The rise of the activists
A look at the impact of activist investors on the Aerospace and Defence sector
Last week it emerged that the activist investor, Elliott Capital Advisors, now holds a 5% stake in Meggitt. This makes Meggitt the third European Aerospace & Defence company to have such an investor on its shareholder register and it led me to ponder what is driving these activists? Why the interest in Aerospace and Defence? And what are they trying to achieve?
Activism has been rife in the US for the past decades, but in the UK and Europe it has been far less common. In 2014 Bill Ackman the US activist founder of Pershing Square Capital said that pressure to meet pension obligations in Europe would “make shareholders inherently more active”. He has been right to an extent. European investors have started pushing companies harder to improve governance and returns. However, confrontational activism of the style seen in the US though still remains rare.
Against this background then, it is intriguing that Safran, Rolls-Royce, and now Meggitt all have vocal activist investors on their registers. The Children’s Investment Fund (TCI) took a stake in Safran in 2012 before then openly criticizing its acquisition track record. TCI outlined a list of demands of management, including an audit of all recent acquisitions, holding managers to account for any poorly performing deals, a ban on deals outside of civil aerospace and raising the dividend to 50 per cent of profits.
The San Franciso based hedge fund ValueAct became a shareholder in Rolls-Royce last year. ValueAct is known for working behind the scenes with companies when it believes strategic change or management shake-up is needed. The Chief Operating Officer (COO) Bradley Singer was granted a seat on Rolls-Royce’s board earlier this year, and it is reported that he has pushed the company to accelerate its cost-cutting plans. It has been reported that ValueAct also wants Rolls-Royce divest its non-aerospace businesses.
Elliott Capital Advisors now has control of a 5% stake in Meggitt. Elliott is the UK operation of American Hedge Fund Elliott Management, which has a long history of agitating for change at companies, and is particularly known for spotting potential takeover targets. Meggitt profit warned last year, primarily because the company’s energy business has been struggling with the lower price of oil.
TCI, ValueAct and Elliott Capital Advisors seem to have different objectives with their investments, however at the most fundamental level they are aiming to maximize value for shareholders. That explains why Safran, Rolls-Royce and Meggitt all saw their share price rise when it became public knowledge that they had an activist investor on their register. The market generally sees activism as a good thing because it forces companies to listen to shareholders and be open to their ideas. Activists can make companies more accountable and responsive to the market and their influence often prompts management to think about a wide spectrum of initiatives; including strategy reviews, leadership succession plans and portfolio management.
That three aerospace and defence companies have come under the activist’s spotlight is likely to have occurred because the companies are exposed to the attractive end market of civil aerospace which is in the middle of a significant period of structural growth. However, Safran, Rolls-Royce and Meggitt are not as profitable as their US peers, seemingly because of struggling to cut costs and structural management issues within large businesses. Activists it seems think they are underperforming their potential, although it is important to note that many of the challenges these businesses are facing are due to the large investment required on new programmes during this growth period.
In order to work with an activist investor, company management requires a high level of detail and knowledge about what is going on in its business which can only be a good thing. Notably this is where Rolls-Royce has particularly struggled, highlighting that one of the causes for its recent string of profit warnings was poor management information systems.
There are a number of long only shareholders who worry that activists with short-term agendas, particularly that of achieving a company break-up, will undermine the independent non-executives who represent all shareholders. This is understandable, and for every activist campaign that succeeds in the UK, another one fails. However, long-only fund managers and increasingly thought to be using activist investors to do their bidding to management in order to effect change. TCI’s criticism of Safran’s acquisitions is a prime example of this; TCI only said what most of the market was thinking.
Activism does not look likely to become as prevalent in the UK as in the US, however it is becoming an increasingly important item on the boardroom agenda. Safran, Rolls-Royce and Meggitt will feel its influence first hand in the coming weeks and months, but their peers will also have to challenge themselves to ensure that they are equipped to handle any potential activists questions. It seems to me to be a force for good in a sector that is famed for its lack of transparency.
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