June 27, 2017

Malaysia Airlines: You’ll Find More Success Flying a Magic Carpet Singing, “Icahn Show You the World…”

Malaysian Airlines in the early years

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The Malaysian airline disappearance is dominating the headlines. Where is that plane, anyway?

Well, perhaps the airline company and others can take a cue from the growing trend of successful activist investors’ results. Carl Icahn is the most notorious of the bunch and has the track record to back up his requests. If he had a message at this time it might be, “Hey, Malaysia Airlines: You’ll find more success flying a magic carpet singing, “Icahn Show You the World…” The Economist gave a nice summary of the story.

A visit from an activist shareholder is now a possibility for any publicly traded company: if not the 77-year-old Mr Icahn, then one of the growing army of younger imitators he has inspired. Mr Cook was first put under pressure to “stop hoarding cash” last year by David Einhorn, boss of Greenlight Capital, a hedge fund. Having shaken up Yahoo’s management and strategy in 2012, Dan Loeb and his fund, Third Point, have turned their attention to Sony, calling for it to separate its electronics and entertainment arms; to Sotheby’s, an auction house they want to repurchase shares; and to Dow Chemical, which they want to shed its petrochemicals business.

Nelson Peltz, who has been a shareholder activist almost as long as Mr Icahn, last month joined the board of Mondelez, a snacks business he had targeted. TCI, a London-based fund run by Chris Hohn, has rediscovered its activist mojo after having been badly hurt by the financial crisis. Last year it urged EADS (now Airbus Group) to sell its military-planes business, and took on the management of Japan Tobacco. Steve Ballmer was helped on his way out of Microsoft’s top job by ValueAct Capital, run by Mason Morfit.

Last month Bill Ackman’s Pershing Square made a tasty profit when Suntory acquired Beam (the maker of Jim Beam bourbon), which had been spun out of Fortune Brands as a result of his activism. But Mr Ackman has also demonstrated that activists have no monopoly on wisdom: Ron Johnson, the new boss he lobbied for J.C. Penney to install in 2011, made things worse at the struggling retailer, and lasted just 17 months. Mr Ackman has been at loggerheads with Messrs Icahn and Loeb over Herbalife, a nutritional-supplements business. Mr Ackman has shorted its shares, calling the firm a “pyramid scheme” (a charge Herbalife denies). His rivals have gone long on them. So far, Mr Ackman is out of pocket.

It is the way these profits are made that is the focus of the activists’ critics. Activists usually buy a block of shares, make a public call for change and lobby management and other shareholders to implement it. When they do, the activists sell at a profit. Martin Lipton, a lawyer, argues that activists encourage firms to do things that boost their share price in the short run but harm their long-term performance.

Where’s the evidence?
Yet empirical proof that activists exacerbate short-termism is strangely elusive. Indeed, such evidence as there is suggests the opposite. “The Long-Term Effects of Hedge-Fund Activism”, a recent paper by Lucian Bebchuk of Harvard Law School and others, examined the roughly 2,000 interventions at companies by activist funds from 1994 to 2007. Over the five years following an intervention both the share price and the operating performance of the target company improved, on average. The operating performance got stronger towards the end of the five-year period, not weaker.

Boards have an obvious motive to back curbs on troublesome activists. But a better strategy—and one that big firms are increasingly adopting—is to talk to them, consider their ideas and even invite them or their representatives to become directors, as firms from Microsoft to Mondelez have done. If a board’s strategy is in fact better than that proposed by the activist, having the debate in public may strengthen the incumbent management, as happened when activists took on firms such as AOL, Target and Clorox.

Indra Nooyi, the boss of PepsiCo, chose to work with Ralph Whitworth, a veteran activist who took a stake in the company. By doing so she was able to head off calls for a break-up of the firm (led by Mr Peltz), while still boosting its shares, thereby restoring her authority. Mr Donohoe’s encounter with Mr Icahn may prove less nightmarish if he treats his ideas about eBay on their merits rather than dismissing them out of hand.

So what do we get? Professional investors, especially in private equity and hedge funds, may have great ideas that should at least be considered. It’s the new corporate governship. So if Carl Icahn shouts, “Hey, Malaysia Airlines: You’ll find more success flying a magic carpet singing, “Icahn Show You the World…”,” they might want to at least hear what they have to say.

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