Activist Investing – What You Need To Know

As activist investing in the oil and gas industry metamorphoses from a growing trend into a situation that is starting the rule the day, investors and industry experts alike are starting to wonder whether this is really beneficial for shareholders-and for the American economy in general.

What is an Activist Investor?

Activist investors-also often referred to as "activist shareholders" or "dissident shareholders"-are typically individuals or groups, such as hedge funds, that attempt to fundamentally change a company by acquiring large shares to obtain seats on the board and forcing emergency general meetings (EGMs) to take over a company and remove its management to this end.

This is a phenomenon that has gained momentum in recent years, and which can be particularly prominent in times of oil and gas market crisis and price slumps. The year 2013 was dubbed by many as the year of the activist investor, and indeed, that year saw more than 200 activist campaigns across business sectors.

The shale oil and gas boom and the hydraulic fracturing revolution created a great deal of market turbulence, which was compounded with the dramatic drop in oil prices that began in third and fourth quarter of 2014. The activist investor has emerged out of these new oil and gas realities as a very prominent force pushing shareholders to go to great effort themselves to ensure higher returns.

The trend began in the 1980s-but then its 'pioneers' were called 'corporate raiders'. Since then--and particularly since 2013--activist investors have begun to win approval from large institutional shareholders.

Recent E&P Activism

• Activist investor Carl Icahn pressured the board of Chesapeake Energy to get rid of CEO Aubrey McClendon, forcing his resignation in April 2013, and the replacement of almost the entire board.

• Elliot Management Corp. took on John Hess, chairman and CEO of Hess Corp. in May 2013, keeping him on as CEO but forcing him out of the chairmanship. The restructuring saw Hess start shedding non-core assets and giving more back to shareholders.

• Deepwater driller Transocean was also targeted in 2013 by Icahn, who managed to win enough proxy votes to force a leadership change in the company; again the result was a slashing of costs and more dividends for shareholders.

• Occidental Petroleum Corp.'s CEO, Ray Irani, was forced out in May 2013 by activist shareholder First Pacific Advisors LLC.

• In August 2013, Murphy Oil Corp. was forced by activist investors to pay shareholders a special dividend and spin-off its retail gas business.

• In June 2013, activist investors forced out SandRidge Energy's Tom Ward.

What motivates activist investors?

In most cases, activist investors are interested in one thing-superior shareholder returns. Typically, in US case studies, this is not about control, but about improving the bottom line. In rarer cases, the interest is a hostile takeover, on the pretext of poor management and misguided strategy. The strategy is to buy stocks perceived as undervalued and then pressure management to take measures which the activist investor believes will raise the value of the stock.

Is it a positive trend for the industry?

The jury is still out on this, and deliberations will be lengthy and painful. On one hand, shareholders will take note that activist investors-and institutional investors who are increasingly jumping on their band wagon-are generating positive returns. On the other hand, this could very well be short term only and the economy may soon find that this obsession with immediate financial rewards is not good for the long term. In order for CEOs to fight activist investors, they must be prepared. Being prepared means understanding what motivates the activist investor and putting a very clear strategy in place that can serve as a viable alternative for shareholders who may be convinced to support activist investors. Shareholders are becoming much more assertive; so, too must CEOs.

It's getting trickier by the day. Earlier this month, Chesapeake Energy went as far as to file a lawsuit against its founder and former CEO, McClendon, alleging he stole confidential company data during his last months on the job in order to launch his new oil and gas empire. According to the lawsuit: "McClendon misappropriated highly sensitive trade secrets from Chesapeake and subsequently used these trade secrets for the benefit of a company he founded in 2013, American Energy Partners LP."

Among the allegedly sensitive information are said to be maps and data about unleased acreage. Chesapeake alleges the information was used by McClendon and American Energy Partners to acquire drilling rights on land in the Utica Shale formation in four separate transactions. Chesapeake is seeking damages in this case for violations of the Oklahoma Uniform Trade Secrets Act. Even more significantly, the lawsuit is asking for American Energy Partners' income from its Utica Shale plays to be placed in a trust. The Utica shale income, they say, belongs to Chesapeake.

McClendon-who built Chesapeake up from nothing, but whose methods have been controversial and eventually led to his overthrow-insists that he was entitled to own and use the information in his possession by contractual right and that his agreement with the company gave him broad and deep information rights. Regardless, this activist investment scenario will be caught up in a fierce legal battle for some time to come-and we're not sure how that will ultimately benefit shareholders.