Smart money: The role of activist investors, Part 1

Posted on Posted in Financial Blog

An activist investor acquires a large number of shares in a target company and takes an active role in the company’s management and other affairs. Naturally investors are looking for the most profitable use of their capital, and they don’t call them activist investors for nothing—so it’s safe to say these people (or groups of people) are looking for companies where they can exert their will and bring about the changes they wish to see. Whether the target firm’s management, board and major shareholders welcome the insight of the activist investor or not, one thing holds true—they usually play ball.

Why do activist investors have so much influence?

Famed activist investor Carl Icahn recently disclosed he has a roughly $2 billion stake in Apple (NASDAQ: AAPL). On Tuesday he made public his belief that Apple should buy back an additional $150 billion in common shares (after the company already bought back $60 billion worth of shares earlier this year). Not coincidentally, the stock closed up +2% after he tweeted about his dinner with Apple CEO Tim Cook the previous night. When the investing community at-large finds out a veteran activist investor has taken a large position in a firm, that firm’s stock usually experiences a pop directly related to that news.

[Finance lesson: When a company buys back its own shares on the open market, that’s usually a good indicator that management believes its shares are being undervalued by the market. Icahn believes Apple stock is headed upwards so his view is that a buyback at the current share price of $480-485 is a “deal” for Apple shareholders.]

The most basic explanation of why activist investors’ voices are usually heard by the executives is that they can sell their position all at once, sending the stock price down quickly and sometimes drastically. Typically a company’s management will control a significant number of that company’s common shares meaning they are the ones hurt most when the price falls—this is reason enough for them to play ball. A single investor (or group of investors) can also start proxy battles, acquire board seats and find all sorts of ways to take at least some amount of control within the company if need be.

At the end of the day the activist investor, management and every other shareholder share the same common goal: making more money. Activist investors typically have impressive track records of turning companies around or increasing their current profitability, so management and the board are usually happy to hear their opinions and appease them whenever possible. Even if Tim Cook decides against taking Icahn’s advice to buy back another $150 in common shares, he will have to give Icahn a good reason or suffer public criticism and maybe even a market selloff of Apple stock.