Some words are so misused that they should be removed from the financial lexicon. “Stake” is one example. For many readers, this is a shorthand for “shareholding”. This suggests that when sophisticated investors, such as Patrick Drahi or Elliott Management, “take a stake” in a publicly traded company, their interests are closely aligned with those of ordinary shareholders of BT Group or GSK, respectively.
Investors have traditionally paid to gamble if they wanted to intervene in the management of companies. The influence is deemed to be proportional to their disbursement in ordinary shares.
But that would make activism, which depends on securing the support of long-term investors, a costly business. Professionals therefore often resort to derivatives and leverage to obtain cheap voting rights. They can also avoid disclosure of significant holdings that would otherwise apply. They do this by exercising voting rights through investment banks which benefit from significant disclosure exemptions.
Their actual exposure to gains and losses may be much lower than that of so-called long funds that invest for pension plans and insurers. Management and the media can therefore overestimate the real financial commitment of activists – and therefore the alignment of their interests with other investors.
Activists and other corporate raiders are generally a good thing. They challenge complacent bosses and highlight strategies that have failed. To be fair, they rarely use the word “stake”, preferring a more vague phraseology. But it’s time for them to take on a few more challenges on their own relationships.
Elliott is the simplest example to start with. The New York hedge fund ranks among the most influential activists in the world, with notable victories against BHP and Alliance Trust. In the UK, he is involved with GSK and SSE, where he advocates divestitures, and with Taylor Wimpey, where he called for a management overhaul. In the announcements, he described himself as holding “a significant position” in the pharmaceutical group and as one of the “top five investors” in both the energy supplier and the homebuilder.
Databases such as Bloomberg and S&P Global do not record any shareholder register data to show that Elliott has direct interests of any size in any of these companies.
It is in such moments of doubt that public relations specialists rally to explain to the poor and naive financial writer that hedge funds like Elliott get their exposure through more effective means. The problem with the explanation is that these exhibits are rarely disclosed in detail, so the true scale of their investments cannot be verified.
Some hygienic sunshine fell on them in 2019 via the Securities and Exchange Commission deposits on Sherborne’s failed investment in Barclays. The American activist had claimed a 5.5% investment in the British bank, with a theoretical value of around £ 2 billion. As it turned out, two-thirds of this “stake” was represented by a cap-and-collar derivative agreement with Bank of America. This limited gains and losses and secured a $ 1.4 billion loan.
French tycoon Drahi could theoretically have used similar methods to finance the 18% stake in BT acquired by his leveraged telecommunications group Altice. One way to get into debt to pay some of this would be to pledge shares through a fixed-price put option in a transaction involving an investment bank.
Assuming that just under 10 percentage points of Altice’s stake is covered by such a deal, its unhedged net exposure to BT would be greater than 8 percentage points. The company would still have 18% of the vote on any major change in strategy.
Some professionals in the City of London believe that such an arrangement exists or has existed. Others dismiss the idea as a conspiracy theory. Altice declines to comment. However, its own European business was valued at just € 5.7 billion when it bought out minority shareholders last year, while net debt was around € 30 billion. Buying an unleveraged £ 3 billion stake in BT could be a difficult exercise for Altice.
It is customary at this point in a financial opinion column to require more legal disclosure. But I don’t think more regulation would help. Sophisticated investors and their investment banks would quickly find ways to keep playing their cards close to their chests.
A simpler fix would be for GMs and long funds to be more skeptical. They should challenge activists and other savvy investors to disclose their detailed exposure to a target company with approval from an investment bank. If the wheel dealers refused, it would be reasonable to ask why. And we should stop throwing around that silly word “game”.