As shareholder activism has become an accepted and mainstream investment strategy, publicly agitating for change at public companies and calling out management for underperformance no longer has the same stigma it once carried. Over the last few years, those activists tended to focus on companies that were perceived to be undervalued. However, as valuations have expanded, companies may be targeted by an increasingly common breed of activists, the short activist.
While certainly not a new concept, the likes of Bill Ackman and David Einhorn are well known for their short campaigns, these types of ‘attacks’ have generally been lower profile. According to Activist Insight Online, the number of companies subjected to short activist campaigns peaked in 2015 with 233 public campaigns. While this decreased to 161 in 2017, the bull market and frothy valuations we are currently witnessing have created a natural short landscape, with the risk of a rising number of campaigns in 2018.
At the risk of over-simplifying how short sellers target companies, these campaigns tend to fall into two broad buckets – the first involves claims of some form of financial or operational malfeasance, and the second relates to over-valuation. With the market hitting new highs on a seemingly daily basis, activists targeting companies now have essentially two ways to win – they can create shareholder concern over their claims, or simply benefit from investors questioning if a company’s underlying valuation has simply gotten ahead of the business results and prospects.
There are a number of factors that could align to make 2018 the year of the short.
The Environment Setting Up for Increased Short Activity
There are a growing number of activists that publish their research to drive down stock prices and a growing number of platforms for shorts to get their message out. The increased mainstreaming and social acceptance of shareholder activism has softened the public perception of activist shorts.
There are a number of indicators that markets may be stretching valuations, such as:
- It took the DJIA just 23 trading days to go from 24,000 to 25,000, at the time the fastest 1,000 point increase for the index.
- It then only took just another 13 trading days to close above 26,000.
- The PE ratio for Russell 2000 ended 2017 at 131.96 (12/29/2017 http://www.wsj.com/mdc/public/page/2_3021-peyield.html), which is significantly higher than previous market tops of 2000, where it was in the mid 50s – and 2008, where it was just below 60.
- Another potential harbinger was the recent upgrade of Wal-Mart by Scott Mushkin of Wolfe Research LLC. Mushkin was the last remaining bear on Wal-Mart, who had been negative on the stock since 2014. On December 20, 2017 he threw in the towel and upgraded the stock.
Short Activists Effectively Get Their Message Out
In addition to a growing acceptance of activism and by extension now short activism, the short activists now have more ways to get their message out to inflict maximum pain.
These activists are using many of the same communications tools and tactics that companies use to get their message out, including hosting conference calls, investor meetings, and leveraging the print and broadcast media. They are also using social and digital strategies by posting on Seeking Alpha, tweeting their thesis, creating websites, and/or creating and posting videos. They are even hiring third-party researchers, commissioning scientific testing laboratories and retaining private investigators to dig for dirt that will support their thesis. There are no expenses spared in waging these campaigns. The strategy is to hit hard and fast, without warning, hoping investors will sell on the news, immediately putting the company on defense and creating a virtuous cycle of commentary that lends credibility to their assertions.
What to Do if Attacked
So with rising valuations, more activist communication channels, and an increased acceptance of, and even credibility given to, short activists, what can a company do if they are attacked?
A short attack can be a very personal attack on management, however companies should refrain from automatically attacking the short seller and their questionable motivations.
No two attacks are the same, so each situation will require a customized response strategy, focused on the facts. So, what can companies do if they are targeted?
- Isolate the core issues and claims of the short thesis – the short report will often have pages and pages of innuendo and accusations, so the first step is to identify the core of the thesis.
- Prepare responses to the claims – once the core issues are identified, the facts should be used to address any misperceptions or fabrications. This is not meant to be a point by point rebuttal, as the talking points should focus on addressing the core issues.
- Communicate with all stakeholders – while a short attack is focused on the stock price, all stakeholders will have questions and concerns, so there should be an integrated communications response that reaches shareholders, employees, customers, and other key partners. In certain situations, a press release may be the best way to reach all stakeholders.
- Contact top shareholders and analysts – the short attack will impact all shareholders, but in the interest of time, ensure covering analysts understand any issues with the short’s thesis.
- Research and understand your adversary to anticipate potential next moves – not every short activist is the same and not every campaign is the same, but it is important to understand how the activist has behaved in the past in order to anticipate and prepare for potential follow on attacks.
- Start getting back on your front foot to tell your story – the short activist has the first-mover advantage and while the attack may have the company on its heels initially, it is important to find opportunities to regain control of the narrative and get back to telling your story.
With markets reaching new highs, valuations expanding, and a more accepting marketplace for short sellers, companies should be prepared to respond to an attack by regaining control of the narrative, directly addressing the short thesis and engaging with key stakeholders to counter any misperceptions. More importantly, finding ways to proactively get back to telling your story, your way, is key to regaining control of the narrative.
By Phil Denning, Partner, ICR
