Shareholder Activism: Preparedness and Response

Fall 2016

PRIVILEGED AND CONFIDENTIAL

Contents

• CURRENT ACTIVISM ENVIRONMENT

• ANTICIPATING ACTIVISM AND RESPONDING TO ACTIVISM

1

Current Activism Environment

2

Activism remains a threat amid volatility

Source: 13F filings, Hedge Fund Research, financial advisor analysis as of March 8, 2016.

Activists Have Recently Underperformed

Current Dynamics

● State of the market new investment opportunities for those with dry powder

● Activists may take more aggressive actions to generate returns

● Activists will be both catalyst for, and potential obstacle to, M&A execution

● New entrants, any shareholder can be an activist

● Some activists are rebranding themselves as “engaged shareholders”

33%

61%

18%

-50%

-25%

0%

25%

50%

75%

100%

GS Activist IndexS&P 500 Total ReturnHFR Fund Weighted Composite Index

3

Despite challenges, activists are more active • Poor performance hobbled some large activist funds heading into 2016, with investors pulling out $15 billion from

hedge funds in Q1 2016 alone.

• However, activist attacks have been growing steadily and successful campaigns have been on the rise, due to 1) greater access to capital, 2) an increase in “occasional activism”, and 3) a broader set of corporate targets

Source: FTI Consulting and Activist Insight; FT.com and HFR; SharkRepellent. Firepower includes AUM of primary-focus and partial-focus activist funds. Number of activist attacks represents U.S. campaign announcements, including the following campaigns types: value creation, public short, board seat and officer/director removal. Campaigns resulting in board seat(s) includes campaigns resulting in at least one board seat for the activist (or where the activist had a meaningful say in the appointment of a new independent director); based on date seat was won/granted.

Growth in Activist Attacks and… Campaigns Resulting in Board Seat(s)

61

51

68

73

91

120

8

8

11

18

16

10

0 50 100 150

2010

2011

2012

2013

2014

2015

Granted Won Via Vote

219 242

262 274

347 374

2010 2011 2012 2013 2014 2015

4

No Company Is Too Big, Too Popular, or Too Successful to Be Immune from Activism

5

More shareholders are trying activism

Source: Activist Insight, with latest full year results from 2015

Rise of the Occasional Activist More Campaigns by First-Time Activists

More investors are trying their hand at the activism game

15

28

20

36

49

0

10

20

30

40

50

2011 2012 2013 2014 2015

20%

34% 32%

10%

4% Primary Focus

Partial Focus

Occasional Focus

ConcernedShareholder

Other

11%

21%

51%

14%

3% Primary Focus

Partial Focus

Occasional Focus

ConcernedShareholder

Other

2012

2015

6

$5B- 10B, 7%

$1B-5B, 33%

$250M-1B, 45%

>$10B, 15%

Companies of all sizes are becoming targets

Source: SharkRepellent and Activist Insight, with latest full year results from 2015

Activist Targets by Size, 2015

Since 2010, more than 1/3 of S&P 500 companies have faced a public demand from an activist

7

0%

20%

40%

60%

80%

100%

____________________ Source: Blume and Keim (2012), Wharton School Dept. of Finance, “Institutional Investors and Stock Market Liquidity: Trends and Relationships,”

Strategic Insight 2010; Proxy Pulse (2015); Broadridge Financial Solutions, Inc. (2015); Bloomberg (2010, 2016). Bloomberg data for 2010 and 2016 only for S&P 500 companies; may not be entirely comparable to earlier data.

Indexed Assets as a Percentage of All Mutual Fund Industry Assets

0%

5%

10%

15%

20%

25%

30%

35%

1985 1990 1995 2000 2005 2010 Q42015

Households/Retail Investors Institutions

Share of Institutional Ownership of U.S. Common Stock

The Rise and Rise of Institutional Ownership

8

Passive mutual funds are accumulating larger stakes in more big companies, often collectively exceeding the holdings of actively managed funds.

9

3

468

0

50

100

150

200

250

300

350

400

450

500

2005 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Com

pani

es

Number of S&P 500 companies in which Vanguard Group’s U.S.-based passive mutual funds

and exchange-traded funds owned 5% or more

12

112

0

20

40

60

80

100

120

2005 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Com

pani

es

Number of S&P 500 companies in which U.S.-based passive mutual funds and ETFs collectively own

more stock than active ones do

Note: Applies to total market value of share classes included in the S&P 500. All figures as of year-end except for 2016, which is as of June 30. Sources: Wall Street Journal analysis of data from Morningstar (funds and stock ownership); S&P Global Market Intelligence (S&P 500 constituents, share classes, share counts and market values)

The Rise and Rise of Index Funds

Traditional Institutional Investors Have Also Become More Directly Engaged in Activism

Source: FactSet, Thomson, “Are Institutional Investors Part of the Problem or Part of the Solution?” (Committee for Economic Development, 2011). 1 Includes percent of times voted dissident slate in global proxy fights as of January 23, 2016.

Institutional Investors Are Willing to Support and Even Participate in Campaigns

. . . And Support Activists in Proxy Fights

Company Institutional Investor Activist

Pershing Square

Icahn/ Southeastern

Starboard

Trian

Icahn

Trian

JANA

KnightVinke

Elliott

Legion Partners

Relational Investors

Firm Name % “FOR” Dissident

Nominee(1)

Activ

ely

Man

aged

T. Rowe Price Associates 62.5

Janus Capital Management 50.0

Fidelity Management & Research 45.5

Morgan Stanley Investment Management 44.4

MFS Investment Management 42.1

TIAA-CREF 30.6

Franklin Advisors 39.0

Inde

x Fu

nds

Norges Bank Investment Management 39.6

Mellon Capital 34.4

Geode Capital 57.1

BlackRock 40.6

State Street Global 30.7

Northern Trust 26.7

The Vanguard Group 23.3

10

“[C]ompanies are usually better served when ideas for value creation are part of an overall framework developed and driven by the company, rather than forced upon them in a proxy fight….Over time, as companies do a better job laying out their long-term growth frameworks, the need diminishes for quarterly EPS guidance, and we would urge companies to move away from providing it.” (Laurence D. Fink, BlackRock)

“When activists raise legitimate questions and tie their business cases to long-term shareholder value, that gets our attention…[but] board members cannot be more worried about their own seats than they are about the future of the company they oversee. Boards must take a principled stand to do the right thing for the long term and not acquiesce to short-term demands simply to make them go away. (F. William McNabb, III, Vanguard)

Major Institutional Investors Speak

11

“Our main goal as a near-permanent source of capital for companies listed in the indices is to maximize the probability of long-term value creation on behalf of our clients…we recognize there are different ways for activists to engage with companies and that some activists can drive positive change. But we are wary of activist situations that favor short-term gains at the expense of long-term investor interests.” (Ronald P. O’Hanley, State Street Global Advisors)

“As of August 2016, 49 companies had conceded 104 board seats to activists in settlements, almost on par with the 106 seats conceded by 54 companies in all of 2015. This significant uptick represents a dramatic increase in situations where long-term shareholders have not been afforded the benefit of public discussion regarding these activists’ views on strategy, compensation, share buyback programs and other factors.” (Ronald P. O’Hanley, State Street Global Advisors)

There is a new paradigm of corporate governance

12

Less outsourcing of governance and portfolio oversight to proxy advisors and activist hedge funds

Activists use a variety of screening criteria to identify targets

13

Primary Focus of Recent Campaigns:

Factors Considered by Activists:

“Screening” Criteria Potential Questions

• Return of capital – e.g.:

— Share repurchases

— Extraordinary dividends

• New and “improved” capital allocation strategies

• Sale of the Company or division

• Spin-offs

• Management change

• Board change

— Withhold-vote campaign

— Launch short-slate proxy contest

• Compensation reform

• New corporate strategies

• Perceived consolidation opportunity

• Is the Company a logical target for a strategic consolidation?

• Stock price performance/relative valuation

• What is the absolute stock price performance? What is my cost basis? • How is the stock performing vs. peer and/or industry?

• Management stability/performance

• Has there been a change in CEO or other top execs or CEO succession questions? • Has the company had difficulty filling key vacancies?

• Capital structure • Is there excess cash with a poorly defined strategy for deployment? — What is the level of net cash relative to market cap? — Capital ratios vs. peers?

• Is cash/debt funded repurchase accretive?

• Candidate for break-up, restructuring or other outsized returns

• Is the Company trading below the sum-of-the-parts value? • Are there opportunities for divestitures or restructuring?

• Poorly understood strategy • Has the company clearly and consistently articulated its strategy? • Is company’s strategy well supported by the market?

• Research analyst criticism/negative press commentary

• Are there any reports or press calling for sale of the Company or subsidiary? • Any rumors about the Board, management team or Company’s operation?

• Takeover defenses • Is the Company vulnerable from a structural defense standpoint? — Can I remove directors without cause? — Is there a stockholder rights plan in place? — Can I act by written consent or call a special meeting?

• Stockholder base • Are there other activists in the stock that I can team with? • What percentages of institutions do hedge funds and index funds comprise? • How significant is the retail ownership?

• Corporate governance • Has ISS recommended any “withhold” votes for directors at other directorships? • What are the ISS and Corporate Library scores? Any notable downgrades? • Is there a history of stockholder proposals? • Are the Company’s directors long-tenured, senior in age or over-boarded?

1

2

3

4

7

8

6

5

9

10

Board Representation Sale of the Company Split the Company Return Capital

Remove CEO Bid for Company Oppose Transaction Attack Corporate Governance

/

/

/ /

/

/ / / / / /

/

/

/

/

/

/

/

/ Various / Greenlight *

/ Icahn / /

/

/ /

/ /

/

/

/ / / / /

/ &

/

/

/ /

Objectives of Economic Activism

14

Activists may deploy a wide range of private and public tactics to achieve their goals . . . Less Coercive PRIVATE APPROACH

More Coercive PUBLIC APPROACH

1 Private conversation between activist and target CEO

2 Private conversation between activist and target chairman / lead director / select directors

3 Private letter from activist to target CEO / Board members

4 Acquire stock without public disclosure (less than 5% under U.S. 13D regime)

5 Seek “on-Record” conversation between activist and Board members / management

6 Acquire stock with public disclosure (greater than 5% or announce; HSR early clearance)

7 Discussion of potential deal or governance changes with analysts / third parties

8 Publicly disclosed letter (tone and firmness varies)

9 Stockholder proposal

10 Proxy fight (at annual meeting or through special meeting or action by written consent)

11 Litigation plus proxy fight

PRIVATE / PUBLIC LINE

15

. . . and will typically follow a familiar pattern of escalating pressure

Build Stake Apply Pressure Take Action Against Board

• Accumulate initial stake (may include "hidden" economic ownership amassed through derivatives)

• Make Hart-Scott-Rodino filing

• Continue to build stake

• Publicly disclose stakebuilding

• File 13D (or similar)

• Team up with other institutional or activist shareholders

• Request meetings with management and/or Board

• Send private letters threatening public action

• Issue open letters to Board

• Become aggressive with management on analyst calls

• Aggressive 13D disclosures

• Threaten to agitate against Board's preferred strategic alternatives or to vote against Board-approved M&A activity

• Seek to stir up third-party interest and rally other investors ("wolf pack" phenomenon)

• Use aggressive public relations, including leaking rumors

• Litigate

• Threaten "withhold the vote" campaign

• Demand Board seats

• Launch short-slate or full-slate proxy contest

• Call a special meeting (where available)

• Propose a precatory proposal for specific action

• Take action by written consent

• (Aggressive use of derivatives ("riskless voting")

• Make public bear hug (rarely)

• Commence tender offer (rarely)

16

Launch public proxy fight

Public letter to the board

Private letter to the board

Phone call or meeting with CEO or attempt to “pick off” a

director

Or, more simply . . .

17

Proxy advisory firms often support activists

• When analyzing proxy contests, ISS focuses on the following questions: — Have the dissidents made a compelling case that change is warranted?

— If so, are dissident nominees more likely to effect that change than incumbents?

• ISS has lent substantial support to dissidents in proxy contests

— In practice, ISS policy has put the burden on the company to show that change is not warranted

— In contests waged by hedge funds since the beginning of 2008 in which ISS issued recommendations, ISS supported at least part of the dissident slate in approximately 60% of the cases

— Of these cases in which ISS supported at least part of the dissident slate, at least one dissident was elected in approximately 70% of cases

• Glass Lewis has been slightly more favorable to management

18

ISS Recommendations in Proxy Contests

19

Source: ISS Governance Voting Analytics. Data based upon meeting date between 1/1/2014 and 7/19/2016. Proxy contests for all indices in the U.S.A. Includes elect directors (opposition slate) and remove existing directors only.

16 17

11

12 (43%)

18 (51%)

19 (63%)

0

5

10

15

20

25

30

35

40

2014 2015 Thru July2016

# M

eetin

gs

Management

Activist

Proxy Fights where ISS issued recommendation

20

Historical Board Representation & Time to Settlement with Activists

Source: FactSet, Activist Insight, public sources. 1 Includes activist campaigns announced from 2012 – 2015; targeting companies with equity market capitalization >$500M; including private and public settlements for board seats; involving activists on FactSet’s “SharkWatch50” list; excluding activism directed at funds. 2 Represents time elapsed between initial public agitation and the date on which board seats were granted.

20

26

28

31

101 Days

146 Days

93 Days

60 Days

2012 2013 2014 2015

Campaigns Where Seats Gained¹

Average Days to Settlement²

How Will the New Paradigm Affect Activism?

Activists May seek to discredit individual directors and undermine the board

Overview Attack Themes

Long-Tenured Directors

Lack of “Shareholder Perspective”

on Board

Lack of Recent / Relevant Industry Expertise

Lack of share ownership

Over-Boarded Directors

“Problem” Directors

“Too many” insiders

Alleged “Conflicts of

Interest”

• Activists have gained seats on well performing companies by targeting individual directors

• Corporate governance remains an important voting issue for index funds

— Activists are tailoring their argument to various segments of the target’s shareholder base

— Companies can do the same

• Growing focus on Board tenure

— Average director tenure

— Individual director tenure

— Absence of any new directors in recent years

— “Lumpiness” of tenure

• Companies can take proactive steps to create pipeline for director succession and enhancing board composition

Activists are increasingly assembling slates of directors with a mix of seasoned executives, corporate governance notables, and others with “investor” perspective

21

Anticipating Activism and Responding to Activism

Advance preparation • Stay one step ahead: Core strategy of activist is to try to create a wedge between (1) the Board

and management; (2) directors; and (3) the company and its shareholders.

• Look at your business the way a short-term financial investor would and understand how that might differ from how a long-term oriented investor would evaluate the Company

• Understand the new paradigm of corporate governance and stay close to shareholders by: — Tracking ownership, trading volumes and other indicia of activity — Maintaining an open dialogue with shareholders; year-round sport (not just proxy season) — Consider board level engagement in select situations as appropriate — Continuing regular temperature taking calls pre- and post- earnings and conferences — Objectively assessing what you hear – are you receiving candid feedback? — Engaging with portfolio managers as well as proxy/voting departments

• Be alert to early warning signs, such as: — Extremely pointed questions during Q&A — Analyst reports suggesting structural changes or adverse shareholder sentiment — Changes in shareholder base — Activist’s prior history

• Be ready for the first phone call – It can be difficult to recover from mistakes made in the first conversation — Establish internal and external teams, including advisors — Directors should know to refer calls to the CEO — Consider a dress rehearsal (for senior management and advisors) for next steps by activists

23

Principles for responding to live activist situation • Everything should go through the CEO

— All executives and directors should refer activist approaches, overtures and conversations to the CEO. It is essential that the company speak with one voice

— Whether or not to “reward” an activist with access to the CEO is a tactical decision that should be thought through under the specific circumstances

— Activists may try to contact board members directly, all conversations are “on the record” and any comments may be used by dissidents in the dissident’s private and public communications

— Chairman / Lead Director involvement may be warranted in certain circumstances

• Keep the Board prepared and informed – maintaining board unity and preserving confidentiality is essential — A unified, supportive board is essential to producing the best outcome; key is to avoid having the activist

drive a wedge between management and the board

— Remember that although CEO is the focus of attention in peacetime; in an activist situation, the directors will also perceive themselves to be under attack and challenge

— The CEO should consult with the board and solicit advice. Honest and open debate should be encouraged, but kept within the boardroom

• Keeping the situation private can have significant advantages — Once public, a target’s options narrow dramatically, including because it becomes harder for activist to

withdraw without extracting changes it can take credit for

— It may be difficult to win over institutional shareholders (and impossible to win over arbs) with sensible economic arguments — “long-term” means months and “value” means anything above their buy-in price

24

1

2

3

Principles for responding to live activist situation (cont’d)

25

• Remain focused on the business — Activist approaches can be time-consuming for a board and management, but continued strong performance

of the business, though not an absolute defense, is one of the best defenses — When/if business challenges arise, handling in a manner that preserves credibility is critical

• Nature of response must be determined based on the specific circumstances at the time; however, constructive engagement is often (though not always) preferable to “combat” — Many activists will listen to reason — Activist will want to know: (1) that its views are being taken seriously; (2) that the board is open to change,

not asleep at the wheel and not willfully blind to potential alternatives

• Act and speak as though everything you do and say will be made public — Activists will not hesitate to quote you out of context or twist your words — Appreciate that the public dialogue is often asymmetrical; while activists can, often without consequence,

make personal attacks and use aggressive language, the company cannot respond in this manner

• Be aware that activist is likely to talk to: — Other shareholders, large and small — Sell-side analysts — PE Funds and other potential acquirors — Shareholders of your competitors — Former and current employees — Business partners

5

6

7

4

Principles for responding to live activist situation (cont’d)

• Do not allow activists to occupy the “moral high ground” of corporate governance or shareholder rights — No activist represents the interests of all shareholders (and usually they represent the interests of only a

small minority) — and it is ok to point this out, at the right time and in the right way

— Do not be cowed by arguments that “good governance” requires the board to act as the shareholder demands

• The board will have time and flexibility in responding — and plenty of latitude from a legal perspective — Risk of legal liability is low, as long as board acts in a deliberative manner on an informed basis

• If activist situation becomes public . . . — Initially, no response other than “the board will consider and welcomes input from its shareholders”

— Call special board meeting to meet with team and consider further communications

— Commence communications outreach

Press release acknowledging receipt and affirming board’s openness to shareholder input

Reach out to largest shareholders; offer phone calls or in-person meetings

Consider outreach to, or have prepared quote for, key media contacts

Consider possible communications to employees, as necessary

Update / draft investor presentation deck

26

10

8

9

Playbook: Outline of steps

• Assemble Team in Advance

— Typically 3 to 5 key officers, such as CEO, CFO, General Counsel, Head of IR and PR, as well as outside counsel, investment banker, proxy solicitor and PR/IR firm

• Prepare General PR/IR Statements in Advance

• Understand Major Dos and Don’ts

• Steps for Non-Public Approaches

• Steps for Public Approaches

• Keep Board Apprised

27

Responding to an activist’s call: General guidelines

What to Do or Say… What Not to Do or Say…

• Emphasize that the Company is open to engaging with all shareholders and listening to their perspectives

• Highlight that the Company values receiving the activist’s view and input as a shareholder

• Listen more than speak, and allow the activist to lead the conversation

• Maintain the high ground and avoid debating with the activist; however, it is okay to correct factual errors

• Remember Regulation FD and that everything you say could be put in the activist’s public filings

• Avoid commentary on how the Board will view a particular action (other than that the Board is firmly committed to delivering shareholder value)

• Do not establish any hard lines in the sand

• Do not engage in a detailed debate on the merits of any proposal or respond to hypothetical scenarios

• Do not make negative comments regarding the Company governance or operations

• Do not say anything that you do not want to see subsequently disclosed to the press or shareholders (avoid sound bites)

• Do not commit to respond on any particular timetable

• Do not commit to any particular follow up (such as agreeing to allow the activist to talk to other executives, directors or the whole Board)

• Prepare Core Statements — “We remain focused on continuing to create shareholder value…”

— “We know our company well and have a thorough understanding of both our opportunities and challenges…”

— “We communicate frequently with our shareholders and welcome a continued dialogue…”

No Company representative should speak to the activist alone

28

Responding to non-public communication • Assemble team and determine initial strategy. Response is an art not a science; one size does

not fit all

• No duty to disclose

• Try to learn as much as possible by listening

• No duty to respond, but failure to respond may have negative consequences

• Team should confer to carefully orchestrate a particular approach

• A short meeting with activist to determine its agenda and to avoid it going public is often helpful

— Do not be defensive or confrontational

— Developing a framework for private communication and nonpublic engagement may avoid escalation

• Be prepared for transition to a public campaign by activist

— Everything is “on the record” and may appear in a public shareholder letter, SEC filing or future proxy fight

— Screen phone calls (office and cell); activist may try to reach out to various executives or directors

• Keep Board apprised

29

Responding to public communication • No initial response other than “the Board will consider”

• Assemble team; inform directors

• Call special Board meeting to meet with team and consider the communication

• Determine the Board’s response and whether to meet with the activist

— Failure to meet may be viewed negatively by institutional investors

• Avoid mixed messages

— Management and Board should work together

— Large format or group meetings should generally be limited or avoided

• Proactive public relations campaign important to level playing field

— Present investors with a well-articulated and compelling plan for long-term success

• Appreciate that the public dialogue is often asymmetrical

— Activists can make attacks and use aggressive language; the company will not respond in this manner

• Gauge whether the best outcome is to agree upon Board representation and/or strategic business change to avoid a proxy fight

• Be prepared and willing to defend vigorously if a reasonable settlement is not possible

• Remain focused on the business; activist approaches can be all-consuming

30