If you’re in the investment banking division of a European universal bank, and your parent company isn’t making a double digit return on equity, then one of the biggest potential threats to your job might be activist investors. After all, Barclays, Deutsche and Credit Suisse have all come under pressure for activist investors in recent months and in some cases it looks like the pressure is beginning to tell in terms of restraining management from the markets led growth strategies that they would really prefer to be following.
In a sense, though, the sudden prevalence of activist investors is strange. Historically, the banking sector has been a bit of a graveyard for activist shareholders. There are only a few success stories of value-creating change organised by outsiders, and there are lots more stories of raids that started with a lot of noise and finished by quietly selling shares at a loss, with greater or lesser degrees of embarrassment.
The pattern was set at the start of the millennium, when “Cobra”, an investment syndicate made up of former investment bankers, showed up owning 17% of Commerzbank and demanding that the company restructure itself and look for an acquirer. Two years later, the stake had been sold and the syndicate broken up. The pattern repeated itself in 2008, when Luqman Arnold, the former president of UBS, arrived at the head of Olivant, an activist shareholder with 2.8% of the company and a thesis that UBS could create value by breaking itself up in the aftermath of the investment bank’s mortgage-backed securities disaster. That ended badly, partly because Olivant had its prime brokerage account with Lehman Brothers. Knight Vinke fared better in financial terms in their activist struggle with HSBC, but had surprisingly little impact on the management structure or business strategy.
There are several reasons why activist investing comes to grief in the financial sector. Most importantly, the typical activist recipe for success is to force management to buy-back stock, utilise idle cash or spin off under-performing subsidiaries. All of these things are much more difficult to achieve in a regulated industry. And it’s harder to understand the operations of a big bank, the shared services and synergies from the outside than an industrial company or a retailer; even a former CEO can’t always make a convincing case. And incumbent management are more likely to be well-connected with the financial institutions among their investors, making it more difficult for activists to build a consensus (Edward Bramson appears to be finding this out in Barclays).
So why do they do it? Because the success stories can be spectacular. Chris Hohn’s activist raid on ABN Amro led to the company’s breakup and acquisition by the consortium led by RBS, and left Rijkman Groenink as the bank CEO who created more shareholder value than any other in the 2000s, all of it on the last day of his tenure when he accepted the offer. ValueAct made a killing with their position in Morgan Stanley, although this seems to be more attributable to good timing with respect to the market cycle than to activism per se.
The problem and the opportunity are that bank franchises are really valuable, really durable and really easy to mismanage badly, meaning that the wrong management team can send market capitalisation much further below the intrinsic value than in almost any other industry.
So if your company has activist shareholders, the evidence suggests that they are unlikely to succeed in forcing strategic change if things are merely under-performing. Activists in the industry do best when they can force a break-up or acquisition, and the climate still doesn’t seem to be right for big M&A activity. They might still be a constraint on growth ambitions, though.
Dan Davies, is a senior research advisor at Frontline Analysts and a former banking analyst at Cazenove, Credit Suisse and BNP Paribas.
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