Success breeds imitation. The persistence of that cliché is good evidence of its accuracy. Its implications, however, may be a warning call with respect to shareholder activism in Canada.
The woes of Valeant Pharmaceuticals International Inc. (“Valeant”) and its share price have been well documented in the media. Following a report by Citron Research, who held a short position in Valeant, alleging improper revenue recognition, Valeant’s shares fell precipitously: on the day prior to the report, October 20, 2015, Valeant’s shares closed at $190.85 (CDN) on the TSX. On October 22, 2015, Valeant’s shares closed at $144.05. By now, Valeant’s shares have declined to under $40, albeit not solely on the basis of Citron’s allegations.
It is not my intention to recite in depth the news surrounding Valeant. Its plight does, however, highlight an important form of activism that should not be overlooked: short-selling activism.
In broad strokes, the practice of short-selling activism involves an activist taking a short position on a company, while publically identifying reasons why the share price is overvalued – often (but not always) through explosive allegations of fraud or criminality. The practice is not particularly new, with well documented cases of public shorts in North America in 2011 and 2012, but the Valeant case represents one of the largest, most notorious, and most consequential public short in Canada in recent memory. It is a fair assumption that this notoriety may lead to an uptick in short-selling activism, and it is an issue that boards should be prepared to address.
Traditional shareholder activism generally seeks to increase a corporation’s share price, at least in the short term. Short-selling activists, in contrast, only profit when a company’s share price declines. The dissimilar incentives as between shareholder activism generally and short-selling activism means that responding to this unique form of activism, or being prepared in advanced to respond to it, presents unique challenges.
We have outlined strategies for responding to shareholder activism in the past, and our Special Situation Team, in collaboration with The Boston Consulting Group and RBC Capital Markets, has released a white paper addressing defensive strategies to shareholder activism. Many of these strategies, including engagement with long-term shareholders, good governance, and proactive board involvement in value creation, remain relevant and important to defending against virtually all forms of activism. Engagement with the activist, however, which may be beneficial in responding to traditional activism, has little to recommend itself in the context of short-selling activist, as it is effectively a zero-sum situation: there can only be one winner when one party seeks value creation and the other value destruction. Consequently, a board should be prepared to adopt a significantly more aggressive strategy in dealing with a short-selling activist, and should expect the activist to respond in kind.