Senior Partner & Managing Director
Engineering, construction, and services (ECS) companies based in the developed world dominated the industry for decades. In recent years, though, they have lost ground to developing-world newcomers with lower cost structures and easy access to high-growth markets. Activist investors have taken notice, and their presence on the scene is spurring many developed-world companies to intensify their focus on margins, operational excellence, and cost discipline.
Shareholder activists have developed into a formidable force over the past five years. Their capital bases have expanded, and their market clout has grown along with the size of their targets. Now they have the ECS sector in their sights. Two prominent ECS companies have been targeted over the past two years, providing more validation for the industry’s broader shift from pure growth toward margins and capital discipline—two classic elements of the activist thesis.
BCG research suggests that the number of activist campaigns has increased by about 12 percent per year since 2005, and Morgan Stanley estimates that capital invested in activist hedge funds over the same period has risen from about $30 billion to nearly $90 billion. Activists have also been targeting bigger and bigger companies—to the point that they now include not only major ECS companies with multibillion-dollar market capitalizations but also companies such as Dell and Sony, both of which have market capitalizations well over $15 billion.
The activist efforts in the ECS space may not be over, either. BCG has developed a proprietary “activist screen” to better gauge its clients’ vulnerability to activists. We found that one major ECS company had triggered four of nine activist “flags” at the time it was targeted, while a sample of ten leading U.S.-based ECS companies had triggered a median of three flags. One company had activated six.
What are activists looking for? In short, shareholder value creation. They are looking to crank up stock returns through both increases to share price and the return of capital directly to investors. Whereas the typical institutional investor is “passive”—basically picking winning companies and executives and going along for the ride—an activist selects companies whose management can be pressured to make two or three critical moves that will “flip” returns to the positive side.
The most common activist tactics involve pressuring management to cut costs, change the business portfolio (usually by divesting an underperforming unit), change the capital structure (usually by adding leverage to a cash-rich balance sheet), and change capital deployment policies (boosting dividends and share buybacks). More often than not, the changes are met with short-term share-price gains. But activists typically have a six-month to one-year time horizon, while senior managers may be thinking about the next five to ten years. So to ensure that shareholders understand the implications of both activist recommendations and moves that might be made to preserve the longer-term prospects of the company, management must be ready to respond rapidly and rigorously when activists come calling.
A time-worn truism applies here: the best defense is a good offense. By proactively making some of the moves an activist would want the company to make, a company can lower its vulnerability to activist raids and demonstrate to shareholders that it has their best interests in mind. (See “Do-It-Yourself Activism,” BCG article, February 2014.)