An interview with Okapi co-founder and head of its U.K. expansion, Pat McHugh.

Okapi Partners opened a new London base in September. What drove the expansion?

This was a long time coming. I think COVID threw us a curveball a few years back, but we’ve been looking at these markets for a while. For several years now, we’ve been getting inquiries from some of our activist clients asking us if we could work on campaigns in Europe and specifically in the U.K. We were always a little reluctant because the rules of the road were a little different. We were hesitant to get involved without bringing in a local team to help us, and as we worked on more and more of these transactions, we got very comfortable with the folks we’re working with to the point where they basically came over to become a part of Okapi.

There seems to be a consensus that much of the low hanging fruit in the activism space in the U.S. has been picked away. So, people are looking elsewhere. Additionally, funds in Europe are now starting to pursue those activist strategies a bit more frequently than they did in the past. So, we thought the time was right and it made perfect sense to expand to Europe.

There’s also the additional benefit of having an extra team on the ground to help us with campaigns in the U.S., especially when you’re working on large- and mega-cap companies who have a global investor base. So, to have a whole other team of folks that can help us communicate with and track down investors in Europe and Asia gives our team a little bit more firepower.

Conversely, we can do the same for them by giving them the infrastructure and the knowledge that we have here at Okapi. We also noticed the markets in Europe (including U.K.), on the ESG front, in some ways are ahead of us in the States, but we think there’s an opportunity here.

Since we’ve started our Governance Consulting Group at Okapi, it’s been very successful, and we think that there’s a lot of opportunity to do similar work in Europe. ESG is ever evolving, but there is still a lot of work to be done in this space and that’s why we feel we want to grow that presence in Europe. ?

What specific challenges does the European market present compared to others?

Our London office is going to work on campaigns across Europe, and every country has its own nuances, regulations and specific processes, whereas here in the U.S., everything runs the same way. It’s very much a well-established process and everybody understands what everyone’s role is.

I think in Europe, there’s a lot more chasing down votes and finding all the different links in the custodial chain, whereas in the U.S., it’s much flatter. It’s easier to get information and get responses. It’s why we brought in some experienced people in London. Hopefully we can use some of the processes and some of the techniques we’ve used in the States and cross-pollinate each of our respective teams to come up with some creative solutions. One of the things we’ve always done is try to look over the horizon to see what’s coming next, anticipate what people need and how best to get that to them. With technology, things are changing rapidly. We’ve got to be very responsive and can’t just stick to doing things the way we used to.

What activism trends have you observed in the U.K. this year?

I think that private equity had pulled back earlier relative to last year. I’ve heard from a number of the advisors that I speak to in the U.K. that they seem to be picking up a little bit later in the year. Part of agitating from the perspective of an activist is that if you’re going to push an M&A agenda, you must have willing buyers. It’s one thing to say, “sell the company,” but if there are no buyers available in the market, you’re whistling past the graveyard.

There’s a concept right now that there are a lot of companies in the U.K. that shouldn’t be public companies. You need to have an exit strategy if you’re going to push that agenda and I don’t know if the lever is available to pull. So, I think some of those campaigns maybe went by the wayside. That’s part of it. I do think that as the U.K. becomes more accustomed to a more aggressive U.S.-style activism, they’ve understood what the moves on the chessboard are. In the past, they might just throw up barriers, whereas now they may be a little bit more engaged behind the scenes and are willing to reach more amenable mutually agreeable outcomes. From our perspective – because we work on both sides of the equation, sometimes for the company, sometimes for the activist – some of the best activism assignments to work on, from the corporate side, are the ones that never see the light of day and the world never knows existed. I think there’s some of that going on.

How have European investors been responding to activism?

The markets have become more accustomed to it, and as a result, I think the European investors have become more accustomed to activist campaigns on their home turf. Many of the European index investors have been voting in U.S. activist campaigns for years. I think the way in which boards and management view activists is evolving in the U.K., in particular. There are different markets in Europe, where there are different degrees of how successful an activist can be, but I think in the U.K., historically, the campaigns took a longer time to fully play out. As investors are utilizing these more aggressive U.S.-style techniques, it’s shrunk the timeline. Companies know, “this is where we are, and this is what we must do immediately.” There’s no more foot dragging, so some of these things don’t become public because they just get settled quickly.

DMI data has revealed a six-fold increase in the number of U.K. companies subjected to return cash demands in the first nine months of the year. Are activists changing tack due to market conditions?

A lot of U.K. companies have lagging valuations despite maintaining good cash flow. Good cash flow with a poor valuation combined with a higher interest rate environment and the spreads between return on invested capital and weighted average cost of capital tightening has put companies in the position where they have to ask themselves what the best use of that capital is. Investors have looked at these situations and said, “well wait a minute, maybe rather than trying to reinvest this cash when conversion and interest rates are unfavorable, you would be better served sending it back to shareholders.”

As you mentioned earlier, the regulatory environment in Europe is unique and ever evolving. This includes new regulatory frameworks and governance codes, including some involving ESG policies and practices. How are investors responding?

During engagement with companies, we frequently hear investors ask management whether the compensation committees have considered adding ESG metrics to their incentive plans. We haven’t seen investors come out and demand this from companies, but investors seem to be responding to these regulations by letting companies know that adoption of ESG metrics would be preferred. In the past, we were in what I would term an exclusive environment where if you as a company failed an investor’s ESG purity test, they would simply exclude you from their ESG strategy or portfolio. Now we are getting to a more inclusive environment where while you may not pass the up/down test at present, if you can articulate what you are doing, how you are considering these things, what metrics you consider and why, they may still be included in their portfolio with the thought you are moving in the right direction and doing enough now that warrants credit and consideration.

The challenge to companies who believe they are doing the right thing is often not just doing it but telling their story adequately to the market. You would be surprised how many companies find themselves in this situation.

As you move towards a regulatory environment, one of the benefits in the ESG realm is there is more uniformity in reporting and measurement so it makes it easier for investors to gauge and compare companies against one another and the markets as a whole and should lead to more informed decisions.

Looking forward, what activism trends are you keeping an eye on across Europe?

In the U.K., you’re going to get more of the mid-cap, small-cap kind of activism there, I think. If you look at the FTSE 100, a lot of these are very stable, steady companies. They tend to be well run and they tend to be harder targets. In the U.S., the targets were more of a large-cap because those mid-cap and small-cap firms have already been targeted. The number of large-cap companies in the U.S. is larger, so in Europe and the U.K., I think it’s going to be lower down the market cap list pecking order.

It’s going to be interesting to see what continues to happen in the U.K. with companies considering whether to delist and go private or figure out what they’re going to do at these companies that many believe shouldn’t be public. Are there going to be efforts to block them? There’s always a phenomenon that they’re going private, but at what cost? That’s something to keep an eye on in the U.K, as well as redomiciling. At present, I think many U.K. companies feel that that’s their best option unless something changes in the U.K.

In the EU, there are different markets that have different unique possibilities. In Germany, there are a lot of opportunities there for a lot of reasons, particularly the governance structures in Germany, with the two separate boards and you can insert yourself between the two. In the Scandinavian countries, there are opportunities there if you find the right companies. Again, the environment there is good for an activist to look for a company to target there. We’re working on something in Switzerland and we think there’s some activism that can take place there. But again, each of these markets carries their own unique challenges.

France is a very difficult place to run a campaign though. There are lots of things that activists take issue with, but I think you must pick and choose because the environment there can be very difficult for an activist. So, there are a lot of different opportunities in the European markets, but they vary by issue and company and are based on the rules and the ability to communicate with other investors. That’s always at the heart of any activist campaign: who are the holders and how do you communicate with them? In some markets, it’s easier than others.

That’s a big part of figuring out whether something can get done or not, but we think we have a great team in London that can help guide us through that and help us provide our clients with advice on how to effectuate or defeat activist campaigns- depending on who we’re working for.