Many laggards are arguably takeover proof because they are seen as vital to national interest or because block holders such as family foundations or estates obstruct change.
I just finished teaching a corporate governance class to a cohort of senior European directors. As a part of the assigned readings package, I had included my piece on firms in the S&P 1500 that have hung around for more than 10 years and have not even managed a total stock return (TSR) of what a US treasuries ETF would have earned over that period.
Understandably, the European directors wanted to know how Europe stacked up. I told them I would dig into the data and get back to them.
Who are you running the company for?
To start with, I focus on the S&P Europe 350 index. The S&P Europe 350 measures the performance of 350 large cap companies domiciled and listed in the 16 major developed European markets that includes the United Kingdom and of course, France, Germany, Netherlands, Norway, and Sweden. Hence, I have stacked the argument against me as these firms are supposed to be the crĂšme-de-la crĂšme of Europe.
I then looked at their total return (price appreciation and dividends) over the last 10-years. Measured in Euros, the index has returned a reasonable 105% cumulative over the last decade. However, it is well known that the pound and the Euro have fallen roughly 25-30% against the USD in the last 10 years. When measured in dollars, it turns out that annual returns fall to around 61% cumulative over the decade. As expected, the return attributable to stock price appreciation in USD accounts for only 11% over the whole decade. It appears capital gains have been mostly wiped out by currency depreciation.
More important, this raises an uncomfortable governance question: in theory, are you running a European company to satisfy return expectations of your American or your European shareholder base? In other contexts, especially ESG, we often wring our hands about how European regulation will apply to US companies operating there. This is the flip side of that question given that many of us retail US investors and several US based institutions own indexes mirroring companies headquartered in Europe.
Index laggards in the S&P Europe 350
Letâs turn now to the definition of index laggards. If you are an European investor, you can presumably buy US treasuries. So, it may not be unreasonable to consider the performance of US treasuries as the next best option you have as an investor. The S&P U.S. Treasury Bond Index, over the last 10 years, has returned 0.93% per annum, annualized or approximately 9.7%.
I ran a screen to investigate how many firms in the S&P Europe 350 had not earned even 9.7% USD return cumulated over the last 10 years. It turns out that there are 48 such firms (14%). Note that the universe consists of the very best of developed Europe. Hence, this problem is arguably worse when we consider the rest of the long tail of mid cap and smaller cap stocks.
A quick look suggests that the laggards list is made up of big recognizable names such as Telecom Italia (-60% return cumulative over the last 10 years), Bayer (-56%), Deutsche Bank (-55%), the Swatch group (-52%), BT group plc (-49%), Alstom (-43%), Telefonica SA (-43%), Standard Chartered Bank (-42%), Vodafone (-41%), Valeo S.E (-38.5%) and so on.
I wonder how many of these laggards are potentially takeover-proof because their governments will protect them from foreign investor interference on the grounds that these businesses are essential for national security in some way. Consider Deutsche Bank, Telecom Italia, BT Group, Alstom, Telefonica and even Stan Chart and Vodafone as potential data points in support of the national strategic interest theory.
As always, the governance question that comes up with these laggards: where are their boards? How can this performance justify CEO pay? I looked through publicly available documents for five worst offenders to detect some sign of challenge to management or the board. Here is what I found.
What does governance look like in five of these laggards?
Telecom Italia
Letâs start with the ownership structure. S&P Cap IQ reports that the two largest block holders are Vivendi SE, controlled by the Bollore Group, which holds 17.13% of the stock in the company, followed by Cassa Depositi e Prestiti SPA, which owns 7.08%. Relatively smaller holdings are owned by other institutions such as Vanguard (2.93%), Norges Bank (2.21%) and BlackRock (1.52%). Vivendi, which is a French company, seems to have held the same number of shares in Telecom Italia since 2017. Cassa Depositi seems to have bought a stake in March 2018 and upped that stake in December 2020 and stayed with it since.
So, itsâ up to the block holders to do something, as is often the case in most European companies. In November 2023, Vivendi announced it opposed Telecom Italiaâs deal to sell the fixed line network of 22 billion Euros to KKR. Given that a potential sale will release capital and some value, this is a good development, from a governance standpoint. Hence, I did not look too deeply into the board and management that sadly brought the company to the brink of liquidation.
Bayer
Part of Bayerâs problem was the arguably ill-advised acquisition of Monsanto in 2018 and all the legal issues that came with that purchase. Bayerâs ownership structure looks like a typical American firm with dispersed investors. The largest block holding is held by BlackRock (4.9%), followed by Vanguard (3.86%) and a few other prominent institutions such as Massachusetts Financial Services Company (3.04%), Harris Associates (2.99%) and Norges Bank (2.94%).
I found at least two recent attempts at a challenge, perhaps triggered by the disastrous Monsanto related lawsuits. Incidentally, Monsanto is a poster child for the ESG folks who have always said that a product that is toxic to your ecosystem will eventually come back to bite you.
Union Asset Management Holding, the asset management arm of DZ bank in Germany, owns 0.7% of the company. On January 22, 2023, they have criticized Bayer’s AG chairman Norbert Winkeljohann for a lack of engagement, such as exploring a spin-off of the company’s consumer health division. On January 10, 2023, Bluebell Capital Partners Ltd. announced that it is pushing for a breakup of Bayer AG after another investor, Jeff Ubben, urged the Company to consider strategic options. Bluebell Capital stated that it is urging Bayer to separate its crop science business from its pharmaceuticalâs unit.
Again, its good to see activists involved. Hence, I did not look deeply into board composition, proxy voting and pay.
Deutsche Bank
I did not see much recently by way of investor activism. The last meaningful attempt seems to have been in 2019, when Riebeck-Brauerei von 1862 AG announced that it has filed a motion to oust Deutsche Bank AGâs chairman, Paul Achleitner, at the Company’s annual general meeting. Riebeck-Brauerei criticized the chairman in its filing for the payment of bonuses and severance packages as well as money-laundering-related issues at the bank. Later, Glass Lewis announced that it has recommended the Deutsche Bank AG shareholders to vote against ratifying the actions of Paul Achleitner, at the May 20 annual general meeting. Subsequently, Deutsche Bank Aktiengesellschaft held its annual meeting on May 20, 2020, and the company shareholders re-elected Paul M. L. Achleitner to the board.
Deutsche ownership structure is dispersed: BlackRock owns 5.5%, H.E. Sh. Sheikh Hamad Bin Jabor Bin Jassim Al-Thani of Qatar holds 4.7%, and Vanguard owns 3.89%. Deutsche sounds like a good candidate for greater scrutiny related to CEO pay, board composition and the like.
Swatch group
The largest holder of stock in the Swatch group is the estate of NG Hayek (23%) followed by a 2.15% stake held by Nayla Hayek. Blackrock holds 4.22%, Vanguard has 2.83% and UBS has 2.53%. Because this is essentially a family-owned firm, investor activism is potentially harder to pull off.
BT Group plc
Patrick Drahi, a private investor, owns 25% of BT, followed by 12.27% owned by Deutsche Telekom. A presumably affiliated entity, BT Group plc Shareview Clients, owns 5.25% followed by Vanguard (3.2%) and BlackRock (2.7%). The last formal activism event I could find was back in 2018 when Greenlight Capital, led by the famous investor David Einhorn, had taken a stake in BT and noted that a possible spin-off of the Openreach infrastructure division could unlock value. Subsequently, BT Group plc announced that it is considering selling a stake in its broadband infrastructure arm Openreach. I could not find formal activism events since. Is this one more case where the block holders will coordinate to find a way to release value?
Conclusions:
The five cases l looked at led to the following tentative differences between laggards in developed Europe and the US:
· I was surprised to find as many instances of investor activism in Europe relative to what I would have expected before looking at the data. In contrast, I found far fewer instances of activism in the 37 laggards in the S&P 500.
· The Big Three institutions (Vanguard, BlackRock and State Street), collectively, own far less stock in developed European markets and perhaps have less clout than in US laggards.
· Companies are likely to be owned by significant block holders in Europe. Depending on the specific case, they can serve either as enablers of change (e.g., Telecom Italia) or potential obstacles to change (e.g., family-owned Swatch Group).
· Governments and their desire to protect under-performers, who can hide under the âstrategic national securityâ umbrella, might also deserve blame for the European index laggards.
Of course, one can always ask, for both Europe and the US: what are such perennial under-performers doing in highly followed stock market indexes? As always, constructive comments welcome.