Some words are so misused that they have to be deleted from the financial lexicon. “Stake” is an example. For many readers, this is a shorthand for “shareholding”. This suggests that when sophisticated investors, such as Patrick Drahi or Elliott Management, take an “interest” in a publicly quoted firm, their interests are now closely aligned with ordinary shareholders in BT Group or GSK.
Investors have traditionally paid to gamble if they want to intervene in how companies are run. Impact is deemed proportional to their cash expenditures on ordinary shares.
But it will make activism, which depends on winning the support of long-term investors, an expensive business. The professionals therefore often use derivative instruments and leverage to get cheap voting rights. They can also avoid the disclosure of significant possession that would otherwise apply. They do this by using voting rights via investment banks that enjoy important disclosure exemptions.
Their actual exposure to gains and losses can be much lower than that of the so-called long-term funds that invest for pension schemes and insurers. Management and the media can therefore overestimate activists’ real financial commitment – and thus the alignment of their interests with other investors.
Activists and other corporate poachers are generally a good thing. They challenge complacent bosses and highlight failed strategies. To be fair, they rarely use the word “stake”, preferring vague phraseology. But it’s time for them to face a little more challenge over their own actions.
Elliott is the easiest example to start with. The New York Hedge Fund is considered the world’s most influential activist, and has won some notable victories over people like BHP and Alliance Trust. In the United Kingdom, it is involved in GSK and SSE, where it advocates dispositions, and with Taylor Wimpey, where it requested a management overhaul. In announcements, he described himself as holding a ‘significant position’ in the pharmaceutical group and a ‘top five investor’ in both the energy supplier and the home builder.
Databases such as Bloomberg and S&P Global do not record shareholder register data to indicate that Elliott has direct interests of any size in any of these companies.
It is at such moments of doubt that PR people come together to explain to the poor, naive financial writer that hedge funds like Elliott get their exposure in more efficient ways. The problem with the explanation is that these exposures are rarely disclosed in any detail, so the actual extent of their investments can not be verified.
A bit of hygienic sunshine fell on them in 2019 via Securities and Exchange Commission filings about Sherborne’s failed investment in Barclays. The American activist has demanded a 5.5 per cent investment in the British bank, supposed to be worth about £ 2 billion. It turned out two-thirds of this “interest” was took into consideraton through a cap-and-collar derivative transaction with Bank of America. It limited profits and losses and guaranteed a $ 1.4 billion loan.
The French tycoon Drahi could theoretically have used similar methods to finance the 18 percent shareholding acquired in BT by its highly-leveraged telecommunications group Altice. One way to raise debt to pay for a portion of this would be to pledge shares through an option to sell them at a fixed price in a transaction involving an investment bank.
Assuming just under 10 percentage points of Altice’s interest was covered by such an arrangement, its net unhedged exposure to BT would be more than 8 percentage points. The company will still have 18 percent of the vote on any major strategy change.
Some City of London professionals believe such an arrangement exists, or exists. Others dismiss the idea as a conspiracy theory. Altice declined to comment. However, its own European business was valued at just € 5.7 billion in last year’s buyout of minority shareholders, when net debt was around € 30 billion. Buying a non-leveraged £ 3bn shareholding in BT could be a bit much for Altice.
It is customary at this stage in a financial opinion column to demand greater statutory disclosure. But I do not think more regulation will help. Sophisticated investors and their investment banks will quickly find ways to play their cards near their chest.
A simpler correction would be for general managers and long-term funds to be more skeptical. They need to challenge activists and other sophisticated investors to report their detailed exposure to a target company with a signature from an investment bank. If the wheeled dealers refused, it would be reasonable to wonder why. And we need to stop throwing that silly word “stake” around.