Activists Increasingly Seeking Out E&S Laggards

The number of global activist campaigns dropped 10% in 2020 compared to the prior year, largely due to sensitivities around the COVID-19 pandemic. After sitting on the sidelines for most of 2020, activist campaigns are expected to starkly increase in 2021, and activists may be less willing to settle after a year on hold.

Traditional activism (or headline grabbing activism) targets financially underperforming companies and seeks to win board seats or oust management. These activists notoriously target companies due to a perceived mismanagement of the Company’s operations, M&A decisions, or capital allocation strategy.

Recently, however, activist campaigns have increasingly targeted companies that underperform on ESG issues as well. These campaigns will cite oversight failure on ESG factors as one reason for starting a proxy fight.

While the traditional activism approach is still prominent, companies that struggle with ESG issues are becoming increasingly popular targets. Safe to say, companies that are perceived to be financially underperforming and perform poorly on ESG metrics are extremely vulnerable to the threat of a successful activist campaign.

Traditional Activist Managers and ESG Campaigns

Historically, activist investors identify potential targets by finding companies that were underperforming relative to their industry or made questionable capital allocation decisions. Lately, activists have begun to cite environmental and social concerns as part of the rationale behind the need for a strategic shift. Below are three high profile examples from the past few years:

1. Evergy, Inc. (Targeted by: Elliot Management)
   • Campaign: For most of 2020 Elliot pushed the company to implement a new “high performance path” or to explore a merger. The performance path included a slew of environmental related metrics, amongst other items.
   • ESG Metrics: Increased mix of renewable energy, reduced carbon footprint, closing of coal plants, shifting towards more wind and solar energy.
   • Result: Evergy conceded two board seats in late February 2021.
     
     
2. Prudential plc (Targeted by: Third Point LLC)
   • Campaign: Third Point applied pressure in early 2020 to separate the insurer’s US and Asian business, citing that the two should not be held under a single British holding company. The campaign also cites carbon footprint as a key reason to pursue the breakup.
   • ESG Metric: Reduced carbon footprint
   • Result: Prudential has announced the separation of the businesses through a demerger that will take place in Q2 2021. Third Point praised the decision and applauded Prudential’s recent focus on board talent, board diversity, and ESG factors.
     
     
3. L Brands (Targeted by Barrington Capital Group)
   • Campaign: In March of 2019, Barrington applied pressure for L brands to break up and replace its directors. The major thesis was that Victoria’s Secret’s brand image was ‘outdated’ and ‘tone deaf’ to women’s developing ideas of beauty, diversity, and inclusion. Barrington also cited concerns of a stale board with low independence and diversity levels, and a combined Chair/CEO.
   • ESG Metrics: Diversity and inclusion, consumer preferences, board diversity and refreshment, board independence and leadership.
   • Result: Soon after the campaign began in 2019, L brands elected two new female directors. In February of 2020, the Company sold Victoria’s secret to a private equity firm. At the time of the deal, L brands also announced the CEO was resigning and the 3 longest tenured directors on the board were stepping down. The board was also declassified and supermajority voting requirements were removed from the Company’s bylaws.

ESG Specific Activist Funds

Another way ESG has found itself within the activist space is through the creation of activist hedge funds that specifically seek out companies with poor ESG oversight and risk management. While more of these funds are expected to be created in the future, below are three high profile ones:

• Engine No. 1: Launched in December 2020, this impact-investing activist is already making headlines with its campaign at Exxon, Inc. Engine No. 1 cites concerns with capital allocation, a long-term strategic plan, poorly structured executive compensation, and poor shareholder return. The strategic plan cited by the activist includes investing in clean energy to ensure Exxon can commit to emission reduction targets and accuses Exxon for falsely claiming to be aligned with the Paris Agreement.
  • Update: On March 1^st, Exxon added two directors to its board in an effort to ease criticism on its capital allocation and environmental practices. These directors are Michael Angelakis (ex-executive of Comcast) and Jeffrey Ubben (an ESG activist investor). In response, Engine No. 1 announced they will continue their campaign for 4 board seats.

• Inclusive Capital Partners: Founded by Jeffrey Ubben in 2020, after the long-time investor left ValueAct Capital Partners. Inclusive Capital Partners is a socially responsible investment firm that will target companies with poor environmental and social profiles. The fund plans to build stakes in roughly 15 companies that are the “very companies that sustainable funds tend to avoid.”

• Impactive Capital: Led by Lauren Taylor Wolfe and Christian Alejandro Asmar, the long-term and ESG oriented fund has a $250 Million commitment from California State Teachers’ Retirement System (Calstrs) with a six-year investment horizon.

Investor Sentiment on E&S Topics

If the activist and the target company fail to reach an agreement on the concerns raised, then a proxy contest is likely to soon follow. This is where a company’s lackluster E&S performance provides a huge opening for activists. Where institutional investors have publicly endorsed the importance of ESG-related disclosures, there is an increased likelihood of voting in favor of a campaign citing the same concerns. Of late, institutional investors have stressed the following:

• Larry Fink’s letter to CEO’s made it clear that Blackrock is prioritizing sustainability and diversity in 2021.
• Vanguard’s 2020 Investment Stewardship Report adds extra emphasis on the importance of diversity and climate change.
• State Street’s Letter from the CEO on its 2021 proxy voting agenda describes “our main stewardship priorities for 2021 will be the systemic risks associated with climate change and a lack of racial and ethnic diversity.”

These three asset managers alone manage over $15 trillion in assets across the world but are far from the only asset managers that will be focusing on ESG issues in 2021. During this proxy season, investors are expected to focus on climate change and sustainability, human capital management, diversity and inclusion, corporate political contributions, and alignment of executive compensation with company performance.

To emphasize how E&S issues are increasingly important for investors, we can analyze E&S shareholder proposals as a proxy for investor sentiment. A few note-worthy statistics are provided below:

• Average support for climate-related shareholder proposals rose to 31.6% in 2020, up from 24.1% in 2019.
• Support for proposals relating to board diversity reached average support of 36.8% in 2020, more than doubling the 18.3% support received in 2018.
• Workforce diversity proposals averaged 38.2% support.
• 7 shareholder proposals covering human capital management received over 50% support in 2020.
• Shareholder proposals on political activity have seen significant increases in support levels over the past 5 years.

Conclusion

With many E&S issues being of heightened significance to investors after the COVID-19 pandemic, activism experts predict that campaigns will increasingly target poor performing ESG companies for years to come. Activists are already increasingly using ESG issues to open the door for a campaign and win over institutional investors’ support. For companies looking to reduce the risks of activists taking a position in their stock, assessing performance in ESG metrics and reporting has never been more important.