The corporate raiders of the 1980s are alive and well, proverbial wolves now disguised in the sheeps’ clothing of shareholder rights activism—and they are poised for more hunting in 2015. With the 2015 proxy season just around the corner, these activists are dusting off their screens to determine who might be a good target. In the energy space, household names including Apache, Hess, Murphy, Occidental, Transocean, TransCanada and Nabors have gained the attention of activists striving to make their mark on another company.

In recent years, the energy sector has begun to attract more activist attention.

In recent years the energy sector has begun to attract more activist attention for a host of reasons. Many energy companies have multiple business lines and substantial tangible assets that can be sold or spun off. Capital spending in the sector is reaching new heights, driven by the unconventional boom.

The market is currently rewarding pure-play companies with higher valuations, resulting in increased levels of scrutiny of multi-basin upstream companies. Midstream assets continue to receive lofty valuations, well in excess of their value embedded in an integrated company. The fourth-quarter volatility in energy stocks will increase activists’ focus on the sector. And finally, the perception of a “wildcatter” mentality persists in the marketplace for many of the more entrepreneurial energy companies.

With a relatively modest position in a company stock, well-funded and savvy activist investors can wage proxy fights or well-staged publicity campaigns to compel change. On the surface, the activists’ and company managements’ objectives are arguably the same: maximizing shareholder value.

However, the fundamental perspective of a professional fund manager who can exit an investment in nanoseconds in today’s high-speed trading world differs markedly from that of a CEO and board making investment decisions that must stand for years or decades. In addition, the disruptive methods employed by activists can have lingering effects on a company’s culture, structure and management team.

According to Hedge Fund Research, activist hedge funds have outperformed general hedge fund performance by 13.1% over the past five years.

According to Hedge Fund Research, activist hedge funds have outperformed general hedge fund performance by 13.1% over the past five years (see Fig. 2). With such performance success, these funds continue to gather assets. By some estimates, the activist funds (i.e., Elliott Management Corp., Greenlight Capital Inc., et al) have more than $100 billion of assets under management (AUM), and their treasure troves keep growing (see Fig. 3).

By some estimates, the activist funds have more than $100 billion of assets under management, and growing.

And, unlike in more genteel times, these activist funds are gaining strong allies. In addition to activist funds “clubbing” together, there is a growing trend of traditionally passive pension funds joining the fray and forming alliances with the hedge funds to effect change. CalSTRS, the pension fund giant with some $186 billion of assets under management, earmarks nearly $5 billion for activist investors, with a $1 billion capital commitment to Relational Investors alone. And the state teachers’ pension fund is now taking co-invest positions in target companies, meaning CalSTRS is directly engaged in the activist effort. With this much clout, these investors are formidable constituents for all management teams.

No longer just the slowest antelope

How, then, to avoid becoming a target of the activists—the slowest antelope? With more dollars chasing activist opportunities, the activists will begin to pursue historically “safe” companies. Larger companies have become targets (see Fig. 4), and “underperformance” is being redefined. Companies that outperform their peers are no longer immune to attacks by activists. Activist funds are increasingly focused on absolute performance and unlocking trapped value at targeted companies.

Before entering a stock and agitating for change, the new breed of activists will do their homework, hiring financial advisers, technical consultants, PR and law firms to maximize their odds of success. The activist then enters the stock, often in surprisingly modest amounts or through derivative transactions, which are more challenging to trace. The goals of these activists can range from economic to social. And what they count as a win is often unrelated to stock price, as touted in one recent email by an activist: “Our track record—more than 40 activist campaigns, three successful proxy fights, 11 new CEOs, 36 new directors and good risk-adjusted returns—was solid”—hardly a ringing endorsement for creating real shareholder value.

In many cases, the activists demand that the target firms unlock value through corporate or asset transactions or by distributing “excess cash” to shareholders. Others strive to implement governance changes (presumably for more facile management of the company), with specific demands for a board’s structure or changes to a company’s governance (i.e., dismantling poison pills and declassifying boards).

There are also “socially responsible” funds that have specific investment mandates and not only invest with particular agendas (i.e., alternative energy) but will also agitate for companies to abandon lines, businesses or practices (i.e., tobacco). These funds are not primarily focused on shareholder value and therefore can be at odds with a board focused on its fiduciary duties to all shareholders.

Who are these guys?

Generally speaking, activists can be split into three camps:

The Intentional Activist: The Carl Icahns of the crowd, these investors take a position in a company with the express intent of agitating for a strategic change. Very public in their battles, their ongoing fundraising is dependent upon public wins and continued gains. They are opportunistic investors with relatively short time horizons. Others in this camp include Elliott Associates, the Clinton Group and Third Point.

The Accidental Activist: These investors have often been in the stock for years, and are more focused on the fundamentals of the business. Sustained underperformance awakens these activists, and rather than voting with their feet (i.e., closing out of a position) they will agitate for change out of sheer frustration. Their focus generally ranges from governance to strategic change. Recent examples include TPG-Axon and Steelhead Partners.

The Activist Groupie: Happy to join a wolfpack, these investors will club up with other investors. These include the aforementioned CalSTRS and Relational Investors. Also included are Blackrock and CalPERS. This group packs a lot of brawn given their cumulative assets under management.

What to do?

The early-warning systems of days gone by are no longer effective in flagging management that a movement is afoot. The disclosure requirements for 13D filings—when certain investors have to disclose within 10 calendar days that they have a 5% position in the target company—are too slow and too high a hurdle. In an era of high-speed trading and fast communications, activists can embark on a campaign far sooner than 10 days and, perhaps more concerning, with far less than a 5% equity position. More useful warnings come with current HSR filing thresholds, and more importantly the level of dialogue and inquiry between known activists and company investor relations.

Larger companies have become targets and "underperformance" is being redefined.

Activists often start by reaching out to management to test their premise and gauge management’s reaction. There may be weeks or months of back-and-forth communication, often with tension building, before anything is made public. A public campaign can range from a mere letter-writing campaign to a proxy fight or even teaming with a potential hostile acquirer. And once public, the activist samurai has difficulty backing down without losing face.

An experienced team of advisers is critical to helping a company navigate this activist minefield and defending the long-term interests of all shareholders.

Lance Gilliland is a managing director at Tudor, Pickering, Holt & Co. As head of M&A, he leads the firm’s M&A business, with a focus on public company transactions, shareholder activism, board and special committee advisory engagements and cross-border and joint-venture transactions. He also manages the infrastructure team at TPH. Previously, he was with Goldman Sachs in Houston, New York and Menlo Park.

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