Debate continues to rage among politicians, professors, senior lawyers, and members of the media over the regulation of hedge fund activism. The primary criticism is that, in the absence of merger and acquisition activity, such activism does not create value for the target company’s shareholders in the long-term. Furthermore, even in the event of a hedge fund activist-initiated merger, studies have indicated that value-creation is limited to short-term stock price boosts and takeover premia.
With the objective of examining whether hedge fund activists are indeed “wolves,” as described by critics whose goal is to extract short-term profits, we recently wrote a paper on another essential way that activists create value: corporate divestitures. Corporate divestitures refer to a firm’s strategic action to remove some of its assets. They primarily include spinoffs, which create an independent company through the sale or distribution of new shares of a subsidiary; and selloffs, which are sales of a parent company’s assets for cash or securities of another firm.
Divestitures are increasingly popular among hedge fund activists. According to data from Lazard, 28 percent of the M&A-driven activist campaigns launched in 2018 Q3 demanded a divestiture of a non-core business line or company breakup. Popular divestiture campaigns in 2018 included Elliott Management’s efforts to push Whitbread PLC to sell its Costa Coffee chain and SpringOwl Asset Management’s campaign urging Playtech to divest its financial services division to focus on core gambling operations.
Given the popularity of divestitures among hedge fund activists, the question arises of whether the objective is to place a“for sale” sign in front of the parent company or to create long-term value? A 2014 article in The Economist magazine, The activists’ cookbook, suggested that divestitures, especially spinoffs, help companies focus energy and resources more efficiently. An interesting example of a short-term impact of divestitures is the case of restaurant chain Brinker, which sold its chain of Mexican restaurants, On the Border, to an affiliate of a private-equity firm in June 2010. The result: Share prices trebled.
We can already hear critics sharpening their knives: Divestitures appear to be yet another way to boost stock prices for hedge fund activists. Fortunately, that is not what we find. While there is the obvious short-term impact of a bump in share price when hedge fund activist-initiated divestitures are announced, as suggested by most studies on hedge fund activism, there is also concrete evidence of hedge fund activist-initiated divestitures increasing the return on assets and firm profitability. Furthermore, we do not find any evidence that hedge fund activists pursued divestitures with the goal of eventually selling their targets. In other words, the goal of hedge fund activist is not to make a quick buck for their investors. On the contrary, there are tangible improvements in activist targets in the long run following the completion of the divestitures.
We also compare the activist efforts of hedge funds with those of mutual funds, pension funds, private equity firms, financial institutions, investment managers, individual investors, corporations, and shareholder committees. We find that while, in the long run, divestitures initiated by activist hedge funds improved firm profitability, divestitures initiated by other activists destroyed firm profitability in the long-run.
As the debate rages on about whether hedge fund activists need to be regulated, our study offers reasons for policymakers to be cautious about restricting hedge fund activism. Hedge fund activists are in for the long-haul, and their flexibility and absence of conflicts enable them to be efficient long-term value creators. For those reasons, other shareholder activists should consider partnering with hedge funds rather than undertaking their own activist campaigns.
This post comes to us from Professor Jie (Michael) Guo at Durham University Business School; Vinay Utham, a PhD candidate at the school; and Professor George Jiaguo Wang at Lancaster University Management School. It is based on their recent article, “Shepherds in Wolves’ Clothing? Hedge Fund Activism Using Corporate Divestitures,” available here.