Do Hedge Funds Create Value? 3 Lessons From Danone And Unilever
On March 15, 2021, activist hedge fund managers forced Emmanuel Faber out as CEO of multinational food company Danone, arguing that the company was underperforming financially in its dairy and water brands.
It is true that Danone’s financial performance had been lacklustre relative to its peers. From the time that Faber took over the company in 2014, its shares had risen by only 11%. The shares of one of its closest competitors, Unilever PLC, had increased by 55% over the same period.
Both Danone and Unilever were led by CEOs who were titans of the corporate social responsibility (CSR) movement and transformed their firms into beacons of what a ‘good’ firm could be. This made them targets of activist hedge funds. However, Unilever’s former CEO, Paul Polman, was able to deflect hedge fund activism, whereas Faber was not. It is worth understanding why.
Danone’s Leadership in Social Responsibility
Emmanuel Faber had an impressive track record of championing CSR at Danone. Under his leadership, the company aligned its 2030 goals with the UN’s Sustainable Development Goals. Like many companies, Danone had committed to reducing its CO 2 emissions; unlike most, though, it targeted reductions not only for carbon emitted in its producing products but also in how the products are consumed. What’s more, Danone not only committed to 100% renewable energy by 2030, it adjusted its Earnings per Share (EPS) by the estimated financial cost for carbon-called a “ carbon-adjusted EPS.” All of this and more led Danone to announce in 2020 that it would be investing €2bn towards climate action.
But, Faber wasn’t happy with just dealing with climate change, he was also leading the charge in tackling biodiversity loss. Faber advocated for regenerative agriculture, stating, “The biggest risk that I think we face as a species is the lack of biodiversity of the ingredients, seeds and animals that are used to make our food.” To support the biodiversity cause, Danone supported over 100,000 farmers through the Danone Ecosystem Fund and Livelihoods Funds.
All of these initiatives cost money and the returns take a long time to manifest. This makes socially responsible companies the targets of activist hedge funds, whose managers smell an opportunity for short-term gains.
Activist Hedge Funds Attack Socially Responsible Corporations
In the U.S., hedge funds do not have to disclose to the SEC any intentions to exert control of a company if they own less than 5% of a company. These small stakes can still have huge impact, as we have seen at corporate giants like Exxon and Nestle. Even small hedge funds can have significant influence if they get others to join their pack, as Bluebell Capital had with Danone. These so called ‘wolf packs’ of multiple funds coordinate their activism to exert enormous influence on the governance of the firm.
A study by Mark DesJardine, an assistant professor of strategy and sustainability at Pennsylvania State University, with colleagues showed that hedge funds are likely to target corporations that are socially responsible, especially when the company stands above its peers — as was the case with Danone and Unilever.
These hedge-funds managers see an opportunity to score quick financial wins. They strip companies of seemingly unnecessary expenditures, such as Danone’s investments in low-carbon technologies and regenerative agriculture, to increase the firm’s value.
But, here’s the rub. Another study by Mark DesJardine and Rodolphe Durand showed that, on average, activist hedge funds are able to extract short-term value, but they erode long-term value. The share prices of the companies hedge funds attacked increased by 7.66% in the first year, but they had fallen by 4.92% in the fourth year and 9.71% in the fifth.
These hedge funds garner short-term wins by cutting the workforce, reducing operating expenses, and investing less on R&D, capital, and CSR. The company improves short-term cash flows, but reduce the company’s ability to innovate and erodes its ties to the community. By the third year, the targeted companies are in a cash crisis.
It is a terrible fate for the company and for society as the company’s CSR efforts are stripped.
DesJardine interviewed hedge-fund managers from around the world as part of his research. He consistently found that, more than any other type of shareholder, fund managers discount future cash flows and prefer short-term gains over long-term returns. As he said to me, “A company can way outperform its peers in terms of social responsibility, and only marginally underperform financially. Yet it will still be targeted by hedge funds and stripped of all the good it is doing, while ultimately reducing long-term profits. What sense does that make?”
Short-term gains, long-term pain.
Activist Hedge Funds Are Growing in Number and Power
This problem is not going away. The evidence points to a massive growth in activist hedge funds. Until 2019, the number of activist campaigns and companies targeted had been growing steadily in the last two decades. The global pandemic put a pause on this increase; however, the COVID-19 effect seems to have worn off, as Q4 of 2020 saw a 128% global increase in the number of activist campaigns over Q3 levels.
The assets managed globally by hedge funds has also grown exponentially in the past two decades, increasing from $118bn USD in 1997 to just over $3,826bn USD in 2020.
What’s a Company to do? Take a Page from Unilever’s Handbook
Paul Polman, former CEO of Unilever, was able to side-step the activist hedge funds even though his company also went down a progressive social responsibility path. The company performed better financially than its peers over the 10-year period he was CEO. Polman and Faber, alongside their companies, were the titans of the CSR community.
Polman not only put Unilever on a strong path of corporate profits but also took major leaps forward with Unilever’s Sustainable Living Plan, which promised to double the company’s revenues and halve its environmental footprint within a decade.
So what did Polman do that other CEOs can learn from?
First, he actively sought to reduce hedge-fund ownership before he announced his Sustainable Living Plan. By stopping quarterly earnings reports and earnings guidance, hedge funds lost interest in Unilever. Polman was telling short-term shareholders to take their money elsewhere.
Polman paid a price in admonishing short-term investors. Unilever’s share price dropped by 22% after these announcements, relative to the FTSE 100’s 16% overall drop during the same period. But the move gave Polman the latitude to make investments in the Sustainable Living Plan and to buy such sustainability-oriented companies as Seventh Generation and Dollar Shave Club.
Second, instead of letting the company be sitting bait, Polman took aim at the wolf pack. When Unilever faced a takeover bid by Kraft Heinz, which is backed by Warren Buffet and Brazilian private equity firm, 3G Capital, Polman sent letters, lots of them, to Kraft Heinz lawyers and investors, including Warren Buffett. He also started an opposition campaign from Unilever’s community supporters, including charity workers, unions and shareholders. He even lined up U2 frontman Bono to write a song. Unconventional tactics to be sure, but they fended off the attack.
3 Leadership Lessons from Faber’s Experiences
The investor and social responsibility communities can learn from Faber’s high-profile resignation and Polman’s high-profile tactics. Here are three lessons.
1. Know your investors
A bunch of passive shareholders do little good for a company that’s facing a pack of activist shareholders. CEOs must carefully select their investors not only for their willingness to invest in the long term, but who are also willing to actively say ‘no’ to activists looking for short-term gain. With the growth in passive shareholders, CEOs must be especially diligent in finding active opponents to short-termism.
2. Ensure you create short-term and long-term value
Companies that genuinely want to pursue sustainability need to focus on long-term gains-but, they can’t be at the cost of persistently low short-term performance. These companies must invest in initiatives that take time to generate returns, such as infrastructure, technology, innovation, and the community. But, they can’t lose sight of the day-to-day cash flows and revenues.
3. Use the power of the collective
When people have invested substantially in doing the right thing, they are often willing to stand up for what they believe. Nothing is more powerful than people who believe in a set of values. If your company is committed to social responsibility, engage these folks and have them invest, even small amounts, in the company. Activism has two sides — one that destroys long-term value and the other that seeks to protect it. Creating a counterbalancing force can help protect the company for the good work it needs to do.
Many executives may wonder if Faber’s experiences shows that CSR does not pay. That is the wrong lesson. Instead, the lessons should be about how corporate executives to manage activist hedge funds. It’s a mistake to accuse the victim and not the assailant.
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Originally published at https://www.forbes.com.
