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Rising Shareholder Activism Mostly Harms Credit Quality

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Rising Shareholder Activism Mostly Harms Credit Quality

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Activist campaigns by shareholders of rated entities reached an all-time high in 2020, fueled not least by a surge in environmental, social, and governance (ESG)-related campaigns. Shareholder activists targeted 313 nonfinancial and financial services companies last year, compared to just 220 in 2019, a rise of 42% on 2019 (see chart 1).

We directly linked 26 rating actions in 2020 to activist campaigns, about the same level as in 2019, although more campaigns last year were credit-negative (see chart 2 and table 1). Our analysis shows that the credit impact of shareholder activism on entities that we rate is largely unfavorable, albeit only moderately so, with most related downgrades being of one notch (see the Appendix for full details of our methodology).

More than 80% of the rating actions triggered by investor campaigns in 2020 were negative. They followed either significant M&A events or shareholder-initiated material changes to an entity's capital structure, or a combination of both (see chart 3).

Chart 1

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Table 1

Rating Actions Following Shareholder Activism, 2020
Number of rating changes Number of outlook revisions Number of CreditWatch placements Total
Credit-negative activism 12 3 6 21
Credit-positive activism 1 1 3 5
Total 13 4 9 26
Source: S&P Global Ratings.

Chart 2

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Chart 3

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While ESG-focused investor campaigns represented 75% of the total campaigns aimed at publicly rated entities in 2020, they led to only a few rating actions. Nevertheless, we believe they indirectly contribute to rating changes over a longer time horizon than one year. The COVID-19 pandemic has focused many shareholders' minds on leadership quality and spurred a twofold rise in public campaigns against boards and executives last year compared with the previous year. Investors who considered companies to be mismanaged, unable to respond well to environmental and social challenges or adapt their business model to the post-pandemic world, laid down governance challenges. We have also seen an exponential eightfold growth in environmental and social campaigns since 2018.

For the first time in 2020, shareholder activism led to as many downgrades in Europe as in the U.S. Although only 7% of campaigns last year targeted European entities, they led to 42% of all rating actions. This was largely driven by the still growing belief by large U.S. activist investors that European corporates are ripe for M&A-driven value creation.

Investment-grade companies continued to be the main targets of investor activists in 2020: they increased to 65% of the total (from 60% in 2019), largely driven by the significant increase in environmental and social activism against large, highly rated oil and retail companies as well as financial services entities. In the years running up to 2020, 'A' rated companies were the most targeted, and suffered the most downgrades. In 2020, however, companies in the 'BBB' rating categories saw the greatest number of rating actions and downgrades.

We expect the number of shareholder activist campaigns against rated entities to continue to rise in 2021, owing to likely strong M&A and ESG-related campaigns.

Activist M&A Is Still The Leading Source Of Downgrades

Shareholder activist M&A or break-up campaigns continue to be the largest contributor to rating changes among nonfinancial and financial corporates that we rate. Last year 70% of all rating actions followed a successful shareholder intervention into M&A. Credit-negative actions were 3x more likely than positive ones, with the chance of a rating action growing to 1 in 2 in 2020 (see chart 4). It is worth noting however, that because M&A transactions, especially spin-offs and mergers, inherently take a long time to complete, rating actions may not materialize for years. We think it is more representative to expect a one-in-three chance of companies experiencing a rating change over a five-year average after M&A-related campaigns.

Chart 4

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Nonfinancial corporates on average suffered a one-notch downgrade following M&A transactions in 2020. The most typical path to such a downgrade is overleveraging during a merger or a break-up that adversely affects the company's financial risk profile. We downgraded U.S.-based technology company Tech Data Corp. from 'BBB-' to 'BB' following Apollo Global Management’s takeover offer in June 2020. As part of the transaction, Tech Data proposed to raise an additional $5.5 billion in debt and therefore pushed the pro forma adjusted leverage below the previous downside trigger. Additionally, we expect the company's financial policies to become more aggressive under the new ownership. Tech Data was one of the two fallen angels in 2020 that resulted from shareholder activism.

Breaking up a diversified group or spinning off non-core assets is generally detrimental to creditworthiness: six out of the 10 such campaigns resulted in a negative rating action last year (see chart 4). We downgraded U.S.-based utility provider Exelon Generation Co. in November 2020 following a successful break-up campaign by the activist Corvex Management. After the parent company, Exelon Corp. agreed to an overall strategic review including the spin off, we removed the one-notch rating uplift from which Exelon Generation Co. LLC previously benefitted as a strategic asset to the group. When we removed the group support, the rating fell to 'BBB' from 'BBB+'.

Opposition to M&A typically comes from large hedge funds, which accumulate shares in companies prior to their acquisition or takeover by another group and then oppose that acquisition or takeover to achieve more advantageous terms.

Such opposition may be credit-positive or intend to positively influence creditworthiness, although this happens rarely. One such example relates to European real estate group, ADO Properties S.A. (ADO). Several activist investors, including Timbercreek Investment Management (U.S.) and Janus Henderson Group plc opposed ADO's takeover of rival Adler Real Estate AG. They believed it would destroy value on a consolidated group level. When the acquisition completed, not only did ADO's financial risk profile materially worsen due to the increased debt leverage, but we also raised concern about the weakened corporate governance profile. The combination of these factors resulted in a two-notch downgrade from 'BBB-' to 'BB', making ADO the second fallen angel in our sample.

Strong Rise In M&A Campaigns Against Financial Services Entities

Traditionally, regulations have helped financial services entities maintain standards of their governance, financial policies, and balance sheets. Shareholder activism-related rating actions have therefore been extremely rare. There was one sole example up to 2019. Yet, 2020 saw the highest number of campaigns yet against financial services entities. This is because consolidation is expected to accelerate after the pandemic. We have also seen increased rating actions on financial services entities following high-profile M&A transactions.

Beginning in August 2019, U.K.-based insurance group Prudential PLC announced that it was exploring options for its U.S.-based life insurer Jackson National, including the acceleration of diversification through reinsurance and third-party capital financing. In the subsequent months, Prudential's shareholders advocated, both privately and publicly as demonstrated by the letter published by hedge fund Third Point LLC, for the separation of Jackson from the group. In August 2020, Prudential announced its decision to fully separate U.S.-based life insurer Jackson National Life Insurance Co. either via an IPO or a demerger. Following this announcement, we affirmed our rating on Prudential PLC and revised our assessment of group support for Jackson, as we no longer view it as a strategic asset to the group. Our view of Jackson's stand-alone creditworthiness improved as a result of its preparations to become a stand-alone company. However, the removal of group support from Prudential PLC resulted in the overall rating being downgraded at the beginning of 2020 to A/Stable/A-1 from AA-/Stable/A-1+.

Governance Changes Are Also Largely Credit-Negative

Corporate governance matters have always featured heavily in shareholder activism campaigns among companies we rate, but in 2020 they exceeded one-half of all campaigns for the first time (see chart 5). The turbulence of the COVID-19 pandemic highlighted the need for effective governance, management, and leadership. We saw a huge increase in matters addressing board accountability and to boost the independence of board members, but also campaigns against what investors considered excessive executive compensation packages. Activists are also evaluating how managements steer companies through the pandemic by adapting business models.

Chart 5

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This has also had rating consequences. Over the five-year period ended 2019, we took eight rating actions resulting from governance-related activism (seven of them negative). Last year we took four (three of them negative). Abrupt changes in management, disagreements between the existing board members and the new activist-nominated board member, or simply the change itself can be credit-negative if we believe that the company's ability to service debt will suffer as a result.

One of the big financial market stories of 2021 so far relates to how Reddit investors took on Wall Street over GameStop Corp. When activist shareholder representatives gained board seats at the U.S.-based video game retailer in July 2020, the new board members stated their willingness to retire debt below par. We view such actions as akin to default and in July placed the 'B-' rating on CreditWatch with negative implications. We later removed the CreditWatch when the company announced its commitment to redeem the bonds at par in March 2021.

While almost all corporate governance-related campaigns have negative consequences, last year we noted one credit-positive development: we revised our outlook on global agribusiness leader Bunge Ltd. from negative to stable following a very successful turnaround program.

Social And Environmental Campaigns Are Soaring

Environmental and particularly social activism surged in 2020 amid growing interest in ESG matters. Rated entities were subject to 103 environmental and social campaigns in 2020 from just 13 in 2018 (see chart 6). Nevertheless, we have yet to take rating actions as a direct consequence of environmental or social activism.

Chart 6

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Environmental campaigns primarily targeted U.S.-based oil majors, transportation, and restaurant/retail sectors as well as financial services. The majority of these campaigns focused on climate change, while a small number pinpointed deforestation and plastic usage. Investors campaigned for more transparency on these matters and enhanced disclosure on the issuers' climate action plans, proposing alignment with the 2015 Paris Agreement on measures to limit global warming. We also noted a new trend whereby activists asked for specific targets to be set in relation to the reduction in greenhouse gas emissions. Following activist pressure, several companies, including Unilever PLC, agreed to allow shareholder votes on its progress towards climate targets on an annual basis.

Although not directly linked to any environmental campaigns in 2020, we believe that the persistent focus on climate change-related risks, the high cost of the energy transition, and long-term declining returns, significantly increased the credit risk of the oil exploration and production sector. In January 2021, we lowered our industry risk assessment score and consequently took multiple rating actions ("S&P Global Ratings Takes Multiple Rating Actions On Major Oil And Gas Companies To Factor In Greater Industry Risks," Jan. 26, 2021).

Unsurprisingly, as a result of the COVID-19 upheaval, a number of social campaigns targeted companies in the consumer products, restaurants, and retail sectors as well as financial services entities. Their focus was the implementation of human rights policies, improvement to workforce health and safety, resilience, and increasing diversity.

Environmental and social activism used to be dominated by individual activists and charitable foundations, but rarely the large activist investors or asset managers. Yet, as ESG considerations have become mainstream in investment management, larger investors have followed suit, including ValueAct Capital or BNP Paribas Asset Management Inc.

Activist-Led Capital Structure Changes Are Often Credit-Negative

Activist shareholder demands typically result in companies adopting more shareholder-friendly financial policies. One key consideration in our rating process for nonfinancial corporates and our understanding of how governance interacts with activist shareholders is our financial policy assessment. This is a measure of the degree to which owner/managerial decision-making can affect the predictability of a company's financial risk profile. A conservative financial policy that is designed to achieve or maintain a certain rating can be a critical factor in our view of creditworthiness.

A sudden, confirmed change in an entity's financial policy may lead to a downgrade. This was the case for French shopping center owner Unibail-Rodamco-Westfield SE when, in November 2020, the majority of its shareholders rejected a €3.5 billion capital increase following a revolt led by a consortium of minority shareholders. The capital increase formed part of a larger strategic reset plan to decrease overall leverage. As a result, in our view, the company will no longer be able to maintain leverage ratios compatible with the 'A-' rating. We therefore we applied a one-notch downgrade to 'BBB+'.

Similarly, we revised our outlook on Japanese investment holding company SoftBank Group Corp. to negative from stable in March 2020 following the issuer's sudden announcement of a new share-buyback plan amid the plunge in stock markets. We assessed that the buyback was likely to negatively influence credit quality because it underscored aggressive financial management.

Campaigns Against European Entities More Likely To Lead To Rating Actions

Shareholder activism has its roots in the U.S., and historically, almost all campaigns have targeted U.S.-based rated entities. However, activism in Europe and Asia has increased notably in recent years. In 2020, for the first time, European rating changes related to shareholder activism equalized those in the U.S. (see chart 7).

Chart 7

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In previous years, we observed that, while U.S.-based corporates were more likely to be targeted, European companies were more likely to see rating changes. This is because activism in Europe tends to target M&A transactions--which are most likely to result in rating actions--and less likely to concern governance. Indeed, only 7% of campaigns last year targeted European entities, but they led to 42% of all rating actions (see table 2).

Table 2

Probability Of Rating Actions By Regions
Probability of rating action taken Probability of rating action taken
2020 2015-2019
U.S. 1 in 33 1 in 9
EU 1 in 2 1 in 6
U.K. 1 in 5 1 in 6
Japan 1 in 2 n/a
N/A--Not applicable. Source: S&P Global Ratings.

Within Europe, companies in the U.K. experienced the highest number of campaigns and rating actions, a continuation of the trend over the past few years. This reflects the still depreciated value of the pound and the sophistication of the U.K. capital markets, along with investors' beliefs that Brexit has created an opportunity snap up underpriced assets. The primary targets were in retail, media, technology, and transportation companies. We placed U.K.-based bookmaker William Hill PLC on CreditWatch with negative implications after the lower-rated Caesars Entertainment Inc. won a takeover bidding war with Apollo Management. The CreditWatch placement indicates that we would likely lower the ratings on William Hill by more than one notch upon acquisition completion, following the group becoming a subsidiary of Caesars. Apart from the William Hill buyout, Apollo Management also agreed a takeover of U.K.-incorporated but U.S.-based ATM operator Cardtronics plc in December 2020, which we believe was credit-negative. The negative CreditWatch placement on Cardtronics reflects our expectation that this transaction will likely deteriorate its existing credit profile through a take-private transaction. Given our expectation for more aggressive financial policies and higher adjusted leverage, we would likely lower our issuer credit rating on the company upon close of the transaction.

M&A And ESG Will Fuel Further Shareholder Activism This Year

In 2021, we expect to see further downgrades or upgrades as a consequence of campaigns in 2020. Four issuers, including William Hill, are currently still on CreditWatch as a result.

We also see scope for more ESG-related campaigns in 2021, following last year's increase in campaigns aimed at increasing transparency and disclosures, and activist investors looking for information. As the post-pandemic world settles and customers materially change their behavior, either in response to social justice or to environmental matters, these originally environmental and social-orientated campaigns can transform into wider governance or strategic review requests on how companies adopt their business models to a new world order.

Appendix: Our Methodology

We derived our sample from S&P Global Market Intelligence's list of publicly promoted shareholder campaigns targeting financial (bank and insurance) and nonfinancial corporations for which we provided a public issuer credit rating as of the start date of the respective activist shareholder campaign. We excluded entities that we did not rate at the time of the campaign, but that subsequently became rated entities. (S&P Global Market Intelligence is a division of S&P Global, as is S&P Global Ratings.)

We focused on determining whether the rationale for any rating action subsequent to a shareholder's campaign was linked to the objective of that campaign. We viewed campaigns as either credit-negative or credit-positive if the subsequent rating change, outlook revision, or CreditWatch designation had a direct link to the related management actions in our published rating rationales.

We defined an activist campaign as credit-negative if it contributed to a negative rating action (downgrade, negative outlook change, or negative CreditWatch placement), or opposed a transaction that we deemed to be credit-positive. We viewed an activist campaign as credit-positive if the related management action contributed to a positive rating action (upgrade, positive outlook change, or positive CreditWatch placement), or opposed a transaction that would have otherwise been credit-negative.

We viewed as credit-neutral campaigns where the subsequent rating change was primarily driven by other factors--such as an improvement or decline in operational performance, or changes in macroeconomic circumstances--even if the campaign contributed to the rating change. Finally, we viewed as neutral campaigns that, while successful in changing the composition of the board or the top layer of management, had no direct linked to the rating action in our published rating action rationale.

Editor: Jennie Brookman. Digital Design: Joe Carrick-Varty.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Imre Guba, Madrid + 442071763849;
imre.guba@spglobal.com

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