In recent years, shareholder activists have shied away from the energy sector. Not anymore: As of the end of June, as many as fourteen 13D filings involving energy companies had been filed over the course of the previous twelve months.
Stephen Gill, who concentrates his practice on M&A, has represented publicly traded energy companies involved in transactions that were challenged by shareholder activists. Recently, he advised Rice Energy in its $6.7 billion merger with EQT Corp., a deal that drew the attention, of not one, but two activist investors.
Gill sat down with 13D Monitor to discuss the pace of shareholder activism in the energy space and how energy companies can defend themselves from activist attacks. The following is an edited version of the conversation.
What factors do you think have contributed to the rise of shareholder activism in the energy sector?
The recent rise in oil prices has refocused activists on the energy space. Also, there were a significant number of energy industry bankruptcies following the oil crash of late 2014 and early 2015. Those companies emerged from bankruptcy with strong balance sheets but a very different shareholder base, one dominated by traditional debt investors. These debt investors are very different from the equity investors that energy companies and their boards had worked with in the past. This has created some interesting dynamics and has led to increased activism.
What was it like advising Rice Energy, a company that was targeted by two separate activist investors, each operating independently?
Best analogy: Playing three-dimensional chess on the back of a moving flatbed truck. It’s invigorating, but there’s a sense of accomplishment and relief when the game is over and the truck stops.
The spotlight and emphasis on ESG-responsible investing has become more pronounced. How does the increased level of awareness and interest around environmental sustainability impact engagement in this sector?
The addition of any driver of engagement is generally a good thing. Engaging with shareholders about ESG-related issues provides an opportunity to engage with them about other concerns they may have and build a track record of engagement that will be invaluable if an activist ever appears.
In 2013, you noted that almost all target companies in the energy sector came under attack for insufficient corporate governance practices. Is this still the case? What have been the other characteristics of energy companies targeted by activists? What steps can an energy company take to reduce its vulnerability to shareholder activism?
The best “moat” for any company in any sector, energy or otherwise, is great performance. Corporate governance becomes more of an issue when a company has disappointed on performance and an activist is looking for mechanisms to change the management that oversaw the performance problems.
The key to reducing activist threats is to be thoughtful and to continue engaging with your shareholder base so they understand why any disappointing results occurred. A board can’t have the mindset of “We’ll fix the operational hiccups first, and then we’ll engage with our base.”
Is activism practicable in an industry where the price of the commodity could trump any benefit from the activist catalyst?
The best answer is a rhetorical question. Does good management matter in an industry highly sensitive to commodity price changes? I think most would answer “yes.” So, if good management matters, then bad management matters, and if bad management matters, then activists will likely believe they could catalyze improvement.
A number of activists don’t have a firm understanding of the energy space. Ones that do have a strong grasp of the energy sector can be very successful.
That being said, I think a number of activists don’t have a firm understanding of the energy space. Ones that do have a strong grasp of the energy sector can be very successful. Ones that don’t might catalyze change, but also create a whole new set of problems. Institutional investors asked to choose between management and activists should focus not only on management’s performance, but also on an activist’s track record in the space.
To what degree do you think the 2017 tax reform legislation will affect activism?
Moderately. Boards of even the most successful companies realize they can’t sit on a bunch of cash for long. Also, a single-issue “management hasn’t allocated cash from 2017 tax reform properly” campaign wouldn’t have much teeth in it from activists.
When energy companies become targets of activists, what types of themes resonate with shareholders and what types do not?
Management teams who can plainly and credibly explain their business plans are the most successful. Companies that have struggled have had a difficult time articulating their business plan. Companies with perceived excessive executive compensation programs have also been vulnerable.
What is the most important thing an activist could do to be well received by management?
Be authentic and genuinely open to working constructively with management. A board is still composed of human beings, and it is difficult for any human being to work constructively with someone they feel is being disingenuous or hiding the ball with respect to their goals.
What trends do you see in shareholder activism and in the energy industry?
I think activists will continue encouraging producing companies to spend within cash flow. With memories of 2014 and 2015 still fresh in their minds, I think investors are going to continue to demand capital discipline. Of course, there will be consequences: I believe capital discipline will lower production and create opportunities for PE-sponsored companies to gain market share.
I also think in certain areas, you’ll see activists continue to advocate for M&A. Investors have rewarded companies that have focused on a few or even a single basin, and I think that trend will continue. As the industry gets its sea legs back from the downturn, I believe you’ll continue to see consolidation.