Wall St. Journal article: Activist shareholder Nelson Peltz threatens to break up Pepsi. Their Board says, no thanks.

Facts: The term “activist shareholder” is a Wall Street polite term for a firm that buys a small percent of a company’s stock and then threatens them with either a takeover or demands seats on their Board or something. Many people do this these days. Carl Icahn buys some Apple shares and demands stock buybacks. The activist shareholder does this for a couple reasons: the firm’s stock price seems low to them and they can make a lot of money on re-selling the shares if the price moves up. Corporate Boards really dislike these people.

Facts: Pepsi sales are $66 billion (a Fortune 500 top 50 firm). Half are beverages and half are snacks and cereals. The snacks business is growing well in sales and profits. The original core beverage business much less so, even though this includes Gatorade and Aquafina water. Apparently, selling sugared drinks and old soda pop is not what it was years ago. Pepsi is resisting Mr. Peltz’s suggestions, but said they would increase dividends and buy back more common stock to make him happy (and hopefully go away!) Just don’t mess with our Doritos!

This article reminded me of two related conversations I had recently: First, a friend and I were wondering how very large firms like General Electric are able to manage themselves. Our agreed answer was that they are not. GE sales are $150 billion which ranks it the 8th largest U.S. firm. It is truly a very mixed conglomerate with appliances, energy (nuclear power equipment) , transportation (trains),  aviation (engines) and finance. Very few of these products, industries or markets have anything to do with each other. But GE’s senior management are some of the highest paid corporate people.

Second, a couple friends asked why some giant companies keep buying other businesses trying to get even bigger. One asked if it was due to the egos of the senior people. A very appropriate and partially true comment. But there is another much more basic reason. And it goes back to my old friends in Human Resources and one of my favorite topics, Management Compensation.

You see, most companies set their salaries and bonus levels in large degree based on the size, usually in sales, of a business. When I was at USG Corporation, the headquarters people were paid the most. Then those who ran the largest business, Gypsum Wallboard,  the next most and so on down the line. And this is not just the President or CEO of a given business, it included all the senior management and on down to managers. For in Management Compensation, size does matter. You might ask, isn’t it harder to manage a bigger business? Answer, no; it’s harder to manage a more multi-faceted or troubled business. Or to manage an international firm with many different country locations, laws, and taxes than one giant U.S. based business. You might also ask, shouldn’t a firm’s Board of Directors figure this out and pay what is right? Well, the Board usually relies on outside Compensation Advisors who are hired by….. you guessed it the company’s Senior H.R. person! Not much help there.

So why do people like Nelson Peltz or Carl Icahn go around and threaten these giant firms? To make a fortune off the money they invest in these companies’ common stock, of course! But how do they know that nine times out of ten they will make money doing this? Because they know the following secrets. First, giant firms really do not maximize shareholder value over the long run by buying (often at huge premiums) and then trying to manage very different businesses. Most of these bolted together giant firms would be more successful and worth more as a smaller  firm or as a part of a similar business. Peltz wants Pepsi’s snacks to merge with Mondelez International which used to be Kraft’s snack business before he and some of his activist friends got involved. The second and most important secret is that the Senior Management of most of these giant firms will do anything in their power to get rid of these activist investors so they can continue to collect large salaries and bonuses based on the fact that they are a Fortune 10 or 50 giant firm. It takes a unique CEO and team to decide to breakup this game and take a chance on actually trying to run a smaller company versus a conglomerate. And remember it is tough being a CEO since their average tenure (or corporate life) is 5 years. They may need that money someday.

So good luck to Pepsi and their Senior Management. As an aside, I have not drunk a Pepsi in years (Vitaminwater instead) but I do love their Doritos and Lay’s chips!