Private Equity Takes on Friendly Activists at Own Game

(Bloomberg) -- Activist investors have worked hard to improve their image over the past few years. The hooligans of corporate America have swapped saber-rattling for soft power and found that there is still money to be made.

Take Starboard Value. The hedge fund sounded loved up last year when it announced a “strategic investment” agreement with Papa John’s International Inc. Within months Papa John’s settled with its obstreperous founder, John Schnatter, enlisted NBA superstar Shaquille O’Neal to join its board, and named a new CEO. For Starboard, nice worked: Papa John’s shares have since soared almost 60%. Yet it’s unlikely the activist would have gotten the chance to show that soft side had it not spent years savaging companies and their directors.

The same could be said of Dan Loeb, who once compared the auction house Sotheby’s to an “Old Master painting in desperate need of restoration” but more recently told investors in his Third Point hedge fund that he favors a “collaborative” approach. The numbers tell the story. In 2016, activists waged at least 333 “impactful” public campaigns against U.S. corporations, ranging from drug maker Abbvie Inc. to Yahoo Holdings Inc. Last year, that figure fell by almost a quarter to 258, according to data from research firm Activist Insight.

This convivial vibe has caught the attention of other reformed barbarians, who are starting to see opportunities on the activists’ turf. Private equity giant KKR & Co. disclosed this month that it had amassed an active 10% stake in pizza-and-pinball chain Dave & Buster’s Entertainment Inc. -- a rare public investment for the firm.

Others are not far behind. Rival buyout firm TPG is raising a new fund to do roughly the same thing, Bloomberg reported this month. One Wall Street rumor could explain why KKR filed now -- it wanted to be the first. Whatever the motivation, the arrival of the private equity giants raises an urgent question for traditional activist investors: what are you for?

If you are a hedge fund offering expertise to the board or management, top-tier private equity has more of that; if you’re investing to help sell the company, it’s more persuasive if you also have the money to buy it. In short, private equity seems better equipped than activists for the ‘kindly take our cash and listen to our ideas, we’re experts’ model of investing. This is especially pertinent for those activists who have done most to embrace kindliness. ValueAct Capital, for example, says it invests to “learn from management teams as they innovate, grow, transform business models, reduce cost structures, manage crises and transact M&A”.

In one sense, private equity’s entrance validates the maturing of activism: by leveraging their reputations to get the same results playing nice, the once enfants terribles are gaining mainstream imitators. But by attracting larger, more experienced competitors to the field, traditional activists also risk their own demise.

Announcing the D&B investment, KKR said upfront that it wasn’t interested in making trouble at the company and wouldn’t be going hostile. Rather, it said it was looking for “constructive dialogue,” perhaps the most hackneyed expression of modern activism.

Usually just being friendly doesn’t work for first timers. Even the politest activists tend to get results only because there is a chance they may turn nasty -- they have previous, after all. But KKR is big enough and looks enough like a prospective buyer of D&B to make it compelling.

The paradox of friendly activism only works so long as richer, friendlier competitors don’t show up. Now they have and there is reason to think they’ll stay.

The buyout industry has struggled to find investments for the vast amounts of capital it has attracted since the financial crisis (the $1.5 trillion of trapped dry powder sitting in private equity funds is an all-time record). As such, it has tended to run hard at strategies where it can eke out a good return, whether that’s buying warehouses, selling insurance, or learning from management teams. If TPG and KKR start winning on the activists’ turf, others will be tempted to follow.

None of this should matter to the more riotous activists -- those like Carl Icahn -- who have rejected the vogue for pleasantry as being either less lucrative or less fun, or both. Rather, their reformist peers could be pushed to start fighting again or risk losing their differentiation.

In this scenario, private equity emerges into the interesting role of least worst engaged investor. For a board member, KKR filing a 13D may get you, ultimately, to exactly the same place as Icahn would (unemployed) but it won’t cause you ego death.

The private equity kings of the 1980s started out as brilliant bruisers who ended up deciding they could make a lot more money being nice. They may be about to deny their disruptive heirs the same opportunity.

To contact the reporter on this story: Ed Hammond in New York at ehammond12@bloomberg.net

To contact the editors responsible for this story: Aaron Kirchfeld at akirchfeld@bloomberg.net, Elizabeth Fournier, Michael Hytha

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