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The benefits of thinking like
an activist investor
Whether or not your company is in the crosshairs of activists, assembling a team to take a good, hard look at
your performance can deliver benefits.
Joseph Cyriac, Snezhana Otto, and David Wells
The rapid growth and influence of activist investors often successful because once they’ve made a
has many executives nervously looking over their strategic decision, they commit themselves
shoulders. Even large companies are increasingly psychologically to following through. Even those
vulnerable (Exhibit 1). But there is a benefit to who invite dissent to challenge unconscious
be had by those managers with the courage to take bias expect dissenters to fall in line once a decision
as hard a look at their own company’s performance is made. And in the absence of an occasional
as a performance-minded outsider might. The external point of view, that singular commitment
objective isn’t necessarily for managers to do what can blind executives and board directors to
activists would do—activists’ performance is opportunities as their company, the industry, and
mixed, after all (Exhibit 2). Instead, the goal is for the economy around them change.
managers to examine their own strategy, gover-
nance, and operations with an eye to unearthing Shining light on those blind spots also requires
opportunities to improve performance. more than just a typical strategy review. In our
experience, that’s where an activist role play can
Doing so, of course, requires acknowledging help. Managers give participants in such exercises
vulnerability. Managers, like all good leaders, are (often called a “red team”) deliberate license to
1
McKinsey on Finance 63 2017
Benefits of thinking like an activist investor
Exhibit 1 of 3
Exhibit 1 Activist campaigns against large US companies are on the rise.
Activist campaigns,1 Companies with market Average market cap,
number cap >$5 billion targeted, $ billion
%
46.5
280
25 24.6
108 10
McKinsey on Finance 63 2017
2010 2016 2010 2016 2010 2016
Benefits of thinking like an activist investor
Exhibit 2 of 3
1 Excludes short sellers and gadfly investors. US companies only.
Source: Activist Insight; Capital IQ; McKinsey analysis
Exhibit 2 Activism’s track record on value creation is mixed.
Excess TRS performance of activist campaigns,1 %
Top-quartile companies Bottom-quartile companies
17
16
1 year after 2 years after 3 years after
campaign campaign campaign
–10
–12 –12
1 year after 2 years after 3 years after
campaign campaign campaign
1N = 252 unique campaigns since 2007 across 151 companies trading on US exchanges that had 3-year TRS data available as of Mar 15, 2017 and
market cap at campaign of more than $10 billion and revenues over $1 billion. Excludes activist short campaigns. Excess performance calculated
vs S&P sector index.
Source: Activist Insight; Capital IQ; McKinsey analysis
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challenge their thinking across the board, including strategy review. The tone can be aggressive, even
strategy, performance, governance, and even confrontational. In one pharmaceutical com-
compensation, with no holds barred. That’s the kind pany, the red team’s efforts sparked a much more
of exercise that many activists do when targeting drastic portfolio conversation than the
prospective companies. For those who successfully usual incremental shifting of resources among
emulate activist thinking, the opportunity can be therapeutic areas. Where there was a highly
striking: top-quartile activist campaigns are heterogeneous portfolio, adopting the activist’s
associated with sustained excess total returns to perspective drove consideration of much
shareholders of more than 9 percent even three more drastic portfolio actions for parts of the port-
years out. It can also better prepare managers, who folio that were not a natural fit. This approach
seldom prevail in disputes with activists (Exhibit 3), helped compel executives to take an outside perspec-
to better respond to their overtures. tive and be a catalyst for overdue changes.
Deploying an activist role play The setup matters. In our experience, the activist
The activist mind-set is, at its heart, a hypersensitive role play can liberate management thinking by
focus on shareholder value creation. Learning creating an environment where all options are on
to think that way is usually only possible if senior the table and there are no sacred cows. It is one
managers agree to subject themselves to a role thing to read a report that suggests some changes
play that bulldozes through established patterns of to the operating model, and it is quite another
thinking and deliberately looks for gaps and to be the CEO in the hot seat and be questioned on
missed opportunities. The goal is to emulate performance, competence, board composition,
the most constructive sort of activists who propose and compensation. Moreover, while many CEOs
fundamental changes to improve long-term may believe that everyone in their organiza-
performance—typically supporting their case with tion is empowered to speak out openly and freely,
McKinsey
sophisticatedonoutside-in
Financeanalyses
63 2017 of strategic it’s frequently the case that, at some point
Benefits of thinking
and operational like an activist investor
performance. during a role play, one of the CEO’s direct reports
Exhibit 3 of 3 will sheepishly raise a hand and recall the
Done well, an activist role-play approach is time that his opinion on an important item was
substantially more provocative than a standard unceremoniously quashed.
Exhibit 3 Across sectors, management wins in less than a third of activist campaigns.
Results of activist campaigns against companies with market cap >$5 billion,1 %
55 13 32
Activist wins Settled Management wins
1N = 272 campaigns of companies with market cap more than $5 billion, excluding gadfly investors and short sellers.
Source: Activist Insight; Capital IQ; McKinsey analysis
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Focusing on strategy, performance, unit accountability, investors saw it differently. The
and governance message they received was that these businesses
Mock activist role plays needn’t cover the entire were independent of each other and that the parent
landscape of a company’s business. It’s possible to was effectively a conglomerate. By taking
anticipate where the activists who care about a skeptical outside-in perspective, managers
long-term value creation will focus their attention. realized they needed to change their
That can give companies a good idea of where communications with investors to highlight the
to deploy this approach to examine performance value of cross-selling and other operational
through the external lens of an activist. synergies among businesses.
Portfolio strategy and capital allocation. It can be Assuming that the right portfolio strategy and
hard for companies to admit that a business unit communication is in place, an activist would
in their portfolio would be better owned by another also evaluate whether capital was allocated to the
business, or that a turnaround isn’t, as many most attractive parts of a company’s portfolio.
managers like to think, “just two quarters away.” The skeptical view in an activist role play can
In our experience, this isn’t a sign of empire highlight which businesses should be considered
building as much as it is an indication that manage- a growth and investment opportunity—or
ment teams honestly believe that they are a an efficiency and harvesting opportunity. It can
business unit’s best owner. To them, asking them also evaluate whether the company sufficiently
to divest a business is akin to asking a parent redeploys resources to the businesses it intends to
which of the children would be better parented keep—new growth platforms or businesses
by someone else? with a clear competitive advantage in the market.
Take, for example, the experience of one
But activists have no such misgivings. An activist basic-materials company. By applying an activist’s
will take a hard look at the synergies among a hypersensitive shareholder-value-creation
company’s different businesses—excluding general perspective, managers realized that a legacy
and administrative synergies in corporate vertical-integration play had led the company to
overhead, since another owner of similar scale subsidize a unit that would have been loss-
could reap the same benefits. They will challenge making as a stand-alone entity. As a result, they
the ability of the owner to manage well all diverted growth capital away from this unit
businesses in a diverse portfolio. And for activists, and toward a unit further downstream that could
past performance doesn’t guarantee that a generate more free cash flow.
business stays in the portfolio; they’ll consider any
unit that does not meet performance criteria Financial strategy. Among the most visible targets
as a candidate for restructuring, divesting, of activist demands are financial strategies that
or harvesting. don’t appear to be friendly to investors. Activists
will evaluate a company’s leverage or debt-to-
At times, portfolio strategy may be right, but equity ratios by benchmarking to likely market
that may not be apparent to investors. One bank peers. They’ll ask hard questions about tax
placed a significant premium on reporting efficiency and whether a business has too much or
the performance of each of its business units as if too little debt. And they’ll weigh a company’s
they were stand-alone businesses. While this deployment of excess cash—whether it could be
approach aimed for transparency and business- invested or returned to shareholders.
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The activist lens can compel managers to take
a different perspective on how a company conducts
its benchmarking.
Activist role plays should raise the same questions. equally across all the business units, which was at
Consider the example of one large and high- the heart of the company’s operating mind-set.
performing technology company. Managers and
the board of directors firmly believed that they Similarly, adopting an activist perspective can
should be investing for growth—as they had done help set a higher bar for operating improvements.
since the company was founded decades earlier. At one consumer-retail company, for example,
Indeed, the company had never paid a dividend or managers took an activist perspective on operational
done a large share-repurchase program. How- benchmarking to review their performance goals.
ever, the company had grown to a market value of From the outside in, they realized, an activist would
more than $30 billion and was enormously likely see incremental changes as insufficient.
profitable. It took a hard push by the red team to They then used that insight to build a case for
make managers see that their commitment change with expectations of doubling their margin
to the narrative behind the company’s success improvement and improving working-capital
had to change. efficiency by 50 percent. Companies could go even
further. With a more radical margin aspiration
Operating performance. A savvy activist will and case for change, a company taking the activist
use outside-in assumptions to benchmark perspective may contemplate going beyond
each business segment in a company’s portfolio industry benchmarks and applying a zero-based
against best-in-class peers, as well as the budgeting approach to fundamentally rethink
combined enterprise. parts of its cost base.
The activist lens can compel managers to take Governance. Activists will take a hard look at
a different perspective on how a company conducts company boards to evaluate whether they
its benchmarking. For example, one large constitute strong, competent oversight on behalf of
pharma company was accustomed to benchmarking shareholders relative to entrenched insiders.
performance against its peers. However, when it Companies will need to ensure board members
looked at individual business units in the role have relevant, specific expertise. Ideally,
play, it uncovered a different story and highlighted boards would include both industry veterans
a number of issues in the cost structure of different familiar with what has historically deter-
parts of the portfolio. It was also clear that in mined success and functional experts from other
certain areas, such as consumer marketing, the com- industries that are ahead—in digital delivery,
pany was underspending and there was too much for example. Such functional experts can bring
R&D spend on business units that would not yield a perspective on the trends that will shape
the same return on investment. That challenged the industry’s future. It is also critical that this
the company’s legacy of spreading savings targets expertise is communicated to shareholders.
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Companies will also need to signal strong gover- pressed to dazzle other shareholders with a
nance of the board of directors over management better proposal.
through the following measures:
Pressure-testing corporate strategy from an
outsider’s point of view. Boards of directors often Thinking like an activist can help managers
only think about the activist perspective improve their own performance before they attract
reactively, after an activist has become involved. activist attention. It can also give them
But considering an activist’s mind-set the confidence to push back if activists attempt
proactively can also help directors to review their to intervene.
strategy more rigorously—and leave them
better prepared to respond to activists when they
show up. The board of one large healthcare Joseph Cyriac is a partner in McKinsey’s New York
company has found the outside-in activist role office, where Snezhana Otto is an associate partner
play so valuable in this regard that it involves and David Wells is a consultant.
the board in an activist role play as part of its
annual strategy-refresh process. Copyright © 2017 McKinsey & Company.
All rights reserved.
Linking executive compensation to long-term
value creation relative to the company’s sector.
Compensation provisions can have the effect
of encouraging executives to focus on near-term
profits at the expense of long-term growth.
An activist role play can help board directors
compare compensation metrics with those
of market peers to ensure that management
compensation is aligned to performance
that leads to growth, higher margins, and returns
on capital. Where appropriate, they may also
want to build in clawbacks to discourage short-
term moves. That way, activists won’t be able
to argue that managers are being rewarded more
than their peers for lower performance.
Thinking through these issues can help provide new
insights into how to maximize business
performance, and, in turn, deter activists. The
process will also help companies develop
a response should activists come knocking.
By incorporating value-creating ideas into its plans
and effectively communicating them to
long-term shareholders, companies may find that
even the most astute activists will be hard
