NEW YORK ( The Deal) -- Joining forces with a large governance-focused public pension fund can add "gravitas" to an activist insurgency campaign, as relative newbie Legion Partners Asset Management learned when it teamed up with the California State Teachers' Retirement System to force changes at Perry Ellis International (PERY).
A cursory look at the year-long campaign suggests that the duo actually lost -- since last week they canceled a short-slate proxy contest to install three dissident director candidates to the apparel company's board.
But under the pressure, Perry Ellis took major steps to improve its governance and board at the same time that its stock price shot up from $17.50 in July when Legion launched the public portion of its campaign to its most recent price of $25.10. Legion and CalSTRS acquired their stake between May and July 2014, at prices ranging from $14.47 to $17.56 a share and, according to a person familiar with the matter, the fund began engaging with the company in the spring last year.
A crucial step -- likely the one that convinced Legion to end its contest -- was the installment of Bruce Klatsky and Michael Rayden as independent directors. Klatsky, who at PVH Corp. (PVH - Get Report) had overseen the acquisition of Calvin Klein, is considered by people familiar with the contest as exactly the kind of top-rated director whom proxy advisers are likely to endorse over a dissident director candidate.
In addition, the structure now includes five independent directors on a board of seven, a new lead independent director with less than a one year tenure and a variety of other governance improvements. Another independent director, Jane DeFlorio, an investment banker, was appointed in December. A nonbinding CalSTRS proposal to de-stagger Perry Ellis' board is also likely to be approved by shareholders at the annual meeting in July -- a move that could set the stage for a change-of-control proxy fight next year if more changes aren't forthcoming.
Still, Legion, led by Chris Kiper, likely would not have gotten as much traction without the public pension fund's backing. For one thing, when an activist walks into a boardroom with a CalSTRS representative by his side, it deprives management of one of their most common grievances about insurgent funds: that they are targeting the company for short-term gain at the expense of long-term performance. CalSTRS' structure requires that it remain a long-term investor -- a majority of its $193 billion in assets under management is allocated to indexed investments across the spectrum of U.S. publicly traded companies.
"The fact that CalSTRS has been a shareholder at Perry Ellis for a decade, and is effectively a permanent investor, helps change the dynamic," said Legion Managing Partner Ted White. "We are able to better focus the debate on long-term performance and governance improvements."
Damien Park, managing partner at advisory firm Hedge Fund Solutions, agrees that the pension fund added "credibility" and some "gravitas" to Legion's activist campaign. "They are a well-respected, long-term oriented investor," he said.
Probably the largest way CalSTRS contributed was with funding. Legion so far has received $50 million of a $200 million commitment from CalSTRS and part of the first $50 million went to acquire Perry Ellis stock. The activist can receive three more allocations in $50 million increments from CalSTRS if it meets certain targets for its assets under management by attracting other investors or increasing the value of existing investments. In addition to the seed funding, CalSTRS' Perry Ellis' co-investment with Legion came to $10 million.
In addition, the public pension fund contributed to key meetings: A top CalSTRS official joined Legion officials to meet with Perry Ellis directors and executives in Miami, early in the activist campaign, to discuss what could be done to improve governance and the company's poor Ebitda (earnings before interest, taxes, depreciation and amortization) margins, according to people familiar with the activists. The pension fund also participated in some calls with the company and was prepared to help solicit institutional investor votes to back Legion's director candidates had the contest moved into its formal stage, according to people familiar with the situation. "CalSTRS, Legion and Perry Ellis had detailed discussions about performance," said a person close to the activists. "Perry's improvement had to do with there being an external threat."
Clearly a partnership with CalSTRS or another major governance-friendly public pension fund is something other activists should covet. Some already have received funding from CalSTRS and other large pension funds. But it takes a long working relationship -- and the pension fund's decision to allocate capital to the activist -- to reach the point that both sides will agree to co-invest with each other. The relationship between CalSTRS and Legion may have formed due to both sides having a long history of collaborations.
For example, Legion's White worked at the other major California public pension fund, CalPERS, as its director of governance between 2000 and 2005. White has known the top governance officials at CalSTRS for over a decade and worked for a while at the Council of Institutional Investors, a lobbying group that represents more than $3 trillion in assets, as a consultant to large institutions, including large pension fund TIAA CREF.
"Legion has a lot of familiarity with what CalSTRS does and both firms are on the same page when it comes to what constitutes proper governance at a publicly traded corporation," White said.
George Feldenkreis, the apparel company's CEO, said he "very pleased" that as the company moves past the "distraction of a proxy contest" Perry Ellis will focus on continuing to further "strategic initiatives" to improve shareholder value. "For the past two years, we have worked very hard to return Perry Ellis to a more profitable path and have made very substantial progress in our efforts to create value for all our stakeholders," he said.
And if shareholder value isn't created, Legion may want to have CalSTRS on board for another campaign next year. As part of the shuffle, George Feldenkreis plans to hand the chief executive position to his son, Oscar, who will take over in 2016. Legion's Kipper holds out small hope for Oscar's ability to beat the company's 2019 target of Ebitda margins of 10% -- something the activists believe the CEO should achieve, according to people familiar with the situation.
CalSTRS, because of its partly indexed investing in equities structure, certainly isn't going away. People familiar with Legion also note that the activist fund is adopting a wait and watch approach and could be back with a director election challenge next year.
Even without a Legion proxy contest, another fund could seek a vote of no-confidence in the incumbent directors in an uncontested election that could have a similar effect of pushing the company to make changes. Perry Ellis last year set up a majority vote director election system, a move that essentially empowers investors to launch these kinds of "just vote no" campaigns. While less intrusive that a proxy fight, "just vote no" insurgencies can drive change -- witness H Partners' successful effort earlier this month at Tempur Sealy International (TPX - Get Report).
Nevertheless, watch for Perry Ellis to make other changes to keep the activists at bay. One possibility is a sale of the company. Legion had urged it as an option, but it is unlikely to occur. Another is a divestiture of its women's apparel segment, a move that could help to appease the insurgents.
CalSTRS has also allocated capital to a group of high-profile funds including, Trian Partners, Starboard Value LP, New Mountain Capital LLC and U.K.-based GO Investment Partners. Much of the pension fund's funding of another activist, Relational Investors LLC, which is in the process of dissolving, has been wound down and anything that remains will be returned, according to a CalSTRS spokesman.
Other funds, including CalPERS and the Ontario Teachers' Pension Plan Board have dabbled in such partnerships with funds like Jana Partners and New Mountain. CalSTRS has been a leader in the co-investment approach, and sucessful campaigns will likely spawn more copycats.