BHP and the Future of Shareholder Activists

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For a company and its board, an activist investor is the last thing it wants to see on its share register.

For a start, it will mean plenty of headaches…and distractions. CEOs should be busy enough running their companies without having to deal with activists as well.

Whether it be the share market, climate or social issues, there seems little doubt activism is on the rise.

With stocks, there are all manner of organisations advising shareholders how to vote at AGMs. Like voting against a remuneration report, which is a common example.

This can be a particularly sensitive topic for shareholders — especially if senior executives are receiving large bonuses despite the company’s performance being on the wane.

The reason why an activist investor buys shares in the first place is that it sees potential for change…and profits.

However, activism applies more broadly than this. It can relate to how a company sources its products, the diversity of its workforce, and how much workers are getting paid.

Where that becomes a problem for management is that the activist investor will typically have a different idea on how the business should be run. And, how it might be structured.

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Elliott puts BHP to the sword

This was especially the case when New York based hedge fund, Elliott Management Corporation, took a stake in BHP Billiton Ltd [ASX:BHP] a few years back.

Elliott was pushing for a number of changes at BHP.

First, it wanted to change BHP’s dual listing structure. In doing so, Elliott believed BHP would be able to share its huge franking credits with all shareholders — not just the Australian-based ones.

Elliott’s other big push was over BHP’s US oil business. It wanted BHP to spin out the whole division and list separately in the US.

However, as we saw, BHP decided on a trade sale instead, selling its onshore shale oil assets to market giant, BP.

No doubt, some put the deal down to Elliott’s activism. However, BHP argued that Elliott’s activities held no sway — after reviewing its shale oil holdings, BHP simply decided it was time to sell.

BHP was just one company on Elliott’s list. There are plenty of other companies the hedge fund has invested in and agitated strongly for change. So too a slew of other hedge funds and activist investors.

Activist investors argue that the reason they agitate for change is simple. Ultimately, for them, it is about maximising value.

Their opponents argue something else. That activist funds are only in it for a quick buck. That they are only in it for the short haul. However, given the size of money invested with activist funds, it is clear they aren’t going away.

Chasing returns

With interest rates cut to oblivion, the world is awash with cheap money — money that needs to find a home. Activist funds are just one avenue that investors seek to generate a return.

Some funds scour small- and mid-cap stocks, on the hunt for the next big sector. Others try to stock pick and beat the index with their weightings.

Activist funds, however, tend to target the big end of the market. Whether it be to sell off or close a division, or to merge with another company. Or, pressuring the company to return excess capital to shareholders.

It is here that they can put their many billions to work, amply rewarding their investors if they get it right, and management buckles.

While the mega-conglomerates attract the headlines, activism is spreading its wings into another part of the market. One sector particularly vulnerable are listed investment companies (LICs).

But what is an LIC?

LICs are similar to a managed fund, in that the manager actively invests to try to beat the market. Or more accurately, beat the benchmark against which they are judged.

As the name implies, an LIC is listed on the market, so you can buy and sell shares like you would any other stock.

Another difference is that an LIC is ‘closed end’. Meaning that the only way an LIC can issue new shares is by raising capital in the market.

Compare that to an ETF, which gives an investor exposure to an asset class. It can offer new units as long as there is sufficient liquidity in the underlying shares that make up that index.

Two of Australia’s oldest and most prestigious investment companies are both LICs — the $7.7 billion Australian Foundation Investment Co Ltd [ASX:AFI] and the $5.9 billion Argo Investments Ltd [ASX:ARG].

Founded in 1928 and 1946 respectively, these two LICs have a history of generating market returns, as well as paying a string of full-franked dividends along the way. Both hold around 100 different stocks — some of which they have held for decades.

Because of their long history of performance, both trade at a premium to their net tangible asset (NTA) backing. AFIC by around 15%, and ARG around 10%.

But these are not the highest in the LIC space. Wilson Asset Management’s WAM Capital Ltd [ASX:WAM] and WAM Research Ltd [ASX:WAX] trade at a significant 16% and 22% premium to their NTA.

However, unfortunately these LICs aren’t representative of the wider LIC market.

If you run through a list of Australian LICs, it is not uncommon to see LICs trading at a significant discount to their NTA.

Often the reason they trade at such a discount is that the LIC has continued to underperform — sometimes significantly. Another reason is that the specialty in which the LIC might focus, has gone out of favour.

Some LICs trade at a 20% discount…some as much as 40% below their NTA.

In other words, if you bought the entire stock listing, and liquidated its holdings at market value, you could achieve a near 20% or 40% return, as per our examples above.

Rationalisation ahead

And this is where some of the smart money is heading. With those kind of potential profits on offer, plenty of activist fund managers are readying themselves for action.

You can expect a wave of rationalisations, mergers, and even LIC closures ahead.

Activism can cause a great deal of angst to a company’s board and management. It also distracts them from doing their job, which is running the company.

However, if a company (or LIC) was trading at its full value, an activist would have little reason to invest. The fund could find better opportunities to invest its money elsewhere.

But like it or not, this is where the rubber hits the road.

If a gap exists — particularly a large gap — between what you can buy an asset for, and what it is worth, there will always be someone trying to cash in on the difference.

All the best,

Matt Hibbard,
For Money Morning

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