Energy Companies Need To Remake Their Boards, Before Activists Force Them To
Boards of directors in the energy sector have been changing faster than ever – and if activist investors have their way, there’s more to come.
As we found at the Egon Zehnder CEO breakfast during IHSCERAWeek in Houston, energy companies are looking intensely at the composition of their boards. In many cases, they’re being compelled to do so by activists, but perhaps it signals a wake-up call for boards to take a stance to defend their organizations from vulnerability, by building stronger boards.
In the past five years the energy sector experienced a four-fold increase in activity by investors with agendas. That compares to only a two-and-a-half-fold increase across all industries during the same period. Last year alone, investors pressured more than a dozen energy companies to reduce spending, sell assets and spin off businesses.
Why such intense focus on energy? As shareholders became less tolerant of the risk involved in complex, long-term international projects, many companies began focusing on North America, where geopolitical and other risks are much lower. Unfortunately, the hyper-competitive environment drove up costs as companies competed for the same acreage, labor and other resources, squeezing margins while prices remained level. Increasingly risk-intolerant shareholders were soon joined by the activists, who saw in unsatisfactory financial performance an opportunity.
They have taken aim at companies of all sizes, not just small caps. In fact, according to a data sample from S&P Capital IQ, 75 percent of oil & gas companies with greater than $10 billion in market cap now have some type of activist investor represented as an owner. And in 15 percent of those companies activist investors have greater than a 2 percent stake.
The activists aren’t just pushing for strategic changes, but also shaking up the composition of boardrooms. In the past two years, based on analysis using BoardEx, 33 percent of newly elected board members in select oil & gas companies targeted by activists were activist-nominated. For example, in March of last year, SandRidge Energy agreed to expand its board by four seats, giving the new positions to TPG-Axon Capital Management, a hedge fund that had been pressing for sweeping changes at the company. In October 2013, veteran activist Carl Icahn acquired a 6 percent stake in Talisman Energy and two months later secured agreement to add two of his representatives to the board. In December, hedge fund Corvex Management took an 8.8 percent stake in pipeline operator Williams, becoming its largest investor and immediately seeking board seats. In January of this year, well known activist hedge fund Jana Partners increased its stake in QEP Resources and announced its intention to nominate board candidates. Activists, having waged similar campaigns at many other prominent companies, show no signs of dialing back their activity.
The activists are calling for directors who have industry experience, as well as strong financial/M&A expertise, preferably as CEOs, COOs, or other strong industry executives who are able reduce costs, decapitalize, improve short-term financial performance and return more cash to shareholders.
This increased pressure for better short-term performance is pushing many companies to specialize and focus more sharply on their core strengths. ConocoPhillips, for example, spun off its downstream assets – pipelines, refining, and retail gas operations – as Phillips 66 in order to concentrate on its core production business, as did Marathon Oil. Similarly, Hess is selling its downstream operations in order to concentrate on production.
Specialization is, in part, driving the demand for board members with industry experience – directors who understand whatever highly focused strategy a company is pursuing. The more specialized and smaller the company, the higher percentage of directors with industry experience it is likely to have. In fact, according to data from BoardEx, there is an inverse relationship between the size of the company and the number of directors who are current or former oil & gas industry executives: 38 percent of directors for large cap companies ($10 billion-plus), 52 percent for mid-caps ($2-10 billion), and 58 percent for small caps (less than $2 billion).
As companies sell assets and businesses in order to specialize, they are likely to find willing buyers in private equity firms. Since 2010, the number of private equity-driven deals in energy has increased by more than 60 percent. Like small public company boards, private equity boards typically seek deep industry expertise when adding independent directors.
Unfortunately, the increasing demand for directors with high-level industry experience is running headlong into an industry trend that has been long in the making. The widespread layoffs and downsizings of the late 1980s and early 1990s led many people to exit the industry and fewer recruits to join. Many of them would now be coming into their own as leaders – and as worthy director candidates. This generation gap in leadership is reflected in a recent Egon Zehnder survey of the industry. Strikingly, 100 percent of the executives surveyed could name a visionary leader 56-plus years of age, but only 26 percent could name a visionary 45-55 years of age. Not surprisingly, given this generation gap, the average age of energy boards has risen – from 60 in 2004 to 63 today.
But what can companies do to curb the activist muscle? Start by defending the boardroom by building stronger boards less vulnerable to incursion. If activists attack the vulnerabilities shore up any potential weaknesses you might exhibit. A well built board encompasses a set of directors with diverse talent and deep sector expertise, balanced with both tenured knowledge and readiness currency to anticipate future business needs. Investor activism is likely to continue for the foreseeable future, and boards need be prepared for these incursions by tightly aligning on strategy and communicating it clearly, striving to outperform peers in total shareholder return and maintaining vigilance on potentially vulnerable areas.
If the past is any indication, the future surely dictates that energy boards will need more strategic agility than ever and directors with extraordinary talent to mandate high-quality governance. Readiness will be the defining denominator. The time to prepare is now.
The authors wish to acknowledge the contribution of Avery Marcus, Research Analyst and based in the Houston Office.
Please note that this article was originally published in Forbes, 4/16/2014