Over the past few weeks, we have discussed a multitude of topics regarding mergers and acquisitions. From tender offers, long-term mergers, structuring deals, anti-takeover measures, we have covered a lot. This article about Hedge Funds as Activist Investors opens up a whole new spectrum of topics we can discuss. This is an introduction to Hedge Funds as Activist Investors.
Hedge Funds as Activist Investors
As a substitute for open-end investment funds or mutual funds, hedge funds were produced. This limited partnership uses high-risk methods so as not to make public solicitations for capital to investors and so as not to be required to report as their mutual counterparts do. Since the reporting requirements are low, investors have less access to return data.
Hedge funds grew during 2013-2007, those were the years when the economy was strong. The truth is, it nearly doubled during those years. During those times, the industry has shrunk and many weak players had no choice but to leave the business as hedge fund assets grew.
The growth resumed in 2009 since there were large amounts of institutional capital to invest. Two years later, both the number of funds and assets outdid the progress in 2007. This progress resumed but declined later on.
The Two Types of Hedge Funds
With regard to mergers and acquisitions, there are two types of hedge funds. First, we have the risk arbitrage and second, the activist hedge funds. Both of which shall be discussed in this article. Before we continue further, it is worth noting that activist hedge funds grew in the post-recession period and even surpassed other types of investments. Hedge funds have actively entered the activist arena from 2009 to 2015 and rose to $123 billion from $29 billion during 2005.
Along with this growth comes the changes in a number of campaigns. The activist assets’ dramatic rise in terms of value is inherently linked to a marked increase in the number of activist campaigns. Two situations can be observed: the many campaigns conducted by new activists as opposed to a limited group of large activists, and the fact that these campaigns had an expanded focus, including more smaller-cap companies.
All these trends grew dramatically partly because of the great returns. In relation to this are the various deterministic macroeconomic factors that created a favorable environment. For such returns to be realized which will be discussed later on.
What is a company A target for Customer Activists?
Going back, activist hedge funds are those that make big enough investment in a company to participate in the management and firm decision-making. Hence, it enables the investors to obtain positions on the company’s boards to influence changes in the company.
Factors for Activist Investors
There are a few factors that make a company become a target for activist investors. For example, if it is not well operated, a corporation becomes a target for activist investors, has high costs, and as a private company could be run more profitable. However, it can also be a target if the activist investor has other issues that can be resolved to make them more competitive and profitable.
Another factor that makes a company a target is its past performance. It may be left with high levels of liquid assets that the investors want them to use to return cash to shareholders in the form of a stock buyback.
Carl Icahn
Such was the case with Carl Icahn way back 2014. He pressured the billion-dollar company Apple to use its cash to fund a more rapid stock buyback program. Carl Icahn got the multinational company to buyback $14 billion within two weeks. Still, he did not succeed because he took on a huge target that was pursuing a buyback program already. Apple’s shareholders failed to rally around the activist and ISS failed to endorse Icahn’s initiative.
Sign of an Activist Hedge Fund
Activist investors can be looked at as long-term oriented since they take a private equity approach to public markets. They enjoy investing in companies where management has insufficient incentives to maximize shareholder value. It’s because, without proper incentives, management can make excessive compensation and benefits and cancel free cash flow. Because of their less diverse portfolio, they vary from conventional funds. Another sign of an activist hedge fund could be the filing of SEC form 13D that must be filed when an investor purchases 5 percent or more of the stock of a company.
Evaluating Macroeconomic Factors
These transactions are related to deterministic macroeconomic factors. For instance, the 18-month long Great Recession from 2008 to June 2009. It was a very relevant downturn since the Great Depression. However, unlike other deep recessions, we had in 1973–1974 and 1982–1983. Originally, It was a very anemic recovery from the Great Recession. Particularly with respect to the labor market, which is inextricably linked to consumer spending.
US economy reached its peak after the growth in 2009, helping stimulate a rebound in equity markets. During this recovery, the stock market was quite strong and indices such as the S&P500 reached record levels. While it can be advantageous for some companies, the laggards and others were not able to keep up, becoming potential targets of opportunistic activist funds.
Additionally, the low-interest-rate environment is a macroeconomic factor that helped many activist funds. It prevailed in the United States and Europe, making the costs of debt financing lower for potential acquirers. Along with this is the fact that many companies had rising cash balances which could also be used to finance acquisitions. These factors made it easier for activists to claim that there were many potential bidders who could finance the acquisition of the target company.
Stay Tune
We hope that this article has helped you understand Hedge Funds as Activist Investors better. In the next few articles, we will discuss this topic in further detail. Tune in to our website to find out more about Leading Activist Hedge Funds and Institutional Investors, Hedge Funds as Acquirers, and Hedge Fund Activism and Firm Performance. In the meantime, check out our previous articles for more important and informative lessons about mergers and acquisitions.
© image credits to Anni Roenkae