Hedge-fund Bullies

Activist fund managers can be brutal, but there are ways to fight back.

Good performance, of course, is the best way to keep activists at bay. But bad accounting or poor reporting can fuel aggression like little else, says Mark Sunshine, president and chief operating officer of First Capital, a West Palm Beach, Florida-based firm that provides back-office accounting services to hedge funds and lends money to companies in the funds’ portfolios. If activists “get squishy answers” to their accounting questions from their target companies, he says, “they go nuts.”

Another way to avoid straining activist nerves is to refrain from firing off confrontational comments. “Public statements can be very dangerous,” says Henry Gosebruch, managing director for mergers and acquisitions at JPMorgan. “So our advice would be: Do not engage in a PR battle with activists.” Exorbitant executive compensation is another attraction for activist hedge funds. (Chapman, for one, takes issue with companies that provide “free stock-option grants that are nothing short of lottery tickets for the recipients.”) Companies that fear an attack should revisit their pay plans.

The Cost of Ineptitude

Just as there are degrees of activism, there’s a range of tactics in defending against it. As part of its Hostile Defense Advisory practice, for instance, JPMorgan works on three levels with clients facing hedge-fund challenges.

The investment bank works with management, the board, and the legal team just after a fund files a 13-D, in what Gosebruch calls a “more reactive setting.” But Morgan also counsels clients before any funds publicly express activist intentions — observing, for instance, that a company with an underperforming subsidiary or a low level of debt might do well to consider a buyback to avert a potentially aggressive move by activists. The firm also advises clients to perform a defense review every 6 to 12 months. The review, says Gosebruch, should look at recent trends in the market, hedge funds that might become agitators or make an offer for the company, and what “the attack theme” might be for potential activists.

Companies under attack might also want to point out that hedge-fund activism doesn’t always turn out so well for shareholders. For example, Chapman’s involvement in Vitesse Semiconductor turned out to be a disaster. Shares in the company were trading at about $1.15 in early May, well off the $1.50 Chapman reportedly paid to acquire his 7.3 percent stake. And Vitesse has yet to be sold, despite Chapman’s calls for a sale. He recently reported that he had reduced his stake in the company to 2.5 percent.

Given the activists’ ability to profit from corporate ineptitude, though, the Vitesse case is more the exception than the rule. “I would hope that we get to the point where Corporate America is sufficiently well run that activist hedge funds no longer have a business,” says Crestmont Research president Ed Easterling. “But as long as we have human nature and misplaced management teams, we’ll have a place for activist hedge funds.”

David M. Katz is deputy editor at CFO.com. Additional reporting by Helen Shaw.

Meet the New Raiders

Activist hedge-fund managers and some of their recent targets.

William Ackman

Pershing Square Capital Management
Ceridian, Borders Group, McDonald’s

Richard Breeden

Breeden Capital Management
Applebee’s International

Robert Chapman

Chapman Capital
Vitesse Semiconductor, Agile Software, Embarcadero Technologies

Carl Icahn

Icahn Partners
Motorola, Time Warner, Blockbuster

Nelson Peltz

Trian Fund Management
H.J. Heinz, Wendy’s, Tiffany

Barry Rosenstein

JANA Partners
Titan International, Mirant

Ralph Whitworth

Relational Investors
Home Depot, Sprint Nextel

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