Do High-Powered Activist Investors Help Ordinary Shareholders?

<b class="credit">Bloomberg via Getty Images</b> William 'Bill' Ackman founder and CEO of Pershing Square Capital Management (left) Daniel Loeb, founder and CEO of Third Point: Two activist investors taking big positions in large public companies and demand even bigger changes.
Bloomberg via Getty Images William 'Bill' Ackman founder and CEO of Pershing Square Capital Management (left) Daniel Loeb, founder and CEO of Third Point: Two activist investors taking big positions in large public companies and demand even bigger changes.

Is activist investing a force for good when it comes to shareholders? Recent events, namely the Bill Ackman-J.C. Penney (JCP) debacle, have left investors and analysts tired of the outspoken hedge-funders of the world.

There are, of course, plenty of activists whose actions have enhanced not just their funds' portfolios, but those of passive, minority shareholders. They've forced companies to make positive changes -- to restructure, elect new board members, and get back on track toward healthier operations.

Then again, others end up like J.C. Penney -- a seemingly lost business, rich with legacy yet left crippled by boardroom drama.

That leaves us -- the average consumers and investors -- with a pressing question: Are these megaphoned power players trying to effect change that will benefit all, the company included? Or are they just after results that will juice their own returns?

The Age of Activism

While many activist investors consider themselves to be molded in the image of a certain Omaha-based super-investor, many of today's hedge fund superstars have taken a very different approach to the craft of identifying mispriced securities.

Like the old guard -- raiders like Carl Icahn and Nelson Peltz -- young guns such as Daniel Loeb and Bill Ackman take substantial positions in large public companies and demand change in an approach that is about as far from Warren Buffett's investor behavior as one can get.

Their style can be best described as personality-driven activism.

The practice is on the rise, too. According to FactSet, 2012 saw 21 activist campaigns in companies with market caps larger than $1 billion. In 2010, the number was 11. In 2003, there were four.

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While some passive shareholders may welcome a helping hand if their pick isn't performing, outsiders seem to be more bothered by the nasty tenor of the dealings.

Perennial nice guy George Clooney has spoken out against hedge fund investor Loeb -- a major investor in Sony (SNE) -- going as far as to call the investor a "carpet bagger ... What he's doing is scaring studios and pushing them to make decisions from a place of fear."

Even Buffett advised Apple (AAPL) CEO Tim Cook to pay as little attention to David Einhorn as possible, and just focus on running the company.

You get the point: Activist investing tends to generate opinions.

As an individual investor, should you avoid swimming in the same pool as headline-generating sharks? Or is the presence of an activist investor a reason to wade in and test the waters?

It's Complicated

Yahoo (YHOO) is a recent example of the complex activist-management relationship.

Loeb took a substantial position in the troubled Internet company, acquired a board seat, ousted then-CEO Scott Thompson, and then spearheaded a campaign to hire Marissa Mayer, who has since gone on to become known as a miracle worker -- the savior of Yahoo.

Now, it's not certain that Mayer would not have joined Yahoo without Loeb's presence, but even the CEO herself acknowledges the investor's vision for the company, whose stock is up more than 80 percent in just 12 months.

If the story ended there, we'd have an activist-management success story. But it doesn't.

Earlier this month, Loeb resigned from the board and dumped his shares, claiming Mayer did not heed his advice to lay off up to 30 percent of the company -- a condition he originally campaigned for and Mayer had agreed to.

There are other ways the activist-management relationship can go. Consider the dealings of another large fund, Elliott Advisors, which amassed a tremendous stake in National Express (NEX) -- the U.K. transportation conglomerate.

Following the usual recipe, Elliott attempted to conduct a board coup d'etat, and gain greater influence over the direction of the company in hopes of breaking it up and selling off the pieces.

The battle raged throughout 2011, but the fund never achieved its coveted board seats. In March of this year, Elliott dumped half of its stake in the company. Since March 2011 through April of this year, the stock had plummeted nearly 20 percent -- lagging the S&P 500 by roughly 40 percent.

In the meantime, the company spent millions fighting off Elliott -- a distraction that certainly took management's focus away from the continued operations of its businesses.

Then, of course, there is the sad story of J.C. Penney and Bill Ackman. With as much attention as the story has gotten, there is no reason to recount details, other than cementing the fact that J.C. Penney has alienated its already weak shopper base, gone through a variety of managers, and lost billions in market value -- bringing Ackman and other shareholders down with it.

It's not that Ackman had malicious intent for the company -- he could have pushed for its dissolution or for taking it private, but instead he truly believed in the viability of the business, and put a retail genius (though in a much different business) in the driver's seat to make it happen.

Things didn't work out, and nearly every media outlet, in addition to Wall Street, has vilified Ackman. As the investor exits his position, various other vocal investors -- from George Soros to Kyle Bass -- have snatched up roughly one-third of the company's stock in hopes of achieving what Ackman couldn't.

Who Ultimately Pays the Price?

There is little doubt that activist investing is a growing game here in the United States. And, with more players, we may see corporations armoring up to protect themselves. And that's not good news for investors.

Companies will have to spend more on legal expenses and anti-activist strategy-making, and undergo boardroom shuffles that, at their core, do not necessarily have direct positive impacts on the operating business. Another takeover defense is the "poison pill" tactic -- flooding the market with shares to prevent any one investor from gaining too much ownership, but also diluting existing shareholders.

Some firms need change, and some firms need an outsider, outspoken party to encourage or force that change. However, it may end up being a minority that ends up creating positive change, while many activist stakes could end up plaguing retail investors with extra costs, internal turmoil, and in the worst case, a loss of direction.

Motley Fool contributor Michael Lewis has no position in any stocks mentioned. The Motley Fool recommends Yahoo!. Try any of our Foolish newsletter services free for 30 days.


Originally published