Carl Icahn
Carl Icahn © Bloomberg

Carl Icahn makes more money between sips on his outsized Martinis than most mortals make in a lifetime. Last week, the activist investor earned roughly $175m on a three-month-old stake in American discount chain Family Dollar. Another investor, Nelson Peltz and his Trian fund, had been doing the heavy lifting for four years, pressing Family Dollar into a sale. But Mr Icahn’s arrival seems to have been a US Cavalry moment, precipitating the acquisition by Dollar Tree.

It seems almost too easy for him these days. Rising markets and an investment approach honed over decades have met with spectacular results. In October, he cashed in around half his 9 per cent stake in Netflix for an $800m profit, after holding it for 14 months. Since he began acquiring a large stake in Apple, the company has followed his advice to increase its stock buybacks and dividends. The mere sight of his dorsal fin in the water sends corporate managers hurtling to shore, begging to do what he wants.

He may be, in the words of his fellow activist investor T. Boone Pickens, “as smooth as a stucco bathtub”, but his returns speak for themselves. Corporate managers may not like activist investors such as Mr Icahn, who can embarrass them, but they would do well to understand how these investors think before they are attacked themselves.

Mr Icahn explained his investment strategy in an essay in Forbes magazine last year. It is to find opportunities not just in his favour, but dramatically in his favour. Activist investing creates these dramatic opportunities. The reason is that many companies are mismanaged and consequently undervalued. Ordinary shareholders can buy the undervalued shares, yet they have no power to change the management.

“But,” Mr Icahn wrote, “if you are able to purchase the stock knowing you have the ability to mount a proxy fight or tender offer, and/or get control or force the board to make positive changes, the odds turn dramatically in your favour, and you may have an A+ investment.” Since corporate democracy is mostly a fiction, managers tend to be unprepared when a shareholder roars up from the deeps.

Slanging matches ensue. But the knife to the throat focuses the mind of flabby-thinking managers.

Some activists are trying to reduce the animosity towards them by calling themselves “suggestivist”. Presumably as in when a pirate suggests his prisoner walk the plank. Mr Icahn is not given to such euphemising.

Ideally, managers will do all they can to ensure they are delivering the best possible return to shareholders, thereby thwarting the activists. They will, at times, examine the company with all the scepticism of a used car buyer. They will ask themselves, “what would Carl Icahn see here that I’m not seeing?” If necessary, they hire an outsider to do this for them.

One of the best known stories of a company reinventing itself from the inside is Intel. In 1985, Andy Grove, then chief operating officer, and Gordon Moore, chief executive, were anxious that Intel had become obsessed with internal bickering over whether to stick with its highly profitable memory chips business or switch to microprocessors. According to Mr Grove he finally asked: “If we got kicked out and the board brought in a new CEO, what do you think he would do?” Mr Moore shot back: “He would get us out of memories.” The decision was made.

In a recent interview in McKinsey Insights, one of the consultancy’s directors, Larry Kanarek, says management often overreacts. They become defensive in the face of the activist’s criticism. Emotion grips both sides and escalates, and it is usually the investor who comes better prepared for a fight, more willing to go to the brink for a deal.

A better approach, Mr Kanarek suggests, would be to invite investors to present their analysis. It will usually be well done. Then take your time. Activists usually allow this if they get a proper hearing. Try to discuss criticisms constructively.

This seems to be what Apple’s Tim Cook did when Mr Icahn was badgering him for stock buybacks. But I can’t help thinking that for lesser prey, by the time an activist smells blood, the time for constructive discussion is over. Either management have done their work and maximised the value of their shares, or they are shark bait.

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