia board in the run-up to the shareholder meeting and reportedly forcing Telecom Italia to consider changes to its corporate governance ahead of its spring annual shareholder meeting.

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As these examples illustrate, shareholder activism has become a regular feature of European markets. Although activists will continue to be challenged by the characteristics of the European market, the search for value will continue to draw hedge funds and other players, regulation and policies friendly to minority shareholders, and with them will come Europe’s own brand of shareholder activism. Accordingly, European companies should not underestimate the risk of attack from activist shareholders, and boards should be prepared to handle requests appropriately and avoid being caught by surprise.

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1 "Shareholder Campaigns Double in Three Years," Financial Times (Nov. 10, 2013).

2 Rising Tide of Global Shareholder Activism, Citigroup (November 2013).


* This article appeared in the firm's sixth annual edition of Insights on January 16, 2014.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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