M&A, activism and shareholder dynamics — what has changed and what’s ahead?
By Bill Anderson and Amy Lissauer

Activists have been added to boards of 224 public companies since 2015.

Evercore expects substantial activity in M&A, hostile activity and shareholder activism in 2017. Here’s what we expect to be the key drivers.

M&A will increase significantly, driven by cash-funded deals: Recent surveys of leading U.S. executives indicate that over 75% expect to pursue M&A in 2017. What’s driving this optimism? An overabundance of cash: Morningstar estimates that cash balances for the S&P 500 (ex-financials) are standing at the highest levels in at least 10 years. These cash balances will be turbocharged by additional firepower that is expected to result from Trump tax cuts. In addition, reduced corporate taxes are also expected to buttress corporate cash; investors expect this relief to be substantial and to occur in the near term.

The Power of Index Funds . . . and the Impact on the Corporate Investor Relations Function: The massive shift of investments into index funds and out of actively managed funds continued through 2016. A much larger percentage of the shareholder register of U.S. public companies is now comprised of index funds.

As a result of this seismic shift, companies are reconfiguring their investor relations (IR) function. Shareholder engagement is being tailored to strengthen relationships with index funds and other proxy voting constituencies. Communicating long-term strategy — and how the company’s board is configured to support that strategy — has now become a standard part of investor dialogues. In addition, director involvement in shareholder communications has sharply increased. In 2016, 66% of companies in the S&P 500 indicated that their directors engaged with shareholders, as compared with only 6% of companies in 2010, according to the Ernst & Young Center for Board Matters.

Activism Continues to Evolve: Activists in 2016 remained incredibly busy, launching 319 new campaigns and 109 proxy fights, according to FactSet. Yet, despite many high-profile campaigns, activist performance continues to be mixed. Some funds have had substantial losses, which is not surprising given the concentrated nature of their investment portfolios and their investments in sectors facing serious headwinds (like energy), while other funds have had a strong year.

In addition, even though activists have continued to outperform other hedge funds, by some measures they have underperformed the market. Regardless, their “success rate” continues to be high: activists have been added to boards of 224 public companies since 2015. Moreover, notwithstanding substantial preparedness exercises with advisors, many companies are woefully unprepared for activist attacks, and quickly accede to forced sales or CEO changes soon after activists disclose a position (25 of the campaigns for board seats in 2016 involved a CEO transition).

Interestingly, recent performance of companies after activists have gained boards seats also has been underwhelming. In the companies where an activist obtained board representation in 2015 and remained on the board through 2016, the average stock price of those companies was down 8.9% through 2016 year end, while the S&P 500 was up 8.8% during that period.

Activists see an increased level of activity in 2017. Specifically, activist funds are reportedly seeing significant opportunities in the information technology, energy, health care, and telecommunications sectors. In these sectors, wide differentials have developed between the outperformers and underperformers, which the activists will be well positioned to exploit. In addition, consolidation continues to accelerate in these sectors.

Boards Remain Unconvinced of the Merits of Activism: In a recent survey by the NYSE of NYSE-listed company directors:
• 85% of those directors believed that activism puts too much emphasis on short-term performance.

• 84% thought that activism creates a negative distraction for management and the board.

• 86% of those directors said they would not welcome an activist’s involvement on their company’s board.

• 97% believed that activist-nominated directors should not be permitted to share confidential information with other members of their fund.

Even though activist performance continues to be mixed, activists continue to achieve board seats in campaigns — typically via settlements. The principal objectives of activists have slightly shifted, from adding leverage and breakups to CEO change and forcing M&A. Campaigns to force sales of midcap companies have become increasingly common, particularly in tech and biotech. These companies are typically put up for sale within a few weeks of the launch of the activist’s public campaign, and the success rates have been uneven.

However, as the index funds continue to grow in size, they are expected to increasingly serve as a powerful influence and, in many situations, a counterweight to the views of activists.

Amy Lissauer is a vice president with Evercore.

2017 First Quarter

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