To Destroy a Software Company’s Worth? Bring on Starboard Value

The first six months of 2022 have been brutal for stock investors. They’re suffering through a bear market after seeing the market more than double from the end of March 2020 to New Year’s Eve 2021. As a result, bottom-fishing value seekers are looking for bargains – including so-called activist hedge funds, which take big positions in target companies, then try to take them over by urging shareholders to elect new members to the board of directors.

In recent months, one of the largest activist investors – Starboard Value – has announced plans to go after no less than 15 publicly traded companies. At some of these companies, shareholders might welcome the attention. But in one group, they are shaking in their boots: software company shareholders want no part of the activist approach.

That’s because when they invest in software companies, activist hedge funds are such strikeout artists they make this year’s bear market look like a home run by comparison

Take the aforementioned Starboard, for example. In recent years, this hedge fund has seized board seats on four software companies: ComScore, Symantec, Commvault and eHealth. Average return for the four stocks? A 38% loss. Imagine how you’d feel as an ComScore shareholder since Starboard came to the rescue in July 2017: the stock is down more than 90% since then. (That’s not a typo.)

It’s not hard to understand why. As this article points out, activist hedge funds tend to hold their shares for only about 14 months, while cutting research and development spending by more than half. Without investing in innovation, software companies get leapfrogged by the competition. Customers flee, and revenue plummets.

Creating turmoil, slashing R&D and laying off workers is especially harmful in the current climate, when unemployment is historically low and qualified workers are scarce. Software companies, which rely on top talent to produce constant innovation, can’t risk losing their best engineers and programmers – not to mention salespeople and marketers – because outsiders with no software expertise take over the company.

Indeed, this 2020 Bain Inc. study of successful software companies found that the #1 most important element that set the best software companies apart was – you guessed it – their ability to retain employees.

Word to the wise: if you’re a software company shareholder looking for a share-price rebound, don’t trust predatory activist hedge funds to deliver results. History’s lesson is clear: they don’t know how.