How can the rise of a shareholder activist be detected?

The recent emergence of activists on the shareholder registers of many Pan-European blue chips has highlighted a new type of risk for Finance Directors. This risk, related indirectly to MiFID and to liquidity fragmentation, is that of being caught by surprise by the eruption of an activist… Open Expert File

Author: Benedicte Thibord – Sales and Marketing Director – France

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A summary for Finance Directors

The recent emergence of activists on the shareholder registers of many Pan-European blue chips has highlighted a new type of risk for Finance Directors. This risk, related indirectly to MiFID and to liquidity fragmentation, is that of being caught by surprise by the eruption of an activist. The risk is not so much about control of your company, but more about interference, rise of a shareholder activist plus the time and resources that have to be expended to deal with activist demands.

How can a corporate accurately monitor its trading flows when the primary markets now account for less than half of total equity volumes? Many corporates admit to being “blind” and devoid of regular, reliable, information on this topic. Unfortunately, it’s no longer sufficient to have a friendly contact on a trading floor who may be able to explain unusual flows or an erratic share performance.

1. What are the implications of MiFID2 for liquidity fragmentation?

The first change of real significance dates from 1 November 2007 with the implementation of the European Directive on Financial Markets (MIF). The underlying objective was to create competition between the various platforms where orders were executed, i.e. Executive Recruitment with Investment between the primary markets (for example, Euronext in France) and Multilateral Trading Facilities (MTFs).

This has lowered transaction fees (the original objective) and accelerated the development of algorithmic trading and other electronic solutions (so-called “low-touch” trading, as opposed to “high touch” — more commonly known as voice trading). On average, 75% of European blue chip volumes (66% of midcap volumes) are now traded on low touch systems.

However, the growing diversity of platforms and solutions (dark pools, systematic internalisation (SI), intraday fixing, etc.) has also reduced visibility for finance departments on their volumes traded. It is not unusual for the primary market today to rise of a shareholder activist account for just one-third of a blue chip’s total traded volumes. Liquidity and volumes have become so fragmented that monitoring the plethora of trading platforms is becoming a near-impossible task for most finance departments.

2. What are dark pools and how do they function?

A dark pool is an automatic transaction system that, as the name suggests, is opaque (put simply, orders are not visible to other investors). The transaction only becomes visible once it has been completed (post-trade transparency).

Dark pools allow investors to trade significant positions anonymously, without any market impact. It is for this reason that they are often used by activists to build up a position quickly and unobserved.

On average, dark pools account for 4–6% of a European blue chip’s total traded flows. When these flows regularly exceed 20–30% and/or occasionally peak above 50%, there is reason to suspect that an activist is building a position.

3. How can the rise of a shareholder activist be detected? What mechanisms are available to build a position?

The list of trading opportunities available to an investor wishing to build a position (long or short) is endless.

To start with so-called “vanilla” solutions, the greater the liquidity, the easier it is to build a large position in just a short time. An investor can go to the listing market, seek blocks (although that has the drawback of attracting attention) or turn to dark pools. This latter solution has the advantage of allowing an investor to buy or sell a big stake without making any impact on the market and without being identified.

Then there are “structured” solutions. Changes are visible (i) on the lending/borrowing market and (ii) on the various markets on which the stock is listed. This market practice highlights a major development that should be integrated in any market monitoring: the growing porosity of the various asset classes. For example, the Exane BNP Paribas Daily360 includes the analysis of the lending/borrowing market (shorts), CDSs (credit risk) and options.

In our experience, it is generally possible to spot signs of potential activity by an activist. However, a structured and detailed analysis is necessary to identify true anomalies. Possible warning signs often turn out to be the result of normal activity, such as index re-balancing or a dividend payment. Experience enables an alert broker to distinguish between such cases and potential indications of “real” activity by an activist.

Stakes are usually built up silently, which allows an activist to take advantage of the “announcement impact”, which is generally an increase in the share price of the target. An activist relies on the surprise effect in order to (i) gain most benefit from the announcement and (ii) to catch management out and at the same time render a counter-attack difficult.

A management team that has received an early warning will have had the time to mount a proactive defense strategy, such as carrying out an internal audit, preparing counter-arguments, and, if deemed appropriate, seeking an ally or white knight (BNP Paribas has a unique experience of such mandates, built up over many years). This grace period which may last several weeks but could be just a few hours in the case of aggressive stake-building, is critical.

This document is neither a recommendation nor a piece of technical. Recipients of this document are invited to make their own independent decision to subscribe to the services described herein (the “Services”) based on their own judgment, considering its specific needs and, as the case may be, upon the advice of any relevant and independent advisors they have consulted (including legal, tax, accounting or other specialist advisors). The information contained in this document does not take into account the specific needs of the Services users. Exane cannot be held liable for any damages or losses resulting from the use of this information or part thereof.

Benedicte Thibord, Alexis Basser – May 2021

LEADING A BUSINESS THROUGH IPO, EXIT AND BEYOND

• Deciding whether to float or not?
• Short, medium, long term – the pros/cons of different scenarios
• How to enhance shareholder / stock value
• What are the pitfalls which can result in a flotation and how to avoid them
• What are the Corporate Governance, risk mitigation and due diligence requirements?
• How do you go about assembling an effective Board of Execs and NEDs?
• What are the key skills of a successful Non-Executive Chairman?
• Examples of leading ailing businesses through turnaround and learnings gained.

DECIDING WHETHER TO FLOAT OR NOT?

Need to be certain you want to move into a public spotlight that comes with being listed

Significant greater rules and regulations as a public company

Undergo internal audit to ascertain whether the business is in a position to do so. A full business review

Assessing in advance issues including:

• Corporate structure
• Board structure
• Board and senior management abilities
• Corporate Governance analyses
• Issues which would prevent Listing
• Internal control reviews
• Tax check ups and requirements

UNDERSTANDING THE REQUIREMENTS OF INSTITUTIONAL INVESTORS

• Solid management team
• Proven concept
• Sizeable market opportunity
• Differentiated proposition
• Rationale for joining the AIM
  • Growth Capital
  • Raise profile
  • Incentive / retain staff through tradable equity

The items above should form an executive summary to the superior strategies for business plan and strategy document, together with a financial summary, to use as a preliminary document to start to assist the Company.

IPO PROCESS – PHASE 1 – STRATEGIC ISSUES

Strategic issues:

• Business Plan and Strategy
• Rationale for an IPO
• Capital Structure and Debt Financing
• Intentions of major shareholders post listing
• Issue size and structure
• Timing
• Advisors
  • Nomad
  • Legal
  • Accountants
  • PR
  • Registrars

Indicative AIM flotation timetable

The Advisors

IPO PROCESS – PHASE 2 – PLANNING

Planning:

• Corporate Structure and domicile
• Financial Track record
• Dividend policy
• Board Structure and Corporate Governance
• Incentivisation Schemes
• Employee Participation
• Project Timetable

DUE DILIGENCE

• Financial Modelling
• Long Form report
• Commercial due diligence
• Legal due diligence
• Prospectus Drafting
• Shareholder Agreement
• Underwriting Agreement
• Lock up undertakings
• Roadshow presentation

We will guide you in the selection of the relevant professionals who can provide relevant services around the above activities

COMMERCIAL AND FINANCIAL DUE DILIGENCE

• Detailed operational, commercial and strategic plan for the business
• Business development opportunities
• Detailed budgets and forecasts

At this preliminary stage this only needs to be provided at a high level and in summary form

LONG FORM REPORT

• Nature and scope of business
• Adequacy of accounting systems and internal controls
• Past record of forecasting of results and working capital requirements
• Appropriateness of accounting policies

SHORT FORM REPORT

• Financial Statements and Cash flow for 3 years
• Accountants to confirm that accounts are fair and reasonable

WORKING CAPITAL REPORT

• Statement is required in prospectus / admission document that company has sufficient working capital for the next 12/15 months
• Detailed review of monthly working capital requirements and compliance with relevant covenants together with sensitivity analysis

Not required at this preliminary stage

SHORT, MEDIUM, LONG TERM THE PROS/CONS OF DIFFERENT SCENARIOS Of AN IPO

Short Term (PROS) 18 Months

• Providing access to Capital for growth – Raise finance for further developments as Company grows
• Placing an objective market value on the Company’s business
• Increasing the Company’s ability to make acquisitions (Available Currency)
• Create a market for Company’s shares and broadening the shareholder base
• Encourage Employee commitment and incentivising their long term motivation e.g. share options
• Creating heightened public profile
• Always under promise and over deliver

Short Term (CONS)

• Dealing with increased disclosure and greater Regulatory obligations
• Additional costs associated with new audit fees, investor relations, NEDs, etc.

Medium Term 3-5 years

• Stable Management team pulling in the same direction
• Stay focused on Plan
• Maintain momentum – with shareholders following IPO
• Be transparent – To obtain the long term support of all shareholders
• Consistently meet the delivery or growth plan
• Do not become obsessed with share price

Change Board / Chair at what point and why?

Long Term 5 year +

Investors looking for:

• A committed and experienced management team
• Commitment to strong corporate governance procedures
• A viable Corporate Culture
• Sustainable Competitive position
• Growing business operating in an expanding market, locally and / or internationally
• Visibility and quality of earnings
• In summary: Quality, Good Governance and Value

HOW TO ENHANCE SHAREHOLDER / STOCK VALUE

• Once transformation into a Public Company is complete, it is just the beginning, and company then needs to meet the ongoing obligations of public markets
• Management needs to execute strategic initiatives and transactions
• Invest in good people and continue to evaluate the performance of the Board and management team
• Under promise and over deliver – Turnover, Profits, etc.
• Engage with investors effectively through a clear communication plan
• Manage Risk and Promoting good Corporate Governance , will add value
• Do not over-value the business. This is less important at IPO time.

WHAT ARE THE PITFALLS WHICH CAN RESULT IN A FAILED FLOTATION AND HOW TO AVOID THEM

• Management – Comply with rules, culture, etc
• Need to be sensible when valuing Company
• Investors will not invest in Companies where the Revenues or Assets are not substantiated
• Need a clear vision with credible management team committed for the long term
• Cannot raise all the funds needed
• Down turn in economy and stock market
• Fraudulent information
• Intellectual Property Rights – issues relating there too

FINANCIAL DUE DILIGENCE

The Business Plan prepared by the Company

• Detailed operational and strategic plan for the business
• Business development
• Detailed Budgets and forecasts

Long form report prepared – by the reporting accountants who records the results of the financial due diligence

• Nature and scope of business trends
• Adequacy of accounting systems
• Forecasting, working capital, accounting policies

Short Form Report

• 3 year Financial statements (Audited)

Working Capital Report – 18 Months

Legal including verification of, Material contracts, Underwriting Agreements

WHAT ARE THE CORPORATE GOVERNANCE, RISK MITIGATION?

RISK MITIGATIONS (who is responsible for reviewing Risk mitigation issues)

• Auditors
• Reporting Accountants
• Lawyers
• NOMAD (Nominated Advisors)

All above would assist in ensuring that the information is correct and ensure due care with risk mitigation

The end result being the admission document which is the responsibility of the NOMAD to the Stock Exchange, ensuring everything is correct and verified.

STRUCTURE AND REQUIREMENTS OF AN EFFECTIVE BOARD

Well functioning Board is led by the Chairman

CORPORATE GOVERNANCE FOR GROWING COMPANIES

WHAT ARE THE OBJECTIVES OF CORPORATE GOVERNANCE?

Corporate Governance is the system of processes, activities, standards and reporting to facilitate and deliver growth in long term shareholder value by reducing risk while maintaining a flexible, efficient and effective management framework within an entrepreneurial environment.

It represents a dynamic relationship between shareholders, the Company and the Directors, influenced by a number of external factors including regulation and social responsibility.

It reduces the risk of uncommercial and inappropriate bad decisions being made.

SUPERIOR STRATEGIES FOR BUSINESS GROWTH: QCA Code

THE PRINCIPLES OF THE QCA CODE

• Establish a strategy and business model which promotes long term value for shareholders
• Seek to understand and meet shareholder needs and expectations
• Take into account why the stakeholder and social responsibilities and their implications for long term success
• Embed effective risk management, considering both opportunities and threats throughout the organisation
• Maintain the board as a well functioning, balanced team led by the chair
• Ensure that between them, the directors have the necessary up-to-date experience, skills and capabilities
• Evaluate board performance based on clear and relevant objectives, seeking continuous improvement
• Promote a corporate cultures that is based on ethical values and behaviours
• Maintain governance structures and processes that are fit for purpose and support good decision making by the board
• Communicate how the company is governed and is performing by maintaining a dialog with shareholders and other relevant stakeholders