As Oil Price readers know, the tiny activist hedge fund, Engine No. 1, challenged management and won three seats on Exxon’s board of directors back in late May. There is nothing unusual in the fiercely competitive US corporate world about hedge funds managers trying to influence top management to increase their and other shareholder’s wealth more expeditiously. But because of Exxon’s size and its large number of shareholders, it is difficult to launch this type of attempt at shareholder democracy. To make the task more difficult, Exxon’s management. led by CEO Darren Woods strongly opposed the competitive slate of four nominees despite all of them possessing long and impressive energy resumes.
And yet the Engine No. 1 backed insurgents won three board seats out of twelve total. Reading most press descriptions of this upset victory you would think that the young Swedish Activist Greta Thunberg herself was now seated on Exxon's board. And as a result, this electoral upset was touted as some type of victory for the environmental movement. In our view nothing could be farther from the truth. We see two powerful sources for this investor discontent.
First, as an investment Exxon has done poorly. From its price peak of almost $103 in 2014, Exxon’s share price declined by almost two-thirds, to $37, in the depths of the first quarter of 2021. Since then the share price has rebounded to about $53. But for long-term investors their holdings are currently valued at about half of what they were more than five years ago while over this same period the US stock market has risen 150%. This is the first source of investor annoyance with existing management—a profound underperformance of the stock price.
But there is a second part to investor’s discontent and maybe worry, namely Exxon’s hefty dividend, now yielding a relatively high 6.6%. All of the oil supermajors have seen global oil demand battered by the ongoing pandemic with subsequent partial recovery. But Exxon, like Chevron, has paid and often raised its common stock dividend without interruption for over thirty years. For yield-seeking investors this is an enviable “club” to belong to. We believe in voting for a dissident board slate that investors were also strongly expressing their views with respect to maintenance of the dividend.
At the senior management level, maintenance of dividend involves an inherent conflict between those who advocate for a “fortress balance sheet” versus those willing to let short-term leverage run a bit higher in the name of investor stability (i.e financing the dividend out borrowings as opposed to earnings). There are relatively few pockets of high dividend yields remaining in our current equity markets. As a result, our interpretation is that Exxon’s newest dissident board members represent in part the revenge of the yield seekers. Related: Oil Sinks As Demand Outlook Worsens
But what else should we expect in the way of corporate machinations by the so-called activists at Engine No.1? An extensive study of corporate activism was published last year by the Strategic Management Journal, titled “Disentangling the Effects of Hedge Fund Activism on Firm Financial and Social Performance”. The study’s two authors, Mark DesJardine and Rudolphe Durand, listed several key findings, the most important being that companies targeted by activists tended to put a halt “to the socially responsible efforts of the companies”. Investing for long-term sustainability, apparently, conflicted with the need to maximize short-term profit potential. As a result, targeted companies spent less on ESG (environment, social and governance) issues and also spent less for corporate research and development.
There is nothing to suggest, despite the vague pro-environment statements of Engine No. 1 that they or their board nominees will behave differently than the other activist targeted companies cited above. There were four key items that Engine No.1 requested of Exxon: add new board members, improve long-term capital allocation discipline, establish a strategic plan for sustainable value creation, and finally, overhaul management compensation. The good news for investors is that targeted companies, according to DesJardine and Durand, did on average get a nice near-term increase in their stock prices but nevertheless underperformed their non-targeted peers longer term, suggesting the eventual limits of cost-cutting.
Activists claim they are attempting to wake up a sleepy, highly compensated senior management. Existing managers resist these efforts on the grounds that they amount to a “hollowing out” of the targeted entity. Perhaps both are right. The interesting thing about Engine No.1 is how it effectively harnessed shareholder discontent versus Exxon, an oil supermajor and done so while only owning an insignificant number of Exxon shares and riding on the ESG bandwagon.
In conclusion, Engine No. 1‘s board additions at Exxon may create shareholder value via a solid bump in the stock price. The existing common stock dividend level may also be safe for a while at least. But we might also expect that long-term environmental and sustainability goals to take a back seat to the more pressing concerns regarding increased profitability. Finally Engine No. 1 recently raised about $100 million in a new ETF listing with the stock ticker VOTE. A cursory look at the ETF’s holdings suggests that it resembles a capital-weighted version of the S&P 500 with a lot of vague discussion about “partnering” with management. Whatever happens with Exxon, these folks will do just fine.
By Leonard Hyman and William Tilles for Oilprice.com
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