An interview with Legion Partners Managing Director Christopher Kiper.

Headquartered in Los Angeles, Legion Partners was formed in April 2012 with the mission of becoming the premier small-cap activist fund for high net worth and institutional investors

What makes Legion’s approach to shareholder activism unique?

Legion Partners is focused on small caps, which we define as market caps of between $250 million up to $6 billion. We think that part of the market is so interesting because, when we look at the ownership of the companies that are in that market cap universe, we see a lot of passive investors. On one hand, we’re competing with passive investors, many of whom don’t really have a deep understanding of the securities that they own and on the other side of it, when we look at the research coverage, the sell-side equity research coverage, there really isn’t much of it for a lot of those companies.

In terms of our engagement style, we always lead with collaboration. We pivot that approach to a more aggressive tactic if the initial collaboration doesn’t bear fruit. My partner Ted [White] and I have been doing this for 20 years each. Ted has over 20 years of experience as an activist having held leadership roles with a focus on corporate governance for CalPERS [California Public Employees’ Retirement System], the Council of Institutional Investors (CII), and Knight Vinke Asset Management. I have also spent the past 20 years doing activism with a particular focus on U.S. small-cap companies, most recently at Shamrock Capital, the investing vehicle for Roy Disney’s family.

ESG is important to everything that we do, and we’ve been on the scene working on the ‘G’ factor for quite a long time. If the ‘G’ is screwed up at a company, it’s going to be really difficult for the rest of the ESG program to have much success. An important element we bring to our engagements is driving board change. So, if you look across our portfolio and over time, we’ve, either through direct settlements or influence, added 61 directors across our portfolio companies and, importantly, 51% have been diverse candidates. We think having a more diverse board allows a company to make better decisions. We’ve interviewed and built up a database of over 150 candidates that we’d like to add to a board if we could identify the appropriate time and place. We want to leave companies performing better than the way that we found them and it’s our sincere hope that the people will stay on the boards long after we have sold the stock and moved on.

In August 2022, Insightia ranked Legion’s campaign at Guess as one of the top 10 wildest activist campaigns of the 2022 proxy season. Were you surprised at how it turned out?

Our campaign at Guess had been years in the making, given that our firm is located in Los Angeles. We’re very near the Guess headquarters so we had a front-row seat to follow the allegations of epic bad behavior of the founders for years, particularly Paul Marciano.

Following the media attention that we witnessed, such as that involving Jeffrey Epstein and Harvey Weinstein, we were deeply suspicious that the Guess board was not properly functioning, given the years of allegations about Paul Marciano’s conduct and the fact that nothing had really happened.

One area that has been a big surprise for us is that no law enforcement authorities have ever taken action to hold Paul Marciano accountable for the allegations of sexual assault and sexual harassment.

We knew the prospect of our withhold campaign was going to be a long shot and that’s because the family owned so much of the outstanding shares, but I think it’s important to keep in mind that that effort was just one aspect of our campaign at Guess that’s still ongoing.

The most surprising thing to us, however, was that there were some institutions, in the face of recommendations from both ISS and Glass Lewis to withhold on Paul Marciano, that decided to support him. That vote is shocking to us, that anyone could come to that conclusion.

Legion’s campaign at Guess was also unique in that the ‘social’ elements of ESG formed a major component of your argument for reform. Do you expect this focus on ESG to continue in your campaigns going forward?

We are always looking at ESG elements. With Guess, damage had been done to the Guess valuation from a failure to address a significant ESG issue. We examined what happened to the stock’s valuations as those issues came out.

We’re really highly focused on driving shareholder value. There’s been a lot written in the press, that there are issues with ESG and it doesn’t drive shareholder value, and we think that nothing could be further from the truth. In fact, when you look at ESG issues and you talk to companies, especially those in the consumer space, we often find that it’s those younger consumers that are deeply interested in brands and companies that have a good ESG story to tell.

It may have seemed our campaign at Guess was focused on a social issue. That social issue was a symptom, the disease was poor governance. The board had been complicit with the behavior of the Marcianos for years. They effectively loaded the board up with people who were beholden to them, notwithstanding that all these allegations had come out. They were happy to leave them in place.

Across the small-cap universe, we find many of the companies have not developed an ESG program. They’ve never written a comprehensive ESG report and they’re not even really sure where to start. Often, they have limited resources to expend on ESG whereas, in the S&P 500, some have whole ESG departments.

How has your strategy been affected by the macro environment, including rising interest rates?

We think the next few years are going to be an amazing time for our strategy. We’re likely going to be in a period of more moderate market equity upside. There are a lot of attractive valuations that are out there. Private equity, whether it’s software buyout firms or otherwise, are all flush with capital waiting to do deals. There’s also a massive opportunity right now for corporates who want to drive growth. We see an environment where we feel M&A is going to be picking up substantially.

We haven’t seen much of it of late because it’s been very hard to get leverage right now and there isn’t a lot of debt funding available. As the interest rate environment becomes clearer, with debt capital markets opening back up again, I think that’s going to be an important element to the M&A story picking back up.

We feel a concentrated fund like ours, that owns 10 stocks and functions as its own catalyst, will do extremely well in this environment where there’s going to be a little more pedestrian equity returns. We think a fund like ours will be able to generate substantial returns, well beyond what the market will generate.

How has shareholder activism evolved this season, compared to the last?

We’re continuing to run our normal playbook. We’re leading with our collaborative approach and then taking further steps where collaboration was ineffective. We probably see one or two situations in the next 12 months that could go to a proxy fight if a settlement can’t be reached.

History shows that for us, we normally find a constructive settlement unless the board that we’re talking to is just too dysfunctional and, in those cases, we welcome the opportunity to drive even more significant improvements. I think it’s going to be really interesting to watch this proxy season to see how the implementation of the universal proxy affects boards and proxy contests. Our view is that it will really help improve board refreshment and place more of an emphasis on candidate-to-candidate comparisons of qualifications and fit.

Where do you think the most plentiful opportunities for activism currently lie?

The best opportunities are probably in software. Many software companies were organized and run over recent years to go for growth at all costs. Many of these firms don’t make money and we’re doubtful, in many cases, that the boards that oversaw that strategy are the right ones to take them forward. Software businesses are pretty amazing when you get under the hood on them. They have strong annual recurring revenues, excellent gross margins of around 80%, and so it’s really just a matter of figuring out all of the middle of the income statement.

If you could introduce one corporate governance reform, whether it be in the U.S. or internationally, what would it be?

The biggest issue in corporate America we see is the agency issue that exists with boards. Most independent board members own very little stock. If you were to dissect the shares that they own, you’d find most of those shares were gained or received through equity grants for board service. It’s a real rarity to see a director reach into her or his pocket and buy stock. We think that directors need to do a better job of representing shareholders and there is no better way to focus thinking and decision making than to have directors buying stock directly. That would make the biggest difference in terms of how boards function.