April 30, 2013 Stephen Taub

Investments like ValueAct’s Microsoft stake and Elliott Management’s proxy fight with Hess are on the rise as activists rachet up their large-cap wagers, new research finds.

A new study has confirmed what has seemed like an anecdotal trend — more and more activist investors are targeting larger companies.

Of 72 financial or board seat activist campaigns so far this year, 29.2 percent have targeted companies with market caps exceeding $1 billion, according to data and research website Sharkrepellent.net. This compares with roughly 20 percent (of 247 campaigns) to 22 percent (of 235 campaigns) the two prior years and less than 7 percent of 221 campaigns in 2009.

Activist campaigns targeting large companies this year include ValueAct Capital’s $2 billion stake in Microsoft, Elliott Management’s proxy fight with Hess Corp. Greenlight Capital’s bullying of Apple to spend more cash on dividends and Carl Icahn’s curious interest in impeding Michael Dell’s attempt to take private the personal computer company he founded.

The trend toward large targets is a little surprising. The traditional view has been that activist campaigns are more likely to succeed with small and midsize companies. For one thing, activists are in a better position to take significant stakes in smaller companies, which gives them more leverage when negotiating with management teams and boards.

In addition, stocks of smaller companies are perceived to be less efficiently priced, since they are less likely to be followed by sell-side analysts and are more likely to be overlooked by investors. As a result, there are more potential gains to be mined if a company takes certain actions, such as selling divisions, recapitalizing or instituting plans to boost margins.

This is the junkyard that Jeffrey Smith’s Starboard Value, a New York City activist hedge fund with $1.3 billion to $1.4 billion of assets under management, likes to sift for undervalued gems. Although several of its recent targets have been larger than in the past, the fund rarely goes above $1 billion in market cap, and usually aims smaller.

So why are activist hedge funds increasingly targeting bigger companies? For one thing, the hedge funds themselves are getting larger as they become more successful. For example, the San Francisco–based ValueAct now manages more than $9 billion, more than double what it managed roughly three years ago.

And most activists like to run concentrated portfolios. If they have more capital, they need to buy stakes in larger-cap companies to maintain a relatively concentrated portfolio and take a meaningful position in a stock.

Activist investing takes more time and is an expensive exercise to pursue effectively, stresses Gregg Feinstein, managing director and co-head of mergers and acquisitions at Houlihan Lokey, a Los Angeles–based investment bank. You really can’t do more than one or two at a time, and they want maybe eight or ten names in their portfolio. And given the expense of running an activist campaign — which can exceed $1 million — activists need scale with the large investment to justify the time and expense.

Of course, you need a lot more money to take, say, an 8 percent stake in a large-cap company than in a small- or mid-cap company, suggesting the activist would enjoy less leverage when negotiating with or making demands of larger companies.

However, experts say that in recent years, more and more institutional investors, such as pension funds, are siding with activists as governance research firms such as Institutional Shareholder Services and Glass, Lewis & Co. increasingly support the activist campaigns. This helps the activists gain more leverage with their target companies, even though they themselves have a smaller piece of the pie.

A number of long-term investors are more supportive of activism, says Bruce Goldfarb, president and CEO of New York–based Okapi Partners, a proxy solicitation firm. And they can collectively hold a significant stake in a large company and make the difference in a campaign. It also helps that activists have been able to refine their image — they used to be known as corporate raiders — and are now often seen as investors with constructive suggestions for boosting the profitability and long-term viability of a company.

In recent cases, activist investors also have been playing big roles in trying to prevent what they deem to be bad deals for shareholders. They include Carl Icahn’s attempt to block Michael Dell’s bid to take the computer company private and Paulson & Co. and P. Schoenfeld Asset Management’s successful campaign to get T-Mobile parent Deutsche Telekom AG to raise its bid for MetroPCS Communications.

Experts stress, however, that although activists have been increasingly targeting large companies, it is not happening at the expense of smaller targets, which are still very attractive. Of course, activists can take more meaningful positions at these companies, so it is easier for them to coax change than with larger targets. Management and boards at smaller companies are more likely to compromise with an activist and agree to place a couple of individuals on their boards rather than go through the expense and time required for a proxy contest, experts say.

Also, small and midsize companies have board members who may not have the experience or skill sets required to move the company to the next stage. Their background may be more limited, says Goldfarb. For example, they may not have run operations of a larger company, or their experience may be in a limited market, geographic or otherwise.

Large companies, on the other hand, may be more inclined to ignore aggressive investors and are in a better position to dig in and absorb the cost of fending them off. Sharkrepellent.net points out that a growing number of large companies are dismantling traditional takeover defenses, such as poison pills and staggered boards of directors.

Says Feinstein, Larger companies are more willing to have a public fight. But these days they are finding their foes to be those brand-name activists who have enlisted a number of allies with sizable stakes of their own.