Q&A: Shareholder activism and hostile M&A in the energy sector

January 2023  |  SPECIAL REPORT: ENERGY & UTILITIES

Financier Worldwide Magazine

January 2023 Issue

FW discusses shareholder activism and hostile M&A in the energy sector with Hillary H. Holmes at Gibson, Dunn & Crutcher LLP, Greg Mulley at Herbert Smith Freehills LLP and Pankaj Sinha at Skadden, Arps, Slate, Meagher & Flom LLP.

FW: Could you provide an overview of recent shareholder activism in the energy sector? What factors typically drive campaigns targeted toward energy companies?

Mulley: We normally see activism in one or a combination of three contexts: the traditional approach of acquiring a stake and agitating around a particular issue, around the time of the annual general meeting (AGM) or on mergers & acquisitions (M&A), where shareholders may look to encourage, influence or threaten a transaction. With the increased focus on environmental, social and governance (ESG) issues, particularly climate change, globally, energy and natural resource companies are under pressure to transition to net zero, to dispose of ‘dirty’ assets and to focus on renewables. We have, for example, seen Elliott criticising SSE’s investment strategy in electricity networks and renewable energy, calling for the company to provide plans to address investor concerns over corporate governance, and for the electricity and renewables businesses to be split into two separate listed companies. Bluebell Capital has also called on Glencore to spin off its coal assets, arguing that they have become a barrier to investment. Examples of AGM activism have been seen at both BP and Royal Dutch Shell, which have each had resolutions requisitioned at their AGMs to require them to set and publish targets that are aligned with the Paris Climate Agreement. To date, the resolutions have not been passed. However, in May 2021, following a lawsuit by Friends of the Earth and Greenpeace, a Dutch court ruled that Shell must cut its carbon dioxide emissions by 45 percent by 2030 in line with the Paris Climate accords. Shell is appealing the decision.

Holmes: Shareholder activism in the energy sector has focused on the same topics as activism in other industries – demands for action by companies that activists contend will increase the long-term value of the company. Energy companies have seen a particular focus on demands for increased sustainability efforts, more reporting on sustainability efforts, improved diversity in company leadership, corporate political responsibility and, to a lesser extent, consolidation or other strategic matters. Energy companies are faced with both shareholders who engage in private activism and shareholders who are known for their public and well-financed activism. Although the number of shareholder proposals submitted to energy companies in the recent proxy season remained high, in the face of worldwide concerns about energy security starting in spring 2022 and increased disclosure by companies about their sustainability plans, the approval percentage of those proposals that went to a shareholder vote declined. As more companies negotiated settlements, the number of withdrawn shareholder proposals relating to climate matters was robust, particularly with respect to commitments to reduce greenhouse gas emissions or provide additional sustainability reporting.

Sinha: The energy sector continues to be an attractive area for activists – the third most active sector for activists by some accounts. Over the last couple of years, there have been several high-profile campaigns against large energy companies, such as Exxon Mobil, Exelon and Duke Energy. These energy companies are typically large cap enterprises with significant assets and businesses. The energy sector, in general, has been undergoing a global transformation, including to renewable energy, and these macro shifts provide opportunities for activists to capitalise upon. For example, Elliott Management approached Duke Energy shortly after Duke Energy announced the termination of a large multi-billion dollar gas pipeline that it was constructing with a couple of partners. The termination of the pipeline caused a dip in Duke’s stock price, which in turn provided an opening for the activist fund to engage. In addition, energy companies tend to have attractive dividend policies, which helps activists back-leverage their positions in such companies. Moreover, in large energy enterprises, there is usually an opportunity for an activist to argue that certain aspects of the portfolio are underperforming or are otherwise non-core and hence should be divested or spun out. This is exactly what activists argued with Exelon and Sempra Energy. Activists also seek to invest in target companies because of the need for capital to fund a large-scale shift in the energy sector – a good example is Carl Icahn’s investment in First Energy. Finally, many energy companies tend to be well-known names and such public campaigns provide ample press and publicity for activists, something that helps them with future fundraising.

FW: How successful have activist campaigns been in putting pressure on energy companies to reassess their strategies, unlock value and deliver greater shareholder returns?

Holmes: Activist campaigns in the oil and gas sector will often focus on the undervalued nature of the industry. Even those campaigns that are withdrawn or shareholder proposals that receive minority approval are shown to spur action by the subject company. Energy companies exist in a dynamic industry and have historically been about creating value – for the shareholders and the world population. Dialogue with shareholders, whether activists or not, can effectively contribute to this effort to unlock value and deliver greater returns. In addition, even if the underlying concept of an activist’s campaign aligns with a shareholder’s values, some shareholder proposals have been seen as too prescriptive – for example, a specific accelerated net-zero goal when the company has articulated its ability to reach net zero by a later date – or repetitive of efforts the company is already making, such as additional emissions reductions when the company is already showing progress on a solid plan. In other words, these proposals are viewed as potentially pulling value away from the investment or the company’s efforts and lose support. This is reflected in the fact that energy companies in the oil and gas industry continue to be the subject of investment policies of asset managers, who can influence behaviour through their ability to control a significant amount of equity market value or support shareholder activist activity. The adversity of these policies has lightened in the last year as they have articulated a focus on value, rather than values, as driving their investment decisions.

Sinha: Activists have historically had mixed results in the energy sector, particularly with respect to regulated utilities. For example, in 2021, Elliott Management published two whitepapers advocating for various changes at Duke Energy Corporation, including splitting the company into three separate pieces. Duke resisted this advance, and eventually settled for appointing two additional mutually agreed board members, with no announced material change to its strategy. However, in 2021, Engine No. 1 waged a successful proxy fight to install three directors on the board of Exxon Mobil, advocating for Exxon Mobil to reduce its carbon footprint. While similar environmental, social and governance (ESG) initiatives were not as successful in the 2022 proxy season, it is likely ESG, and environmental matters in particular, will continue to be a focus in energy sector activism.

Mulley: There have been a number of notable campaigns, including Elliott and others seeking to persuade BHP to divest its shale assets, Rio Tinto supporting activist shareholder resolutions on climate change, activist investor Engine No. 1 having three directors appointed to Exxon Mobil’s board, and AGL, where the founder of Atlassian, an AGL shareholder, lobbied against the company’s demerger plan and managed to have four directors appointed to the board. Even if a specific campaign is not successful, the continued focus on energy and natural resources companies by activists and active shareholders, most recently in the form of allegations of greenwashing, means that companies are responding to these campaigns, albeit often at their own pace and in their own way.

FW: How important is it for energy companies to evaluate their vulnerability to an activist campaign? What characteristics do they need to assess in this regard?

Mulley: There is no doubt that energy and natural resources companies should evaluate their vulnerability to an activist campaign and be prepared. Activist campaigns typically screen potential targets for one or more of several issues, including governance, such as a directors’ expertise, tenure or performance, strategy, transactional opportunities, share price performance or share capital structure, operational issues, including ESG, and negative media or shareholder perception. As well as requisitioning resolutions, we are seeing new tactics being deployed, including the shareholder derivative action being brought against Shell and an increasing number of claims being considered under Schedule 10A of the UK Financial Services and Markets Act 2000, which imposes liability on an issuer for misleading statements or omissions in published information, if a person discharging managerial responsibilities at the issuer knew that, or was reckless as to whether, the statement was untrue or misleading, or knew the omission to be a dishonest concealment of a material fact. We are seeing similar claims being brought outside the UK as well, including in the US and Australia. With the recent increased focus on greenwashing, companies and their boards must make sure that any statements they are making are substantiated through actions in practice. Companies should also engage with their shareholders to understand their perspectives and monitor the company’s share register so that they are alerted if any known activist comes onto it. They should also be prepared for, and be willing to engage with, any activist that does buy a stake in the company.

Sinha: With the activism landscape continuing to evolve, coupled with the new universal proxy rules now in effect, companies should renew their focus on stockholder preparedness by conducting and updating their vulnerability assessment, which includes reviewing a company’s governance profile, capital allocation policy, board composition, stockholder base and benchmarking itself against its peers to ensure the company is abreast of market standards. Companies should also implement a state of the art stock watch programme. This is also a perfect time for companies to review their charter and bylaws for possible improvements. In addition, sometimes activists argue that the entire company should be sold, and hence companies should analyse their change-in-control arrangements on a clear day in the event they are targeted by activists advancing this thesis. Activist campaigns today are now focused more on individual board qualifications, such as age, tenure and relevant experience. We expect individual board scrutinisation will increase with the universal proxy rules, as activists can focus their efforts more clearly on attacking individual board members, particularly in the highly specialised energy sector.

Holmes: It is critical for energy companies to evaluate their vulnerabilities, anticipate activist activity and prepare for any defensive measures. The board of directors and management should both be well-engaged and advised in this regard on a regular basis. The time to prepare is before, not after, receiving an activist’s first communication. When assessing vulnerabilities, an energy company should conduct a review of its shareholder base, its ratings by proxy advisory firms and its profile with respect to areas of common attack, which includes leadership diversity, sustainability efforts, disclosure regarding ESG matters and M&A activity.

FW: How would you describe hostile M&A activity in the energy sector? To what extent is this tying in with activist activity?

Sinha: We have not seen as much of the traditional hostile takeover activity in the energy sector, although some activity occurs under the radar with private bear hug letters. One reason is that energy companies tend to be large and require substantial capital for such a takeover, often too much for financial buyers. Foreign takeovers would face the challenge of securing Committee on Foreign Investment in the United States (CFIUS) approval as most energy-sector companies contain businesses constituting critical infrastructure and hence are subject to CFIUS. Also, many energy companies, and certainly those in the power sector, are subject to a complex web of state and federal regulatory oversight often requiring several regulatory approvals to successfully effectuate a hostile takeover, which could be more difficult to secure in a non-friendly transaction. However, there are often unsolicited approaches by acquirers of potential targets, short of public takeovers, in private settings such as industry conferences. These sometimes have tones of a hostile pursuit, but without going all the way to a public bear hug, tender offer or proxy fight.

Holmes: Hostile M&A has included the traditional demands for smaller energy companies to engage in consolidation and for larger companies to right-size their operations by spinning off divisions. It has also included recently demands for companies to exit certain areas of operations, such as Russia. Shareholders are engaging in activist activity to have their opinions heard on how to preserve long-term value of the investment, although pressure is also coming from equity owners of other public companies interested in consolidation.

Mulley: There is not a huge amount of what is considered purely hostile public M&A in the energy and natural resources sector, but that is not surprising. Hostile M&A in the UK generally is fairly unusual. From January 2018 to date there have been 267 bids in the UK, and only 13 of those were hostile, including three which involved a competing offeror. One example where we did see hostile M&A in the energy sector was the offer for Good Energy by Ecotricity. We also saw a recommended deal voted down by shareholders – Tenaz Energy Corp’s offer for SDX – and the termination of the Tullow/Capricorn Energy merger following an adverse reaction by certain Capricorn Energy shareholders. Of course, there are instances of transactions that start out as hostile or semi-hostile, and end up being recommended, or where no recommendation is given. On the offer for Volga Gas by GEM Capital in 2021, the Volga Gas directors considered that the terms of the offer inadequately valued the company and were not sufficiently compelling that the directors were able to recommend that shareholders accept the offer, but thought it was appropriate for the offer to be made to enable shareholders to decide for themselves.

FW: Have any recent, high profile hostile takeovers in the energy sector caught your attention? What made these takeovers notable in terms of the strategies deployed and the eventual outcome?

Holmes: One interesting aspect of the last couple years was the ability of certain shareholders, who held only a small equity position or who did not have an established history of activism, to be successful in their campaigns for change at large energy companies, including board composition. These campaigns leveraged public interest in climate change matters and ESG-related activities of energy companies while contending the proposed changes would contribute to long-term value of shareholders’ investment in the company.

Mulley: Ecotricity launched a hostile offer for Good Energy in July 2021. The Good Energy board rejected it on the grounds that the offer significantly undervalued the group and its future prospects. They also got confirmation from holders of 15 percent of the company’s shares that they did not intend to accept the offer. Ecotricity then increased its offer, but the Good Energy board continued to reject it as highly opportunistic. It also said that it believed that Ecotricity would be an unfit owner with an unsuitable plan from the point of view of the company and its stakeholders. This is an interesting approach to take as generally the view is that the offer price will be the determining factor, regardless of the fact that target directors are allowed to take other factors into account under the UK Takeover Code and are required to have regard to wider factors as part of their directors’ duties under the UK Companies Act 2006. We might expect to see boards continuing to give more weighting to ESG factors as part of their decision making and discharge of their directors' duties.

Sinha: Carl Icahn’s longstanding campaign against Southwest Gas Holdings, which began with Icahn opposing Southwest Gas’ proposed acquisition of Questar Pipeline, evolved into a contentious proxy contest to replace Southwest Gas’ entire board coupled with a tender offer for all shares of the company and eventually resulted with Icahn and Southwest Gas entering into a settlement whereby Icahn initially received three director appointees and the company agreed to conduct a strategic review. Although Southwest Gas ultimately opted not to sell the entire company, it continues to look for options to spin off its Centuri pipeline, including a sale or spin off, and a sale of MountainWest. Additionally, Icahn received a fourth seat on the board due to the company not spinning off Centuri within 90 days of the settlement. This campaign illustrates the importance of carefully considering any acquisition, as even a slight perceived misstep can lead to shareholder scrutiny and open the door for an activist campaign.

FW: What steps can energy companies take to prepare for and defend against a hostile takeover bid? In what ways have defensive tactics evolved over the years?

Sinha: Companies should regularly review their bylaws to ensure they are state of the art and may wish to adjust as needed to account for the new universal proxy rules. Companies that find themselves vulnerable to hostile takeovers should also consider keeping a shareholder rights plan, commonly known as a poison pill, ‘on the shelf’ so it can be adopted promptly by the board at a later date if circumstances warrant. Born in the 1980s, shareholder rights plans were widely adopted in the following years in response to the proliferation of corporate raiders making hostile bids for public companies. However, the market has generally disincentivised the widespread adoption of rights plans ‘on a clear day’, resulting in only 1.2 percent of S&P Fortune 500 companies currently having a rights plan in place; but, in our experience, a vast majority of public companies maintain a shelf shareholder rights plan, sometimes called a dry poison pill, which could be quickly adopted if needed. Activist campaigns are increasingly sophisticated. We also suggest that companies develop a readiness plan to align the board and key officers on a communication and engagement strategy if approached by an activist shareholder.

Mulley: Companies should, on an ongoing basis, stay close to what their shareholders are saying, monitor their share register and the bidder and activist landscape, undertake self-assessments of strategy and vulnerabilities, anticipate legal issues and plan for an approach. The majority of unsolicited takeover approaches are rejected by the target board without there being any announcement to the market. In the UK, targets can also, if necessary, use the ‘put up or shut up’ regime under the UK Takeover Code to ‘out’ a potential bidder, triggering a 28-day deadline by which the bidder must announce a firm and fully financed offer or announce it will not make an offer, in which case it will generally be locked out from making an offer for six months. If a bidder does proceed to announce a firm offer, saying no, and giving reasons, and encouraging shareholders not to take any action in response to a hostile offer is the most common defence tactic. If the bidder is offering shares as consideration, the target can also look to attack the bidder’s own business and strategy. Good Energy used this tactic on the hostile offer by Ecotricity, even though that was a cash-only offer. Seeking a white knight is a tactic that is often discussed but rarely used in practice. Defensive tactics have evolved over the years to recognise the greater diversity of shareholders who might come onto the register and have a part to play in any takeover bid.

Holmes: Energy companies should be conducting regular reviews of their vulnerabilities with respect to potential shareholder activism. Depending on the results of the assessment by a particular energy company, as much as possible, the company should develop a plan for or implement applicable changes. Changes should be communicated in a careful and clear manner to the broader shareholder base. Often, good communication of these efforts, even if they are only in the planning stages, may hold activists at bay. To the extent a hostile takeover bid is anticipated, the board of directors and management, with the assistance of counsel and other advisers, should be actively engaged in assessing the situation, developing strategic scenario planning and taking action. Defensive measures might include a publicity campaign, adopting a shareholder rights plan, communicating with other shareholders and engaging directly with the activist. US public companies might also consider revisions to their bylaws in light of the recently effective universal proxy card access rules. These actions should be taken in a thoughtful and deliberate manner.

FW: What are your predictions for shareholder activism campaigns across the energy sector in the months ahead? Do you anticipate a rise in hostile M&A activity?

Mulley: We are likely to see more shareholder activism in the energy and natural resources sector, although some activists may wait for the volatility in the markets caused by factors such as the war in Ukraine and inflation to pass. Climate change and ESG more broadly will remain high on everyone’s agenda. We do not, however, anticipate an uptick in purely hostile public M&A, largely because it is not a big feature in UK markets, but also because hostile offers are not often successful – of the 13 hostile offers in the last five years, excluding the two where there was a successful competing offer, only three were successfully completed, and the other eight lapsed. Shareholders will continue to apply pressure, both in an M&A context and otherwise. Activists and other active shareholders may take several stances on M&A. They may look to encourage it, for example by publicly calling for a company to be broken up or taken private. They may look to influence the outcome of a transaction, for example by seeking a price increase, known as ‘bumpitrage’, or agreeing to pay a bidder’s costs, as we saw on the offer for Volga Gas. Or they may seek to block a transaction outright, as we saw on the Tenaz Energy Corp offer for SDX.

Holmes: We will continue to see robust activism in the energy industry for the foreseeable future – both from ‘small a’ and ‘big A’ activists. Activist causes will continue to be heavily weighted toward sustainability efforts, reporting on sustainability efforts and, as the industry continues to be undervalued, strategic initiatives like consolidation. Recent regulatory changes, like universal proxy card and the Securities and Exchange Commission’s (SEC’s) approach to shareholder proposals, will support a potential increase in the number of proposals included on company ballots, although negotiated settlements will continue to be a useful defensive strategy for energy companies. If commodity prices remain at relatively high levels but equity values do not increase correspondingly, we can also expect more hostile M&A activity as investors seek to unlock value in the broader sector. In any event, activism is an area every public energy company should be actively monitoring.

Sinha: Despite macroeconomic uncertainty, activism continues to remain steady. Additionally, we have learned that the market cap size of a company is no longer a deterrent, with many large cap companies being at the centre of activist crosshairs this year. While we do not necessarily predict an increase in hostile M&A, opportunistic activists may take advantage of depressed stock prices. In addition, companies with a lot of cash on hand may become increasingly susceptible to activist campaigns calling for alternative capital allocation strategies. For example, Daseke, SK Holdings and Poshmark all faced activist campaigns this year demanding, among other things, share buybacks. While historically energy companies were not targeted by activists due to the highly regulated nature of the industry, recently that has changed with Duke, Southwest Gas and Exelon, among others, and probably the most notable campaign in recent history was the ESG-focused fight at Exxon Mobil by Engine No. 1.

Hillary Holmes is a partner in the Houston office of Gibson, Dunn & Crutcher and co-chair of the firm’s capital markets practice group. Ms Holmes advises issuers, investment banks and private equity firms on long-term and strategic capital raising. She also advises energy companies and their boards of directors on US securities laws, governance, ESG, complex situations and M&A transactions. She has been named one of the 25 most influential women in energy and an Energy MVP. She can be contacted on +1 (346) 718 6602 or by email: hholmes@gibsondunn.com.

Greg Mulley is a senior corporate and M&A partner in the Herbert Smith Freehills London office. He has particular expertise in public takeovers, private M&A, equity capital markets, corporate governance and restructuring. He is a key boardroom adviser on critical issues including shareholder activism, financial distress and crisis management. He regularly advises on complex cross-border transactions, and contentious or distressed situations. He can be contacted on +44 (0)20 7466 2771 or by email: greg.mulley@hsf.com.

Pankaj K. Sinha is the practice leader of the firm’s M&A group in the Washington, DC office. He concentrates on the areas of M&A, corporate finance and general corporate and securities matters. He has represented purchasers, sellers and their financial advisers in a wide variety of transactions, including public and private acquisitions and divestitures, negotiated and contested public acquisitions, auctions, going-private transactions, proxy fights, initial public offerings and other financings, and joint ventures and other strategic alliances. He can be contacted on +1 (202) 371 7307 or by email: psinha@skadden.com.

© Financier Worldwide

THE PANELLISTS

Hillary H. Holmes

Gibson, Dunn & Crutcher LLP

Greg Mulley

Herbert Smith Freehills LLP

Pankaj Sinha

Skadden, Arps, Slate, Meagher & Flom LLP

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Q&A: Shareholder activism and hostile M&A in the energy sector