Will the retreat of activist investors give industrial bosses more leeway to manage?

Apr 8th 2009 | PARIS
From The Economist

Illustration by David Simonds

A YEAR ago Stephan Howaldt, the chief executive of Hermes Focus Asset Management Europe, a British activist fund, was in full cry against the Pesenti family, an Italian industrial dynasty. The fund had taken a stake in Italmobiliare, a financial holding company controlled by the family, which in turn controls Italcementi, the world’s fifth-largest cement-maker. Hermes demanded a performance review for Carlo Pesenti, Italcementi’s chief executive, and said the cement firm should sell its stakes in unrelated businesses such as newspapers and banking. Things got personal: the family executives, Mr Howaldt said, became “unusually closed-up”.

Italcementi’s management was therefore delighted when Hermes said in January that it was reorganising its fund and replacing Mr Howaldt. The fund’s activist style had been “disproportionately hit” by the financial crisis, it explained. Hermes still owns shares in Italmobiliare, but its management is not expecting much further pressure for change.

Around the world, activist funds are on the back foot, performing poorly, facing investor withdrawals and struggling to assemble the financial firepower to take on new targets. The activist technique of investing in a few underperforming companies and pressing for change is particularly difficult in falling markets, as other investors seek safe havens. In America investors began only two new activist campaigns in the fourth quarter of 2008, down from 32 in the preceding nine months and 61 in 2007, according to Thomson Reuters, a provider of financial data. William Ackman, a well-known activist who started a fund to pursue Target, a discount retailer, wrote to investors in February to apologise for the fund’s “dreadful performance”. It has fallen in value by around 90%.

In continental Europe, where shareholder activism is a newer phenomenon, corporate chiefs will be quick to seize on signs of failure. On March 26th the chief executive of Wendel, a prominent French investment fund, resigned after an activist investment in Saint-Gobain, a 344-year-old French building-materials firm, went disastrously wrong. Shares in Saint-Gobain fell precipitously after Wendel’s investment, dragging down the fund’s own performance. In recent years, comments Alain Minc, a business consultant in Paris, financial investors were encouraged by cheap liquidity to think they were geniuses who knew better than chief executives how to run companies. In future, he says, they will need real industrial credentials.

On April 2nd Christopher Hohn, chief of The Children’s Investment Fund (TCI), a British hedge fund labelled a “locust” in Germany for its aggressive tactics, abandoned its efforts to force further change at Germany’s main stock exchange. It cut its stake in Deutsche Börse from 10% to below 1%. Last year Mr Hohn conceded that activism is “unpredictable and expensive” in current market conditions. In Japan, too, activists are backing down; in October last year, for instance, TCI sold out of J-Power, the country’s former state-run energy wholesaler, having failed to influence its strategy, and suffered an estimated $130m loss. “Our focus has shifted to buying stocks that don’t require activism,” says the local manager of another big fund.

To be sure, there is little chance that chief executives will feel less overall pressure from shareholders to perform. But demands from short-term investors are likely to subside. In 2007 Moody’s, a credit-rating agency, published a controversial report which concluded that the expansion of shareholder power at American companies was increasing potential credit risk, to the detriment of bondholders and long-term shareholders. Short-term investors in America and Europe, it said, were using new powers such as the ability to nominate board directors to push for actions which could damage credit quality. On top of activists’ own difficulties, companies now have a powerful argument to push back against such initiatives. The pressure from investors trying to force through specific changes—such as increased leverage, spin-offs, acquisitions or share buybacks—has receded, probably for several years.

That will delight chief executives. They resented being given advice on important strategic decisions by people with no industrial experience, and feared the long-term consequences of gearing up. “You end up spending too much time in front of these people rather than running your business,” says one European boss, who adds that short-term shareholders have been a “plague” on industrial firms.

“Creating value through financial leverage will be harder in future, so we can get back to our real job,” says Hakan Samuelsson, chairman of MAN, a German truckmaker, “which is creating industrial value through technology, innovation and efficient manufacturing.” He expects less pressure to sell businesses, because the perceived value of divisions that generate cash is greater now that credit is more expensive. Conglomerates, therefore, stand a better chance of staying intact or even bulking up further over the next few years. Mr Samuelsson also expects more patience for organic growth.

“The dialogue with long-term shareholders has never been as robust,” says Jean-Pascal Tricoire, the president and chief executive of Schneider Electric, a 171-year old French firm which makes equipment for electrical distribution and industrial control. “I believe financial investors are now increasingly realising that industrial people can manage and develop businesses very well.”

In America, too, the financial crisis offers an opportunity to push back against short-term pressure from shareholders, so that managers can go back to running firms for the long term, says Martin Lipton, a Wall Street lawyer who has questioned the value of shareholder activism. Quarterly reporting to Wall Street, long unpopular with industry, is now under fire for having contributed to a push for higher returns and more risk-taking in banking. But American bosses are unlikely to take much comfort from any shift to a longer-term philosophy. Public anger at banks has spilled over into broad fury at corporate chiefs and their pay, and they expect more rather than less scrutiny.

As chief executives regain the freedom to manage, they may seize the opportunity to invest for the long term. But there is also a risk they will indulge in empire-building and roll back improvements in corporate governance. “As activism subsides the result is likely to be that management will tend to become even less accountable, and whether that is in the long-term interests of shareholders is a serious question,” says Nathan Gelber of Stamford Associates, a pension-fund consultancy in London. In Japan in particular, the retreat of activist investors is lamentable.

At some firms vocal fund managers are being replaced by a new kind of activist: the government. Barack Obama proved himself more brutal than any hedge fund when he removed Rick Wagoner as the boss of General Motors last month. But having ousted managers they hold responsible for past failures, governments will seek to build big, stable companies capable of increasing employment, rather than stripping them down in the name of efficiency and shareholder value. On March 29th Christian Streiff, chief executive of PSA Peugeot Citroën, was also ousted, possibly because the French government was infuriated by his plan to cut 11,000 jobs at the firm, announced two days after taking a big loan from the state. Industrial bosses should take note: the wind has changed direction, for a few years at least.

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