There are many types of investors out there, ranging from retail to institutional investors, and those who follow a variety of investment strategies. One type of investor that didn’t get much attention until recent years is known as an activist investor.
Shareholder activism, while underrecognized, is an important part of the complex machine known as the stock market. But what exactly is activist investing? And what can you do to turn information about activist investments into profits in your own portfolio?
What Is an Activist Investor?
Activist investors, also referred to less flatteringly as corporate raiders, are investors who look for struggling public companies to invest in and work to change them. To do so, these investors buy large ownership stakes in their target companies.
Activist investors are big money players on Wall Street, including high net worth individuals, private equity firms, and institutional investors like hedge funds. After all, an investor must be able to buy enough of the company’s shares to have a meaningful percentage of the vote when decisions arise.
By purchasing a large percentage of outstanding shares — often representing well over 5% of the total value of the company — these investors push the companies they invest in to make changes that will improve shareholder value. This generally leads to share price increases in two ways:
- By Simply Investing. When the investing community sees that an activist has taken a large stake in a company, they tend to follow suit, hoping that when the activist makes changes, they’ll generate significant profits. This immediate buying often leads to share price increases.
- Through the Changes They Make. Once they take the ownership stake in the company, activists start working with the company to bring about a change in direction that’s beneficial not only for the company, but for its shareholders. These changes often lead to fundamental improvements in the companies, which ultimately boost the value of their stocks.
What Kind of Changes Do Activists Make?
Activist investors often push companies to make a wide range of changes, including but not limited to matters of corporate governance, capital structure and allocation, and spinning off costly parts of the business.
Corporate Governance Changes
One of the first things that tends to change when an activist takes hold of a company is its management team. After all, when something doesn’t go right, the management team is often to blame.
Activist investors often push for changes to a company’s executives and board members, hoping to replace those that aren’t performing well with experts who have a high likelihood of turning things around. In many cases, the activist investor will demand a board seat, making them privy to the actions taking place within the board of directors.
Even if a company is running well, the price of that company’s shares may be depressed by a poor capital structure. For example, if a company has too many shares available to the public, the large supply of shares will tip the scales of supply and demand, leading to slow growth in its share price.
Activists often push investors to perform stock buybacks to bring supply and demand back into balance.
Where companies spend their money has a meaningful impact on their ability — or lack thereof — to grow. As a result, activists look for ways to change how funds are spent in an attempt to use the company’s financial resources in ways that will result in growth in revenue, earnings, and profit margins.
Some companies that are struggling are in the position they are because they’re losing too much money trying to revive subsidiaries that are slowly dying, bringing the value of the overall corporation down.
In these cases, activists push the companies they invest in to spin off underperforming departments or subsidiaries, making them stand-alone companies that must survive on their own, rather than business divisions that bleed the overall corporation of the vital resources needed to affect growth.
How Activist Investors Force Companies to Make Changes
Exactly how are activist investors able to push massive corporations to make changes to how they do business? Here are the steps these investors usually take to force change:
Step #1: A Friendly Request
The first step the activist investor will usually take is to make a friendly but formal request to the company to make the desired changes. This is generally done in the form of a written document that outlines the changes the investor would like to see made and why.
Should the company comply with the demands in the written request, the activist has made the changes and the process is over. If not, they move on to step #2.
Step #2: Make the Investing Public Aware
The next step the activist investor takes is to make the investing public aware of the problems they’ve found, the solutions they’ve proposed, and the fact that the company refused to comply with the requested solutions.
This is generally done through a press release that is distributed to the public and media. At this point, the company, knowing that the investing public is now aware of the battle between it and the activist, will occasionally bend and make the requested changes.
Should the company still refuse to change at this point, the investor may take the third and final step.
Step #3: Start A Proxy Contest
By this point, the activist has done everything possible to play nice with the company they’ve invested in. Now, it’s time to get their hands dirty.
The investor will move forward with a proxy contest, also known as a proxy fight, where they attempt to gain a majority vote of the shareholders and overthrow decisions made by the company’s management team. Although this is a last resort, it’s often the most effective way to get companies to comply with investor demands.
Why Investors Pay Attention to Activists
When activist investors take hold of a company, there’s a strong chance that its management will eventually either comply willingly or be forced to comply with the activist’s requests. As a result, a struggling company will generally be forced to make changes that are in the best interest of shareholders, leading to price increases.
Moreover, when an activist investor first makes an investment in a company, it’s usually because it is struggling and is generally undervalued. By following the moves of activist investors, everyday investors are able to find value stocks with both the potential for significant upward movement and a potential catalyst for major improvement relatively soon.
As a result, when an activist buys a large number of a company’s shares, investors generally follow, purchasing shares of their own in order to take advantage of the upward movement that’s likely ahead.
Don’t Blindly Follow the Activists
Unfortunately, many new investors blindly follow the opinions of the experts, including analysts, media, and institutional and activist investors. However, it’s important to keep in mind that even the experts get it wrong in the stock market from time to time, and activist investors aren’t interested in companies that are already doing well.
Blindly following the investments made by activist investors can be a dangerous game.
Although it’s a good idea to look for opportunities that activists are investing in, you should never invest in anything without your own research. Instead of blindly following activists’ moves, use their investments to find potential opportunities to research.
When researching, consider the current state of the company and the work it will take to turn it around. Moreover, take time to get a feel for the changes the activists are planning on making and form your own opinion as to whether those changes will be enough to lead to growth in the company before making an investment.
How to Tell When an Activist Invests
Any time a large investor makes a purchase of 5% or more of a company’s outstanding shares, they must report it to the investing public by way of a Securities and Exchange Commission (SEC) filing known as a Schedule 13D.
A great way to find out what moves an activist investor is making is to look at the SEC’s tool known as EDGAR, the Electronic Data Gathering, Analysis, and Retrieval tool. There you’ll see a search bar where you can enter either a company name or a person’s name.
Once searched, the SEC will provide you with all the filings that company or person has made with the regulatory authority. Simply look for Schedule 13D filings and read them to get an understanding of the companies the activist is involved with.
Keep in mind that not all 13D filings will be activist investments. Even notable activist investors often make large passive investments in companies they have no intention of influencing. You can usually find all the information you need using your favorite search engine — just type in the name of the company and the name of the investor and read a few of the results that pop up. If the investment is activist in nature, it should become clear within the first two or three articles you read.
Pro tip: Learn more about companies before investing in them with Atom Finance. Not only does Atom allow you to search for SEC filings, they also have the tools available to conduct comprehensive financial analysis on companies. Learn more about Atom Finance.
Notable Activist Investors
There are hundreds of activist investors on Wall Street today, some more successful than others at making changes within publicly traded companies. Some of the most well-known and most successful activist shareholders include:
Carl Icahn is one of the most successful investors in the world, and he has a reputation for being an effective activist. In fact, over his career, he has led several activist campaigns associated with some of the biggest companies in the world through his firm known as Icahn Enterprises.
Some of the names Icahn has been involved in you likely know, including campaigns around RJR Nabisco, Texaco, Western Union, Viacom, Revlon, Time Warner, Yahoo!, Motorola, Apple, and eBay.
As of early June 2021, the largest holdings in Icahn Enterprises included Occidental Petroleum Corporation (OXY), CVR Energy (CVI), Newell Brands (NWL), Cheniere Energy (LNG), and Bausch Health Companies (BHC).
While Icahn has led many successful campaigns, he’s also suffered his fair share of losses, the biggest of which was in Hertz Global. Icahn held a position in Hertz for six years before he sold his stake, losing $1.6 billion in the process.
Bill Ackman is a well-known expert on Wall Street. He’s the founder of Pershing Square Capital Management, one of the largest and most well-respected money management firms in New York. He’s also well known for his work as an activist, unlocking shareholder value for the investing community.
Ackman is known for making one of the best bets an activist investor has ever made. It started when he found a troubled mall operator, General Growth Properties. His activism surrounding the company pulled it from the brink of bankruptcy and resulted in a massive payoff. Ackman invested about $60 million and generated a return of $1.6 billion, a more than 2,600% profit.
Like all activist investors, Ackman has made mistakes as well. One of the biggest losses he faced took place when he bet against a company Icahn was actively working to save, Herbalife. While Icahn made a smooth billion dollars in the process, Ackman lost $1 billion on the other side of the bet.
Yet another star on Wall Street, David Einhorn has earned his place among the greats. In 1996, Einhorn co-founded Greenlight Capital, a hedge fund that manages billions of investor dollars. Through his fund, Einhorn makes several activist investments, buying massive stakes in struggling companies in an effort to turn them around and produce shareholder value.
While Einhorn has made several activist moves, buying into value stocks that were struggling and pushing for change. He’s best known for short selling Lehman Brothers just before the burst of the real estate bubble. Seeing a storm coming in real estate, and having the foresight to see the struggles lenders would face when the storm came, Einhorn profited billions.
However, while he has made some good trades, Einhorn lost his shirt in 2018. Bets against Advanced Micro Devices and Netflix blew up in his face, delivering painful losses. Moreover, investments in value traps like Brighthouse Financial, General Motors, and Ensco, where his activism seemed to get him nowhere, added insult to injury, leading to a year of losses that pushed him off the Forbes billionaire list after his net worth fell to around $700 million.
In 1995, Dan Leob founded the activist hedge fund Third Point. The fund is known for finding value opportunities, buying huge positions in them, and working to take control in an effort to sway the companies in the right direction.
His most famous activist investment was a big bet on Yahoo! After buying 60 million shares of the company’s stock, Leob asked for and was granted a seat on the company’s board of directors.
From there, he led the charge to build a solid management team, starting with the hiring of Marissa Mayer as the CEO of the company after it had flown through five CEOs in the five years prior. After a year of being on the board and pushing for positive changes, Leob sold two-thirds of his position in Yahoo!, resulting in billions of dollars in profits.
Unfortunately, Leob had a horrible start to the year in 2020 when a $2 billion bet on Prudential and a $700 million bet on Essilor Luxottica resulted in swift and painful losses.
Paul Singer is one of the first names that comes to mind when many think of hedge fund activism. In 1977, Singer founded Elliott Management, one of the oldest funds still in operation today and one of the largest, with more than $38 billion in assets under management.
One of his biggest wins came in 2017 when the billionaire investor made a big bet on NRG Energy, a company that was struggling to stay afloat at the time. When Singer disclosed his stake in the company, he told investors that he would be pushing for strategic and operational changes designed to increase shareholder value, and that’s exactly what he did.
In July of 2017, the company unveiled a massive plan to restructure its business, a plan that ended up freeing up billions of dollars and leading to return of value to investors. On the day the plan was announced, the stock rose more than 25%.
While Singer has earned his position as a well-respected Wall Street expert, it took practice to become successful. In fact, he started his career investing with his father, where he lost most of the team’s money.
Nelson Peltz is another highly successful hedge fund manager, the founder of the Trian Partners hedge fund. While the firm is relatively young, it has grown quickly with more than $9 billion dollars in assets under management as of mid-2021.
One of Peltz’s most famous moves was a big bet on Legg Mason, an investment management firm that was founded in 1899. After taking a large stake in the company, Peltz pushed for changes that would ultimately result in an acquisition by Franklin Resources that led to Trian Partners netting a profit of more than $70 million, according to Bloomberg.
As with all other investing pros, Peltz also gets it wrong from time to time. In March of 2020, as the coronavirus pandemic set in, his firm posted a loss of 16% for the month.
Activist investors make big money — for themselves and for retail investors who have experienced losses as a result of poor management — by putting their money where their mouth is. After making massive investments, these investors look at the companies from the outside in and offer a roadmap to better operational efficiency, often resulting in significant growth in the value.
However, even the best and brightest minds on Wall Street lose money from time to time. So, if you’re going to follow activists, it’s important to get a feel for what they’re proposing, what companies they’re proposing it for, and how those changes might affect the company’s future before risking your own money following them.
Nonetheless, with a little bit of research, using moves made by activist investors as a guide to profits is often a lucrative venture.