Case in Point: shareholder activism in the UK

High-profile shareholder activism was, until recently, a mainly US phenomenon. However, in March 1998, the US activist fund Lens Inc. (of which the two authors are principals) joined forces with UK fund manager, Hermes, to form Hermes Lens, a UK focus fund with an eye for exploiting the rights of shareholders to turn around underperforming companies.

Hermes manages $60 billion of postal and telecommunications workers pension fund assets. Its domestic equity portfolio is indexed – the fund owns more than one percent of the 900 largest UK companies - meaning that extraordinary gains can only be made by improving the performance of individual stocks, and not by trading.

A considerable quantity of shareholder activism is common in the UK markets, but it is seldom public. The relative smallness of the market compared to the US, the geographical concentration of investment institutions in London, the high degree of ownership concentration (large UK companies are owned 90 percent or more by institutions), and the very real power that UK investors wield, means that UK institutions seldom need to use the leverage of the press to effect change. Dialogue is usually enough.

In early 1999, however, Hermes Lens was engaged in an activist campaign that, by UK standards, was public indeed.

The target was Mirror Group, a newspaper publishing and cable TV concern. Its principal asset was the famous Daily Mirror tabloid newspaper.

Mirror Group had lost its way under CEO David Montgomery. Numerous strategic decisions had destroyed shareholder value, although there appeared to Hermes Lens to be considerable value waiting to be unlocked. By the end of 1998 the fund had acquired a three percent stake.

Another major Mirror shareholder – holding 22 percent of the stock – was Phillips & Drew Fund Management, also a willing activist.

Relations between David Montgomery and Mirror’s owners had seldom been good – as early as February 1998, Montgomery asked the company’s major shareholders to endorse a succession plan that would see him taking over the chairmanship from Robert Clark. Shareholders shot down the plan.

Mirror Group, whose L!ve TV cable channel had taken both a financial and critical pummeling, was actively casting around for some strategic redirection. In the course of 1998, merger talks with two separate publishing groups fell through. David Montgomery was known to be opposed to merger plans.

Also in 1998, Sir Victor Blank took over as non-executive chairman. He continued to pursue merger talks with publishing group, Trinity, although plans broke down over the role of Mr. Montgomery in a combined company. Phillips & Drew, according to the Financial Times, was “horrified” by the breakdown.

Also according to the FT, David Montgomery warned Sir Victor Blank at a December 1998 board meeting “not to railroad Mirror into a merger.” Continued talks with Trinity again failed in January 1999, for the same reason as before. Shareholders were also concerned by what appeared to be an opportunistic bid price of 155p a share. Regional Independent Media offered 200p a share in January 1999, but shareholders still felt the price seriously undervalued the company.

Phillips & Drew, Hermes Lens, and the Prudential (a five percent holder) told Sir Victor that they would support any board effort to remove Montgomery. Discussions with other shareholders suggested that the views of the dissident shareholders were shared by the holders of up to 50 percent of the equity.

As is customary in the UK, and in stark contrast to US practice, the Mirror board consisted of a majority of executive directors – eight, including Montgomery. Including chairman Blank, there were just six non-executives.

The executive directors were faced with a conflict of interest. What if they supported efforts to remove the chief-executive, and he survived? Self-interest, or even self preservation, surely suggests backing the boss in such a situation.

At least four of the six non-executive directors backed Sir Victor’s proposed removal of Montgomery. But the six executives stood square behind the chief-executive.

A structural flaw in the UK governance system is clearly apparent – how can the non-executive directors on the board perform their monitoring and oversight functions if they make up a minority of the board?

The UK system, however, also provides a solution to this problem – power wielded directly by the owners. Shareholders representing ten percent of stock can call an Extraordinary General Meeting to vote on a resolution of their choosing. In this instance, dissatisfied shareholders represented nearly 30 percent of the stock.

They informed the executive directors that if they voted down a no-confidence motion in David Montgomery on the board, the shareholders would call an EGM for his removal. At a January 1999 board meeting, Sir Victor asked David Montgomery to resign, given this situation. He refused.

Immediately after the meeting, three executive directors met Hermes and the other institutions. “Hermes were quite terrifying,” the FT reported one witness saying. “They brought out charts to show how badly Mirror had performed and they put the fear of God into them.”

The executives decided to abstain on any no confidence vote, thereby pulling the rug from under David Montgomery. He resigned, and a new CEO was later recruited.

Though the right result was achieved, it was arguably only achieved in the wrong way – after all, executive directors have the same legal responsibilities to act for the good of the company as non-executive directors. So is it right that they should abstain on a key board vote?

How might this narrative transpired differently if a US-style board structure had been in place, with a board made up largely of non-executives?

And, consider how the US activism landscape would be different if shareholders representing 10 percent of a company’s equity were able to call an EGM.

Mirror Share Price 6yrs to HLAM Investment relative to FTSE All Share

Mirror Share Price From 1 Jan 1999 to 22 Nov 1999