Directors: Know the Risks before Caving to Activist Demands for a Public Sales Process

Disclosing a strategic review can be the most important decision of a public company director’s tenure. Directors facing activist pressure to announce should weigh the benefits and costs, including the probability and consequences of failing to find a buyer.

In December 2021, Bloomberg reported that activist JANA Partners had taken a stake in Mercury Systems and intended to push the defense technology firm to explore a sale. The news sent the company’s shares 10% higher.[i] The following June, Mercury and JANA signed a cooperation agreement, which saw the addition of two independent directors to the company’s board. In January 2023, Mercury said it would initiate a review of strategic alternatives – a euphemism for a sales process.

The company said in June 2023 that it had ended the review and would continue as a standalone company. On the trading day following the announcement, shares were trading more than 40% below where they were when Mercury disclosed the review. The stock has yet to recover.

Mercury Systems’ outcome is common: Most strategic review announcements do not lead to a sale and destroy shareholder value

In fairness, JANA’s M&A campaigns typically produce deals. Mercury’s outcome is, however, common for companies that publicly announce strategic reviews. Activists with varying track records nonetheless regularly push companies to disclose a sales process, expressing confidence that the announcement will lead to a transaction.

In fact, two-thirds of companies disclosing strategic reviews receive no offers within the following year, causing double-digit share price declines on average.[ii] [iii] While the prospect of a deal sends a company’s shares higher in the days following an announcement, the stock gives back these gains and more as the process drags on. An announcement that the company will continue as a standalone can send the stock into freefall.

With the M&A market showing signs of life, activists are increasingly pushing companies to sell themselves,[iv] often via a public process. Beyond the outcomes described above, directors should understand the common consequences of such an announcement.

Strategic review announcements strain relationships with employees, customers, and partners, hurting company performance

Putting up a “For Sale” sign conveys that a company has problems. Employees, customers, vendors, and other partners react as you would expect.[v]

• Employees, especially top performers, depart. Employee turnover increases in the months following a strategic review announcement. In such periods of uncertainty, top performers, who tend to have more opportunities, leave first.[vi]
• Distraction reins among remaining employees. The concerns that drive some employees to pursue other opportunities cause distractions among others, contributing to productivity losses. A public process also requires more time from supporting employees and executives than one run privately.
• Customers and other constituents reconsider their relationship with the company. Customers and partners, especially those with long-term contracts, may question the viability of a company announcing a sales process. Competitors can capitalize on these worries by poaching customers.

These reactions damage operational performance, reflected in reduced ROA and operating income.

One further downside: An announcement puts pressure on directors to accept any deal

Disclosing a process can back directors into a corner. The stock price bump that often accompanies disclosure reflects expectations for a sale. Additionally, directors at companies announcing a review, likely already vulnerable to activists, may fear activist attacks should a process fail to find a buyer.

Making matters worse, a strategic review announcement can drive long-term holders to leave the stock. Arbitrage traders and event-driven hedge funds may take their place, weakening the company’s position in the event of an activist campaign.

Deciding whether to disclose

Announcing a sales process makes sense at times. Disclosure can lead to more bidders, higher premiums, and better returns.[vii] However, the last two benefits apply only if the company is acquired.

Directors should carefully assess the costs and benefits of disclosure with their financial advisors. Among the most important questions to discuss are:

• How likely is an announcement to identify additional bidders and ultimately result in a sale?
• How are customers, employees, partners, and other constituents likely to react?
• If an activist is pushing for disclosure, and/or making claims about the buyer universe, what is their track record in similar situations?
• For ongoing processes, are leaks causing significant market rumors and distraction?

Faced with activist demands to disclose a process, directors must do their own diligence

Boards under activist pressure to announce a review should weigh the request carefully. They should remember that their interests are only aligned with the activist’s to a point, and that activists can and do exit stocks after the post-announcement pop.

Directors best serve their shareholders by understanding the base-rate outcomes for strategic review announcements and weighing the situation-specific benefits of disclosure against the downsides. Those that decide to announce a process should ensure the company has thoughtfully approached communications and IR planning.