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December 15, 2014
ACTIVIST FUNDS, CANADIAN PENSION PLANS & THE EMERGING NEW M&A LANDSCAPE

Canada’s stable of large pension plans have highlighted both their scale and the profound changes at play in the M&A market through their participation in $12 billion of transactions over the space of 24 hours (with another $6 billion deal apparently within a whisker of happening).

The change in the M&A market highlighted by these deals is the growing importance and relevance of activist funds – as opposed to traditional private equity LBO firms. All $18 billion of announced and rumoured deals were precipitated through pressure from activist investors.

Canadian Pensions, $12 Billion Of Deals & An Emerging New M&A Landscape

The second largest pension fund in Canada – the Caisse de depot et placement du Quebec (assets under management or AUM of ~$CAD215 billion) – lined up with BC Partners to fund the $8.3 billion purchase of PetSmart (NASDAQ:PETM). BC Partners and the Caisse topped the (apparently next closest) bid from K.K.R and Clayton Dubillier & Rice. Separately Ontario Teachers Pension Plan (AUM ~$CAD140 billion) joined a buyers’ syndicate led by Thoma Bravo to purchase wide area networking vendor Riverbed Technologies (NASDAQ:RVBD) for $3.6 billion. Finally Canada’s largest plan – CPPIB (which tops the scales above $CAD225 billion of AUM) – was rumoured to be vying (as underbidder) with Spain’s Repsol for the take-private of one of the historic stars of the Canadian oil & gas sector: Talisman Energy (TSX:TLM). Applying a reasonable deal premium would undoubtedly value Talisman above $8 billion.

Given that these three deals were all precipitated by activist funds (more on which below) – and moreover given that this slew of deals came after Allergan announced its sale to Actavis for $66 billion after having been pursued by the combination of activist fund Pershing Square Capital and serial acquirer Valeant Pharmaceuticals International (nominally Montreal-based) – it is clear that the way we think of the M&A market needs to be re-assessed.

A New Threat Vector For Boards

Previously the public M&A market was oft-times driven by private equity funds buying a company at a premium through the use of cheap debt; they would then sell or re-IPO the business.  In the absence of a bid with a premium – a bid for the whole company – boards (even underperforming ones) could relax. Competition for deals was between private equity (combining the ability to analyse and perceive a business in a new way with tolerance for business- and capital structure- risk) and strategic buyers (able to capture synergies).

The new threat vector for boards comes in the form of multi-billion dollar activist funds of a size that they can purchase a meaningful stake in even significantly-sized public corporations and enforce change or a sales process. Elliott Management, for example, is reported to have assets under management  of $23 billion.

Making their case in well articulated, and at times ferociously-worded,  presentations, they can demand the kind of corporate change previously only seen after private equity had assumed the drivers seat. In so doing they undercut part of the value creation thesis of a traditional LBO firm. (For an example of such a presentation see: http://www.sec.gov/Archives/edgar/data/940944/000092189514000699/ex991dfan14a06297125_033114.pdf ) Likewise companies can be pushed into a transaction even when they appeared to have stable shareholder structures and well-established boards.

The Allergan scenario is instructive. When Pershing Square Capital Management first acquired a ~10% stake, and thereafter announced its partnership with Valeant, the market reaction could best be described as stunned. Yet in retrospect this oughtn’t to have been at all surprising. Pieceing together the 2013-2014 activities of just three activist funds (see below) makes this quite transparent.

A key element in this is that formerly stable shareholders – including large pension funds such as the Canadian plans and their other large peers – are increasingly taking the sides of activist funds. Some of these pension plans are even investors in the activist funds.

When the timing of the proposed Valeant deal was unveiled gossip in M&A circles was that it was an error for Valeant not to bring matters to a quick vote at the May 2014 shareholders’ meeting. The analysis was – correctly – that according Allergan’s board more time would allow the target to erect stronger defences and canvass the market for a higher offer. The M&A strategists surmised that this would work out to Valeant’s detriment. The higher offer from Actavis meant that Perhsing Square and its ally “lost”, but lost is placed in parentheses because Perhshng Square walked away with a $2.6 billion profit. Valeant, on the other hand, made a paltry $390 million on its Allergan position, and that will be trimmed to $100 million after giving effect to deal-related expenses. Admittedly Pershing Square’s profit comes at the cost of a robust and ongoing debate about whether the pre-knowledge of the bid constituted insider dealing; on the other hand Pershing Square has certainly enlarged the scope for creativity in hostile bids.

Interestingly this new world of activist-driven creativity has drawn criticism from the top executive at the largest asset manager on the planet. Mr Laurence D. Fink, CEO of BlackRock Inc (NYSE:BLK) recently warned an investor conference that “If you asked me if activism harms job creation, the answer is yes,” before calling on corporations to invest more. He stated this at the same podium occupied shortly beforehand  by Mr Paul Singer of Elliot Management. Mr Fink pointed out that what may be good – in the near term – for shareholders is perhaps not good for the people who work at the target companies or indeed for the economy as a whole.

Case Studies: Two Years, Three Activist Funds

Mr Fink may have a point, but the wind is definitely in the sails of the activist funds. A study of some of the activities of three of the larger funds is instructive:

Starboard Value

  • Darden Restaurants (NYSE:DRI): We earlier provided the link to the Starboard/Darden presentation  (“Current board and management committed one of the most egregious violations of shareholder trust we have ever seen”… and, addressing food quality “… dishes that are astonishingly far from, authentic Italian culture… pasta is poorly handled and generally overcooked… mushy unappealing product”). StarBoard subsequently oversaw the ousting of the entire board of Dardens and implementation of a new value-creation strategy. The shares of this company (market capitalisation $7.6 billion) have subsequently performed well. In effect StarBoard implemented a private equity turnaround strategy whilst leaving the company public.
  • Staples  (NASDAQ:SPLS) + Office Depot (NYSE:ODP).  Staples has a market capitalisation of $10.6 billion , of which StarBoard reportedly owns 6% whilst OfficeDepot has a market capitalisation of $4.2 billion, roughly 10% of which is apparently held by the activist fund. The rumour mill is rife with speculation that it will seek to merge two two companies in order secure efficiencies: the better to confront intensifying competition from online giant Amazon.com and big box multi-product retailers such as WalMart. Indeed OfficeDepot deployed the same logic when it merged with OfficeMax in 2013. Various investment bank research cited by the financial press suggests that costs synergies could handily top $1.25 billion –  implying as much as $8-10 billion of synergy value at current multiples. Moreover the anti-trust landscape appears to have changed: in 1997 US regulatory authorities blocked a proposed merger of the two companies (citing competition fears). The advent  of Amazon and WalMart has seemingly assuaged fears of consolidation in so-called “category killers”.
  • Yahoo (NASDAQ:YHOO) and AOL (NYSE:AOL). In November StarBoard disclosed stakes of 2.4% in AOL and 1% in Yahoo. The reported goal was to carve out Yahoo’s valuable positions in Alibaba and Yahoo Japan whilst merging much of what remained with a firm such as AOL. This represents something of unfinished business for StarBoard: in 2012 the fund fruitlessly attempted to place three director nominees on AOL’s board in order to effect strategic change (though the position still proved to be profitable).

Elliott Management

  • BMC Software: A year long-campaign culminated – in May 2013 – in enterprise software firm BMC agreeing to a $6.9 billion offer from private equity firms Bain Capital and Golden Gate Capital.  The pattern was simple: Elliott announced a stake, presented its case to investors, eventually secured two seats on the BMC board and helped launch a strategic review.
  • Celesio/McKesson Corporation (NYSE:MCK). In this transaction Elliott initially played the role of spoiler. Opposing MCK’s first bid, Elliott stimulated a higher, $8.3 billion offer for Celesio. Shareholders of the latter initially balked, but were willing to accept a third offer from McKesson (which closed at the start of 2014).
  • Compuware: Elliott began pursuing software vendor Compuware two years ago. During the process Elliott was willing to display boldness – even offering to buy the firm itself as a tactic to highlight its views on value. Ultimately Elliott managed to canvass an offer from Thoma Bravo for $2.5 billion (not quite as high as initial expectations, but a profit nonetheless).
  • Hess Corporation (NYSE: HES). In January 2013 Elliott began its siege of Hess Corporation, the oil & gas firm headed by a member of the eponymous family. After initial resistance the company adopted a rationalization programme that resulted in the sale of Hess Retail to Marathon for $2.6 billion and the spin of some midstream assets.
  • Riverbed: As described above this is the result of yet another multi-month campaign against a technology company leading to a multi-billion dollar offer involving Thoma Bravo. As was the case with Compuware, Elliott Management used an offer for the whole company to underline its arguments about value. Riverbed had initially presented a hard stance against Elliott, but was forced to retreat when the company posted below-consensus results this summer.

Jana Partners

  • PetSmart: As noted above, the pet product retailer is the subject of an announced bid by BC Partners and Caisse de depot. This came at the end of a Jana-inspired auction process launched not terribly long after Jana acquired its stake (August 2104) This process generated a 39% premium.
  • Rockwood Holdings: Jana acquired a position in specialty chemicals maker Rockwood in 2013. It laid out a case for a higher value and seemed to be soliciting takeover offers. This summer Albemarle Corporation (NYSE:ALB) paid $6.2 billion for Rockwood. Jana was correct in its judgment about the company, though (perhaps in a sign of having a less patient investment horizon than StarBoard or Elliott) it had already sold its stake.
  • Safeway. In another indication of a shorter time horizon, Jana amassed a position in Safeway in the autumn of 2013. After surmounting initial management resistance and securing agreement that the company would rationalise its portfolio, Jana began to sell down its shareholding. In March of 2014 Cerberus Capital announced a $9 billion offer for Safeway, with the stated intention of merging it with another food retailer (Albertsons).

Conclusion

This review of shareholder activism and M&A makes plain that multi-billion dollar public companies – no matter how well entrenched their boards seem – are not immune to pressures from activist funds. Firms such as StarBoard, Elliott and Jana are now defining the M&A agenda, and private equity firms (who were once given the impolitic moniker “barbarians at the gate”) are now looking more like polite participants at auctions precipitated by other firms.