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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Activist Investors About To Shake Up The Oil Patch

Activist investing has taken off in prominence in the last five years with guys like Bill Ackman and Carl Icahn making a very public case around firms from Herbalife and Valeant to Dow and Apple. With many more investors in the activist arena now and traditional industrial and life sciences companies shaping up their act, activists need to find new targets. The energy sector is a ripe possibility – and current investors in the energy sector should be thrilled.

With commodity prices starting to rebound, energy sector companies are ripe targets for activists. The sector is still in disarray after the oil price crash and that means that many firms have not adjusted to the new environment well. Activists have an opportunity to push inefficient firms to sell themselves to other companies, and they have an opportunity to push firms that have become too conservative in hoarding cash to disgorge those funds via buybacks and special dividends.

Private equity firms are also likely to be taking a close look at opportunities to buy companies in the sector at still distressed prices. Activist involvement could hasten this process. M&A in the market should certainly heat up if activists get more involved. Firms like Weatherford and Franks International have strong business positions and could be attractive targets. The big dilemma in many cases will be that debt is hard to raise for energy companies right now, but all stock deals are certainly a realistic possibility as are bolt-on acquisitions by larger cash-rich firms like General Electric.

Now it is important to note that activist investing has developed something of a bad name. Politicians like Hillary Clinton have decried activist investing as being too short-term and suggested that is causes companies to make bad long term decisions. That’s a misleading critique. The truth is that activist investing simply puts a form of pressure on management to act in the best interests of shareholders. And let’s face it – that is what management is supposed to do. Companies exist not to serve society, but to serve their shareholders by maximizing value through large profits that can be sustained over time. Activists make life less pleasant for company executives and thus serve as an external incentive for management to act in the best interests of shareholders. Few sectors need this incentive more than the energy sector. Related: Is Iowa The Next Nigeria? Arson Suspected in Pipeline Fire

Part of the reason the energy sector got itself into the current mess was a lack of discipline among management teams. Companies were focused mainly on production growth and capitalizing on the euphoria around fracking. That led to some bad internal investment decisions. Those decisions were famously derided in the David Einhorn Mother Fracker presentation. Some of Einhorn’s conclusions may have been exaggerated, but the fundamental theme that energy companies could use some internal discipline on risk is well-founded. And few forces create this discipline faster than the threat of activist investors.

Investors looking to get in ahead of activists should look for firms that are either (1.) small, deeply depressed companies with valuable assets that could be better used by another firm, or (2.) stable businesses that have become too conservative and risk averse. Activists could pressure the former group to sell themselves in M&A deals, and the latter group to make changes to their corporate capital structure or operations to capitalize on opportunities in the market.

By Michael McDonald of Oilprice.com

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  • Robert on August 04 2016 said:
    Yoi have a Ph.D. And I can't believe you said companies have no role in society other than generating maximum profits. That is far from the truth. Companies perform a role to provide a good or service to the public to fill a need. That need to the public benefit is to provide workers with an income in order to provide for the need. It provides shareholders with value or income for investing in them as being capital efficient. So plainly saying companies only exist to pay shareholders is clearly wrong. As an old economics grad I'd say if I answered like that I'd truly have never made it.

    Activist investors are not the answer that will solve it. The debt fueled glut and fight for market share has led to this. Taking advantage of a company by purely manipulating they need help because oil prices are low does nothing. A merger, share buyback, bigger dividend will do nothing to make oil go higher. And that is what is needed. In low oil environments it's best to pare down debt and have high levels of cash. That is the most efficient use of capital. You don't need an activist to tell management that. These people run businesses not stocks. If they are concerned with the stock price at this point they need to find a new job. That's what a real investor wants.

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