Predictive analytics can bridge market intelligence gap. This article was sponsored by Q4 Web Systems
We’re in the golden age of investor activism – and it’s called that for a reason. In 2014 alone, the number of activist investors identified in regulatory filings jumped more than 40 percent from 2013. Activists like Carl Icahn, William Ackman’s Pershing Square Capital Management, Jana Partners and other hedge funds are raising record amounts of capital as their returns continue to beat the overall market.
With more than $200 bn in aggregate available for investment, activists are using sophisticated computer models to identify new types of companies to target and fuel the boom. Whether it’s from an abundance of cash, poor earnings results or a consolidating industry, few companies today are immune to the activists’ gaze.
The boom has brought other changes with it. Activists are increasingly looking for ways to buy common shares under the radar of IR professionals. One of their newest – and most successful – techniques is through the use of options purchases.
An option is a contract that gives the buyer the right, but not the obligation, to buy or sell shares in a specific security at a set price over a predetermined time period. As the activist has the right to buy, but doesn’t actually own the shares until the contract is exercised, he or she can buy up large stakes in a specific security without the knowledge of the target company or most surveillance firms. Options also allow the activist investor to purchase the vital 5 percent of a target company’s common shares without deploying as much capital as an outright purchase.
When activists open option positions, typically in conjunction with at least nominal purchases of common stock, the target company finds itself with a new major shareholder bent on compelling change such as replacing management, using cash to buy back shares or increase the dividend, spinning off businesses and/or demanding seats on the board.
‘The use of options by activists to build ownership positions is only going to increase in frequency,’ says Darrell Heaps, founder and CEO of Q4 Web Systems, a Toronto-based SaaS platform provider that delivers communication and intelligence solutions to IR executives. ‘The nature of the options market lowers the cost of building positions, while also reducing the number of shares in common that can be observed through settlement analysis. This allows activists a cheaper route to build a sizable position quickly and under the radar of traditional surveillance.’
Nearly 18 mn options trade daily. That equates to the right to buy or sell 1.8 bn shares of stock each day. This options strategy was used earlier this year to covertly take a 5.9 percent ownership stake in Computer Sciences Corp (CSC), a Fortune 500 computer services company with $12 bn in revenue. On February 23 Jana filed a 13D claiming ownership of 8.4 mn CSC shares of which 3.8 mn shares – or nearly half of the stake – were held in options.
Billionaire activist investor Ackman primarily used options to build his 5 percent stake in Valeant Pharmaceuticals, a Laval, Quebec-based company with revenue of $8.25 bn. In a 13D, Pershing claimed ownership of 28.5 mn Valeant shares of which more than 80 percent were held in options.
‘Due to the complex nature of derivatives, traditional market surveillance firms don’t cover options trading,’ says Heaps. ‘Without that information, the ability of IROs to take proactive measures is severely hampered. When an activist buys options, public companies have less time to make contingency plans related to the action and to win the battle for investor and public opinion.’
‘But companies don’t have to remain in the dark,’ says Adam Frederick, senior vice president of intelligence at Q4 Web Systems and former chairman and CEO of market intelligence firm Oxford Intelligence Partners, which merged with Q4 in September this year. The company uses senior surveillance experts, former options traders and doctorate-level quantitative data scientists to develop proprietary surveillance software that can proactively identify activists’ options activities.
‘Predictive analysis techniques derived from datasets focused on activism, volatility, sentiment and options intelligence are emerging as the next generation of surveillance intelligence,’ Frederick says. ‘The power of big data and predictive analytics is incredibly robust and offers tremendous potential for market intelligence and stock surveillance.’
The algorithm used in the Oxford Activist Alarm, or OAA, monitors order flow characteristics across all segments of the equity and derivatives markets. The OAA uses a 0-10 scale to determine the possibility of activist options trading; a score above 6 would indicate a high risk of activist activity.
‘The OAA has proven to be very accurate,’ Frederick says. During the weeks before the activists’ options purchases at both CSC and Valeant, the OAA scale jumped in value to more than 6 for both companies, correctly predicting activist options purchases.
‘With the OAA, Oxford can inform its clients about what is likely to happen, before it happens, and to track the activity of ownership changes,’ Frederick says. ‘Combined, these datasets can provide a level of predictability and accuracy that has never been seen before in the investor relations market. The options market has become too significant for IR professionals to take a ‘head in the sand’ approach.’
Carol Wolf spent 18 years as a reporter with Bloomberg News and writes on business topics. She serves as the senior business writer for Falls Communications
