The Rise of “Sell-Side Activism”: Why It’s Happening and How to Respond

Maggie Dean is Vice President of Strategic Situations and Investor Relations, and Hunter Stenback is Executive Vice President at Edelman Smithfield. This post is based on their Edelman memorandum. Related research from the Program on Corporate Governance includes Dancing with Activists (discussed on the Forum here) and The Long-Term Effects of Hedge Fund Activism (discussed on the Forum here) both by Lucian A. Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch.

Most boards and management teams are acutely aware of the threat posed by shareholder activists who often use public letters and media attention to exert pressure on directors and executives. They may be more surprised to hear about an emerging trend: an increase in so-called “sell-side activism” in which a company’s sell-side analysts advocate directly for change.

Historically, the sell-side has parsed earnings reports and executive commentary to update their financial models and apply a valuation multiple to arrive at a “buy,” “sell,” or “hold” recommendation. While their research might identify an underperforming stock and they might change their rating accordingly, sell-siders were typically content to leave advocacy to the shareholders themselves. Sell-siders have also played an important role in facilitating investors’ access to management through the use of roadshows, conferences, and other avenues, and have traditionally sought to maintain positive relationships with management.

Recently though, a growing number of sell-side reports have channeled traditional activist letters, with a clear call to action for management teams and boards. These letters go beyond a traditional “sell” rating, instead advocating for specific, sometimes wholesale, changes at the company. The target companies span a range of market capitalizations, industries, and geographies, and include names like Walgreens, Amazon, and Verisk Analytics. The analysts, meanwhile, represent a mix of bulge bracket and independent firms.

Some analysts have stated that their purpose is to serve as a mouthpiece for investors who have voiced concerns about the company, and to make their own clients aware of common criticisms they are hearing. Others have expressed an interest in advocating for change on behalf of their clients to help the company and stock succeed. No matter the reason, management teams and directors should be paying attention.

Across these sell-side letters to the board or management, we tend to see some common requests, such as:

  • Increased transparency and improved disclosures
  • Updated medium-to-long term guidance and clear path to achievement
  • Clarity on strategy
  • Expense control
  • Changes to capital allocation
  • Greater access to management
  • Eliminating certain earnings adjustments
  • And, in at least one case, an overhaul of the management team

If the sell-side publishes a call for change, the company is most likely already on the radar of traditional activists, and leadership needs to take notice. Nearly one-third of activists’ public letters mention sell-side analysis, according to a paper in Contemporary Accounting Research, further elevating the need to take sell -side feedback seriously.

Here are five key considerations for senior leadership when faced with a “sell-side activist” report:

  1. Don’t add fuel to the fire – Instead of issuing a public response, engage privately with the analyst to understand their concerns and correct any misconceptions. Meet with other analysts and shareholders to determine if the sentiments are widespread.
  2. Notify the board – While the board should always be made aware of market feedback and ideas to unlock shareholder value, escalate a “sell-side activist” report immediately. Understanding the analyst’s concerns can influence important board-level decisions and allow time to prepare in the event the sell-side analyst or a shareholder reaches out directly to the board.
  3. Discuss the merits of the suggestions – Perhaps the letter serves as a positive catalyst for change, or alerts management to misunderstandings in the investment community. Consider how and where to best incorporate the feedback into normal-course investor communications, such as earnings calls and conference appearances.
  4. Plan for a real activist threat – Regardless of whether activist pressure arises from a sell-side analyst or shareholder, it’s critical to be prepared. Develop or refresh a vulnerabilities assessment, as well as a communications playbook to inform how you would respond to potential criticisms. While your response will likely need to be tailored to reflect the specific contents of the letter, having a framework in place will help you respond more quickly to control the narrative. Proactively analyzing scenarios and responses when times are calm will not only afford you the benefit of being prepared but may help identify issues that can be remediated before they rise to the level of public scrutiny.
  5. Evaluate your ongoing relationship with the sell-side community – Actively engaging with all covering analysts – not only those with a “buy” rating – can reduce the likelihood of being surprised by a negative report. IR teams should have regular touchpoints with the sell-side, similar to how they would treat a sizable shareholder, and include management in the discussion when appropriate. Generally, companies should also aim for at least one marketing event with a covering analyst each year.

While “sell-side activism” is still relatively uncommon, executives and directors would be well-advised to maintain active dialogue with the investment community, actively seek to identify areas of vulnerability, and develop a plan to address them.

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