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ZMH Advisors: Know Before They Knock — Inside the Activist Playbook Targeting Small and Mid-Cap Boards · WTR Small-Cap Spotlight

• 0:01
  SPEAKER_01: Welcome to the WTR Small Cap Spotlight Podcast.
• 0:04
  SPEAKER_01: I'm your host, Tim Gerdeman, Vice Chair and Co-Founder and Chief Marketing Officer of Water Tower Research.
• 0:10
  SPEAKER_01: Today, I'm excited to welcome special guest Wahid Hassan to the WTR Small Cap Spotlight Podcast.
• 0:17
  SPEAKER_01: Wahid is founder and CEO of ZMH Advisors, a strategic advisor on high-stakes activist situations and shareholder engagement.
• 0:26
  SPEAKER_01: Bloomberg ranks ZMH among the top five global strategic advisors for shareholder activism, which is really awesome.
• 0:33
  SPEAKER_01: Wahid brings 25 years of investor engagement, proxy solicitation, and proxy advisory experience, including time at ISS, where he managed the MA and proxy contest research team.
• 0:46
  SPEAKER_01: He has been involved in over 300 campaigns, including Jack in the Box, Cracker Barrel, Target, and Medallion Financial.
• 0:53
  SPEAKER_01: Before founding ZMH, he led the corporate governance and activism defense practice at the Blue Shirt Group and previously headed the shareholder activism practice at one of North America's largest proxy solicitation firms.
• 1:06
  SPEAKER_01: Earlier in his career, he also worked as a senior research analyst at UBS Warburg and an affiliate of Merrill Lynch.
• 1:13
  SPEAKER_01: His experience spans the full spectrum of the activism ecosystem, giving him a rare 360-degree view of how companies' campaigns actually play out.
• 1:22
  SPEAKER_01: More notably, he has advised several leading activists, to include Starboard and others, giving him a firsthand read on the activist playbook that he now puts to work helping companies defend against activist campaigns.
• 1:35
  SPEAKER_01: So without further ado, Wahid, welcome to the podcast.
• 1:38
  SPEAKER_00: Good morning, team.
• 1:39
  SPEAKER_00: Thank you so much.
• 1:39
  SPEAKER_00: Thanks for the kind introduction and inviting me to the podcast.
• 1:43
  SPEAKER_01: Yeah, I mean, you have you have a great background, so I'm really excited to delve into this.
• 1:46
  SPEAKER_01: And I got to tell you, Wahid, the reason I'm so excited to have you on the podcast today is that activism has been a near and dear topic for me for decades.
• 1:54
  SPEAKER_01: So much so, in fact, that Bloomberg wrote an article about me in circa 2001 for their call of the day segment titled Lehman Brothers Analyst Bets Big on Chemical Buyouts.
• 2:05
  SPEAKER_01: And that article spoke to my proprietary top 10 takeover list, in which four small cap companies from my list were taken out two years in a row.
• 2:14
  SPEAKER_01: The first paragraph of that Bloomberg article was very telling and read Wall Street analysts, usually loath to alienate corporate executives, sometimes can't sugarcoat the truth.
• 2:24
  SPEAKER_01: For Lehman Brothers, Timothy Gerdeman, that means telling investors that many specialty chemical companies don't deserve to be independent.
• 2:30
  SPEAKER_01: So using that, so using that to set the stage.
• 2:33
  SPEAKER_01: That was an awkward conversation with my bankers, by the way.
• 2:36
  SPEAKER_01: But uh to set the stage for today's call, Wahid, roughly 70% of activist campaigns now target small and mid-cap companies.
• 2:44
  SPEAKER_01: I'm curious, why is this end of the market cap spectrum so fertile for activists?
• 2:49
  SPEAKER_00: Thanks, Tim.
• 2:50
  SPEAKER_00: So you you're absolutely right about the stats.
• 2:53
  SPEAKER_00: Despite the perception that activism affects larger companies, the fact remains that more small and mid-cap issuers are targeted than large cap companies.
• 3:03
  SPEAKER_00: And there are several reasons for it.
• 3:05
  SPEAKER_00: The most important being that companies lack support system to manage activism risk.
• 3:10
  SPEAKER_00: Most companies do not have a stock surveillance program to identify activist accumulation.
• 3:16
  SPEAKER_00: Secondly, because of the market cap, it is much easier for activists to accumulate a meaningful position without allocating significant dollars to one idea.
• 3:27
  SPEAKER_00: Last but not least, many of these companies have concentrated ownership with the big three funds among the top 10 holders.
• 3:36
  SPEAKER_00: A concentrated ownership structure is very attractive to an activist because they have to convince only a handful of investors to achieve their agenda.
• 3:46
  SPEAKER_00: So those are the reasons why activism tends to be prevalent among small and mid-cap.
• 3:51
  SPEAKER_01: Absolutely fascinating.
• 3:53
  SPEAKER_01: When you look at the companies that end up in activist crosshairs, what patterns keep showing up?
• 3:58
  SPEAKER_00: That's a great question.
• 4:00
  SPEAKER_00: So the one biggest and persistent issue is the underperformance versus peers.
• 4:06
  SPEAKER_00: Not just one bad quarter, but multiple quarters of lagging total shareholder return.
• 4:12
  SPEAKER_00: That's the number one thing most people look at.
• 4:16
  SPEAKER_00: You will also see a valuation gap.
• 4:19
  SPEAKER_00: For example, the stock trades at a discount to peers valuation or some of the parts valuation.
• 4:25
  SPEAKER_00: Sometimes it's because of a conglomerate structure or a non-core business that is dragging the whole overall performance.
• 4:33
  SPEAKER_00: Balance sheet inefficiency is another issue.
• 4:36
  SPEAKER_00: Excess cash sitting on the books, or capital allocation decisions that did not yield the promised results.
• 4:43
  SPEAKER_00: Lastly, there are governance red flags such as low insider ownership, a board that hasn't been refreshed in a long time, or executive compensation that is not aligned with performance.
• 4:56
  SPEAKER_00: There are also situational triggers, specifically a recent CEO transition, or a strategic pivot that didn't land well with investors.
• 5:05
  SPEAKER_00: A good case study is cracker barrel like over the last two years.
• 5:10
  SPEAKER_00: Overall, almost all activist campaigns centered on the same core argument that the target company has failed to create shareholder value or hasn't reached its intrinsic potential.
• 5:24
  SPEAKER_00: And that a change in the board or CEO would lead to better outcome.
• 5:29
  SPEAKER_00: Interestingly, empirical studies suggest a significant increase in CEO turnover within a couple of years of an activist campaign.
• 5:38
  SPEAKER_01: Interesting.
• 5:39
  SPEAKER_01: You probably saw a big smile on my face when you mentioned excessive cash in a balance sheet because that used to be one of the things that I went after on my top 10 takeover list.
• 5:46
  SPEAKER_01: So they had significant cash and weren't deploying it.
• 5:48
  SPEAKER_01: So moving on, for those unfamiliar with how these campaigns unfold, can you walk us through the typical timeline from first stake to final resolution?
• 5:57
  SPEAKER_00: Absolutely.
• 5:58
  SPEAKER_00: It usually starts quietly.
• 6:00
  SPEAKER_00: The activist builds a position over weeks or months, often staying below the 5% threshold.
• 6:06
  SPEAKER_00: So they don't have to file a schedule 13B.
• 6:08
  SPEAKER_00: By the time they reach out to a company, and this is more surprising to many issuers, the activist has already spent months on due diligence, which includes speaking with other shareholders, engaging with current former employees, and even clients.
• 6:24
  SPEAKER_00: We have seen activists hire private investigators to conduct background research on the board and management team.
• 6:31
  SPEAKER_00: Now, most campaigns begin with private engagement, such as a private letter to the company or a phone call or a request for a meeting with the management of the board.
• 6:40
  SPEAKER_00: And this is where most campaigns, I would say 90% of all the campaigns get resolved at this stage.
• 6:47
  SPEAKER_00: But some do escalate to a proxy fight.
• 6:50
  SPEAKER_00: And that happens if the activist feels the company or the board is unresponsive.
• 6:56
  SPEAKER_00: And typically they escalate by in the form of a public letter or a white paper.
• 7:02
  SPEAKER_00: Their goal is to raise the stakes by spotlighting the company's performance and governance failures.
• 7:09
  SPEAKER_00: Putting pressure on the company to come to the table.
• 7:12
  SPEAKER_00: The public demands often center around board seats, management changes, a strategic review, or in some cases, sale of the company.
• 7:20
  SPEAKER_00: If the situation is still unresolved, the activists would then nominate directors ahead of the advanced notice deadline.
• 7:28
  SPEAKER_00: From there, it's either a negotiated settlement where the company and activists agree on a select group of candidates, or it goes to a full proxified order vote.
• 7:38
  SPEAKER_00: All told, once things go public, you're looking at three to nine months for the entire campaign to wind up.
• 7:47
  SPEAKER_01: Definitely a very unpleasant experience for C-suites that are uh targeted and really turns our lives upside down.
• 7:54
  SPEAKER_01: So taking the precautions you're going to talk about will really, really be beneficial.
• 7:58
  SPEAKER_01: Um, so moving on, what should along those lines, by the way, what should a management team be doing today to identify accumulation by an activist and to defend against an activist attack?
• 8:09
  SPEAKER_00: Like what we tell our clients is have a robust stock surveillance program in place.
• 8:16
  SPEAKER_00: Like tracking unusual trading activity, changes in ownership, like are the right signals to identify if someone is building a stake.
• 8:24
  SPEAKER_00: I mean, it's not perfect science, but that is a great place to start.
• 8:28
  SPEAKER_00: The second aspect is vulnerability assessment.
• 8:32
  SPEAKER_00: Be your own activist, identify performance and valuation gaps, look for governance weak points, and conduct a board gap analysis and critically evaluate your capital allocation decision.
• 8:45
  SPEAKER_00: We recommend companies to build an activist case themselves on a clear day.
• 8:50
  SPEAKER_00: So you are well prepared to defend against an activist.
• 8:54
  SPEAKER_00: A regular board refreshment is also key.
• 9:19
  SPEAKER_00: And last but not least, like always engage with your top shareholders.
• 9:23
  SPEAKER_00: The biggest gaps we see is when companies are focused on meeting with portfolio managers only or finding the next new investor, but rarely engage with the index funds who are among, often among the top 20 holders.
• 9:39
  SPEAKER_00: Or the companies do not have any relationship with the proxy voting teams.
• 9:44
  SPEAKER_00: Without off-cycle engagement to build those relationships, companies leave a gap that activists are quick to exploit.
• 9:52
  SPEAKER_00: Great.
• 9:52
  SPEAKER_01: So Wahid, in your with your wealth of experience, what mistakes do companies make when an activist shows up at their door more often than not?
• 10:00
  SPEAKER_00: I would say the biggest mistake is being dismissive, right?
• 10:04
  SPEAKER_00: And not taking the call, not communicating with the activist, right?
• 10:10
  SPEAKER_00: That is the biggest mistake.
• 10:11
  SPEAKER_00: The second mistake we hear is like the companies believe that activist thesis is irrelevant.
• 10:18
  SPEAKER_00: Nobody's gonna listen to their activists, nobody cares about what activists are saying.
• 10:22
  SPEAKER_00: That is not true, right?
• 10:23
  SPEAKER_00: Because, like I said, activists have already spent a lot of time and resources building their thesis by the time they come to you.
• 10:31
  SPEAKER_00: So they know the the traction they have with other investors and they know the thesis is going to resonate.
• 10:38
  SPEAKER_00: I often hear the argument that if the activist does not like the story, they should sell the shares, right?
• 10:44
  SPEAKER_00: Activists are not in the business of selling the shares, they're in the business of running a campaign or agitating for change, which will unlock a catalyst to create value.
• 10:55
  SPEAKER_00: They have a tactical roadmap in place, right?
• 10:58
  SPEAKER_00: Therefore, just wishing for activists to go away is wishful thinking.
• 11:02
  SPEAKER_00: It's not gonna happen.
• 11:03
  SPEAKER_00: Companies often tend to underestimate the traction activists have based on the thesis, right?
• 11:09
  SPEAKER_00: I think the other big issue where I see companies lagging is speed of response.
• 11:15
  SPEAKER_00: Like activists move quickly.
• 11:17
  SPEAKER_00: And if you don't have a game plan in place, like you companies are often reacting to the activists.
• 11:24
  SPEAKER_00: Activists also always always one step ahead of them.
• 11:27
  SPEAKER_00: So having a team in place and a process that will help them react to activists is the best thing to do.
• 11:36
  SPEAKER_01: Right.
• 11:36
  SPEAKER_00: Um, so how does it like can I just add one more if you don't mind?
• 11:41
  SPEAKER_00: So the so apart from like uh speed issue is the board and management need to be aligned on message.
• 11:49
  SPEAKER_00: Activists tend to create a wedge between the board and management.
• 11:53
  SPEAKER_00: And they and unless there is alignment of like messaging, alignment of strategy, it's very difficult to compete for a company to successfully defend against against an activist.
• 12:04
  SPEAKER_01: Totally agree.
• 12:05
  SPEAKER_01: Um, how does a company's existing sell-side coverage and investor relationships impact its level of preparedness for a potential activist attack?
• 12:13
  SPEAKER_00: Well, it makes a big difference.
• 12:14
  SPEAKER_00: When you have a strong, consistent research coverage, the market already has an independent read on your valuation and strategy, which makes it difficult for an activist to build a narrative which is surprising to everyone.
• 12:28
  SPEAKER_00: The same goes for relationship with your top holders.
• 12:31
  SPEAKER_00: That's a trust bank you can draw on.
• 12:34
  SPEAKER_00: And those investors are more likely to hear the company side or support, be supportive of the management than being supportive of the activist.
• 12:43
  SPEAKER_00: On the flip side, companies with thin coverage or infrequent engagement are essentially flying blind, right?
• 12:50
  SPEAKER_00: They don't know what the largest shareholders are thinking and how they would vote.
• 12:55
  SPEAKER_00: So regular engagement also surfaces early warning signs.
• 12:59
  SPEAKER_00: If your analysts and investors are asking specific questions or pointed questions, you know these are the themes that are likely to show up in an activist conversation because most likely the activist already spoke to them.
• 13:13
  SPEAKER_00: And I like, like I said earlier, make sure you have a relationship with both the proxy voting teams as well as the portfolio managers across your shareholder base.
• 13:22
  SPEAKER_00: Not having that relationship can have a huge impact in a proxy contest.
• 13:28
  SPEAKER_01: That's really insightful.
• 13:29
  SPEAKER_01: Um, I know you know my professional background because you and I have caught up multiple times now, but uh post my bulge bracket sell side equity research career.
• 13:37
  SPEAKER_01: For 17 years, I was in two investor relations firms and down the home stretch of that, working with one of my colleagues by the name of Chris Ketman, which is an IR guru.
• 13:45
  SPEAKER_01: Um, we talked to a lot of C-suites about doing crisis communication war gaming.
• 13:50
  SPEAKER_01: So they need to plan for all kinds of worst-case scenarios, including activists showing up at the door and practice how they'd respond so that they can respond instantaneously instead of actually waiting days and frankly just creating a PR crisis.
• 14:03
  SPEAKER_01: So moving on, um, walk us through what screens and signals activists are actually using to find their next target.
• 14:11
  SPEAKER_00: Yeah.
• 14:11
  SPEAKER_00: Like so, like you mentioned in the introduction, like I've worked with a lot of activists, activist investors.
• 14:17
  SPEAKER_00: So some of the things we see on the back end is they start with quantitative screens.
• 14:23
  SPEAKER_00: And the in the quantitative screens, they're looking at total shareholder returns relative to peers, valuation discount, return on invested capital, relative profit margin, history of capital allocation, and balance sheet spent.
• 14:37
  SPEAKER_00: They're also looking at ownership structure, the level of insider ownership, the makeup of the shareholder base between active and passive investors, the influence of the two proxy advisory firms like ISS and Glass Lewis on shareholder voting, and more importantly, the overall level of institutional ownership.
• 14:57
  SPEAKER_00: Most activists are hesitant to target companies with large retail ownership, primarily because retail shareholders tend to be more supportive of management and they're harder to reach.
• 15:08
  SPEAKER_00: The cost of running a retail campaign is significantly higher than running a campaign where ownership is concentrated among the top 20 investors.
• 15:18
  SPEAKER_00: I would also say that governance is all is also a very relevant screen.
• 15:24
  SPEAKER_00: Activists look at shareholder rights, directed tenure in particular, especially if you have long tenure directors, level of board refreshment, director qualification versus what is needed to execute this strategy, and increasingly executive compensation and the degree of its alignment with performance with overall performance.
• 15:46
  SPEAKER_00: Lastly, there are situational triggers, right?
• 15:48
  SPEAKER_00: Like CEO change, missed earnings, uh uh quarterly earnings, a strategy pivot that did not lead to the right results.
• 15:59
  SPEAKER_00: Um, and I would say one other aspect that some activists look at and they specialize in this is running some of the part analysis versus a standalone valuation.
• 16:09
  SPEAKER_00: And so those are overall some of the screens that activists run on their end to identify the targets.
• 16:16
  SPEAKER_01: Wahid, you have my brain spinning right now on that data point about retail investor ownership being a barrier for um activists.
• 16:23
  SPEAKER_01: And the reason I say that is many CEOs turn their noses up to retail investment community when in fact there are multiple benefits, but I never thought of this as being one of the benefits.
• 16:32
  SPEAKER_01: So that's really interesting.
• 16:33
  SPEAKER_01: That will go in my quiver in terms of information for the future.
• 16:36
  SPEAKER_01: So thank you.
• 16:37
  SPEAKER_01: Um, does an activist usually try to work things out quietly with the board first or go public right away?
• 16:42
  SPEAKER_01: And what determines that choice?
• 16:44
  SPEAKER_00: Yeah, most activists start privately.
• 16:47
  SPEAKER_00: It's because it's lower cost to them, lower risk, and it keeps their options open.
• 16:53
  SPEAKER_00: Um, the the decision or the calculus to stay private versus go public depends on a few things.
• 17:00
  SPEAKER_00: The most important being is the board and management being responsive?
• 17:04
  SPEAKER_00: Is management engaging in good faith?
• 17:06
  SPEAKER_00: And does NFT activist believes that going public would actually move the stock or shift the board's thinking?
• 17:13
  SPEAKER_00: Going public is often a pressure tactic.
• 17:16
  SPEAKER_00: It raises reputational risks for incumbent board and management because no director wants to be publicly criticized for overseeing poor performance or presiding over shareholder value destruction.
• 17:27
  SPEAKER_00: A public campaign also sends a signal of conviction.
• 17:31
  SPEAKER_00: Sometimes it's a way of inviting other investors to join the cause, especially when the underlying thesis involves a strategic review or sale of the business.
• 17:40
  SPEAKER_00: That said, going public raises the stakes for everyone and it can actually make settlement harder because both sides have public credibility on the line.
• 17:49
  SPEAKER_00: Some activists have built a reputation for going public quickly as a deliberate target, while most are known for preferring a quieter, more constructive approach and only escalating as a last resort.
• 18:02
  SPEAKER_00: At the end of the day, most activists are running an asset management business, right?
• 18:07
  SPEAKER_00: They need to show their investors they can generate alpha.
• 18:10
  SPEAKER_00: The path may differ, but the goal is the same.
• 18:13
  SPEAKER_00: Generate alpha, whether that's by negotiating with the company privately or forcing change through public pressure.
• 18:21
  SPEAKER_01: I like the way you frame that.
• 18:22
  SPEAKER_01: So Wahid, I could talk to you all day on this topic as I said.
• 18:27
  SPEAKER_01: And your knowledge is just amazing.
• 18:29
  SPEAKER_01: But uh all the good things have to come to an end.
• 18:31
  SPEAKER_01: So my final question for you today before we bring you back on in the future is uh once an activist has a thesis, how do they actually get other shareholders on board to support them?
• 18:40
  SPEAKER_00: Well, that's an interesting question, uh Tim, because the way activists get other shareholders on board are like they have different strategies around it.
• 18:51
  SPEAKER_00: The first being they reach out to the portfolio managers and talk to them.
• 18:55
  SPEAKER_00: Secondly, they understand how the governance teams at the large index funds work.
• 19:00
  SPEAKER_00: They have a working relationship with them.
• 19:02
  SPEAKER_00: That is why I said earlier, it is critical for companies to have an off-cycle engagement program to build a relationship with the governance teams at the index funds, the passives, as well as the actives.
• 19:15
  SPEAKER_00: The third aspect that activists use is public campaign, like by issuing a public letter or to the board or like through a social media, they attract other investors to come into the stock and reach out to them.
• 19:30
  SPEAKER_00: We've seen some activists run social media campaigns on Twitter, right, where large retail shareholders reach out to them.
• 19:38
  SPEAKER_00: In a nutshell, activists have a myraid of like ways of reaching out to other investors or attracting their attention.
• 19:46
  SPEAKER_00: And that is how they get everyone on board.
• 19:48
  SPEAKER_00: In a full-fledged campaign, winning ISS and Glass Lewis support is crucial because they know there are many investors who follow ISS and Glass Lewis recommendations.
• 19:58
  SPEAKER_00: So once they convince ISS in Glass Lewis to support their case, activists know uh have fairly confident that other investors will support their cause.
• 20:08
  SPEAKER_00: So that's in a overall how activists get other shareholders on board.
• 20:12
  SPEAKER_01: That's a really interesting strategy.
• 20:14
  SPEAKER_01: So thanks so much for joining me today, Waheed.
• 20:16
  SPEAKER_01: Um, this this is a, as I said, a topic near and dear.
• 20:19
  SPEAKER_01: And it's really, really a treat to be able to talk to someone so knowledgeable in the space.
• 20:23
  SPEAKER_01: And do me a favor, if there's a high profile, which there will be, we know there will be, a high profile activist campaign in the second half of the year.
• 20:31
  SPEAKER_01: Let's get you on to talk about it.
• 20:32
  SPEAKER_00: Absolutely.
• 20:33
  SPEAKER_00: Thank you, Tim.
• 20:34
  SPEAKER_00: Really enjoy this.
• 20:35
  SPEAKER_00: If your listeners take away one thing, I hope is that shareholder activism isn't something to fear, it's something to prepare for.
• 20:42
  SPEAKER_00: The boards and management teams that are responsive, those who cultivate relationships with both passive and active holders, and those who proactively identify their vulnerabilities and address them are the ones who end up in the strongest position.
• 20:57
  SPEAKER_00: Thanks again for having me on this.
• 20:59
  SPEAKER_01: Totally agree with what you just said in closing.
• 21:00
  SPEAKER_01: I think of planning and kind of wargaming as sort of a form of insurance policy that all small and microcap companies need to be doing for activism.
• 21:08
  SPEAKER_00: Absolutely.
• 21:08
  SPEAKER_01: Thank you so much, Tim.
• 21:10
  SPEAKER_01: Thank you.
• 21:11
  SPEAKER_01: Thank you for listening, and don't forget to subscribe, as well as visiting www.watertowerresearch.com to stay up to speed on the company's small cap written research reports, podcasts, fireside chats, industry specific symposiums, and conference schedules.
• 21:27
  SPEAKER_01: We will see you next time for another edition of the WTR Small Cap Spotlight Podcast.
• 21:33
  SPEAKER_01: Finally, a special thanks to the producer and editor of the podcast, Krista Fitzpatrick.