The new spat between Elliott Management and Duke Energy pits a public utility that analysts largely think has gotten its act together recently against an activist with a formidable track record pushing breakups and a patient habit.

Activist campaigns rarely launch during proxy season, when nomination deadlines are closed and institutional investors distracted. Moreover, Duke looks like an unlikely activist target, having outperformed peers recently and easily rebuffed a potential acquisition from NextEra Energy in recent months. But behind the odd timing is a complicated history which shows Duke management correcting course, and possibly a more patient Elliott than usually expected.

Back and forth

The campaign spilled into the public domain on May 10, when the Wall Street Journal reported that Elliott had built a stake in Duke. To squash speculation about its actual goals, Elliott released a detailed letter outlining its thesis seven days later. The activist said the company should consider splitting into three geographic utilities – the Carolinas, Florida, and the Midwest – arguing the former two are “undermanaged and undervalued” and would perform better independently.

Duke responded to Elliott’s letter the same day in a combative tone that contrasted with the activist’s largely friendly letter. The company disagreed with Elliott’s thesis and left little room for further engagement. It said that a breakup would lead to dyssynergies and a possible credit downgrade for the separated entities, which could force them to raise capital.

The Duke letter also revealed that the private engagement started at least in July 2020. Since then, Duke made substantial improvements to the investment story, including a Florida rate settlement and a minority stake sale in January 2021, as well as a stronger commitment to clean energy in April. These announcements have led to an improvement in the stock price, stealing Elliott’s thunder. Indeed, many analysts say Duke was a more compelling target when it was underperforming.

Into the open

Duke also took a swipe at Elliott’s track record in utilities, noting concerns about its involvement at FirstEnergy, whose stock was pummeled last year after revelation of a bribery scandal and ensuing investigations from regulators, although it is hard to see how Elliott can be blamed for the incident.

Elliott viewed Duke’s response as “emotional,” a source close to the situation told Activist Insight Online, adding that such a reaction might send a signal that management does not want to engage with one of its largest shareholders. After all, Elliott has only proposed the company launch a strategic review to assess Elliott’s proposals, not execute them immediately, the source added.

Duke’s strong reaction might have its origin in the months-long private engagement between the sides. Initially, Elliott proposed a $7 billion investment at a 10% discount to the stock price, a similar playbook the activist applied at FirstEnergy. After the company rejected the terms of the deal, going on to raise $2 billion through a sale of a minority interest in its Indiana operations, Elliott then requested a three-way breakup and board seats, according to the company.

De-risking

Duke also has a strong story to sell if things get nasty. Duke’s shares are up 20% over the past 12 months, outperforming other Elliott utility holdings like Sempra, Evergy, and FirstEnergy, as well as the Utilities Select Sector Index.

The company has also resolved three key issues that weighed on the stock price. It reached a deal with the North Carolina Attorney General to clean up coal ash produced by its power plants, satisfied its capital needs for the next five years, and reached a multiyear settlement on electric rates in Florida.

Duke has “de-risked the story over the past year,” Mizuho Securities analysts said in a May 18 report. As a result, a “proxy contest is more challenging than Elliott reaching an agreement with the company.”

The antagonism aside, some analysts have questioned the logic behind Elliott’s suggestion that a breakup will lead to the creation of an additional $13 billion in value. Vector Research Partners analyst Jonathan Arnold wrote in a May 18 report that Elliott is betting on the standalone companies to improve their multiples rather than “earnings power,” and the activist uses an average price-to-earnings ratio “skewed to higher multiple names.” Arnold even questioned the existence of a discount, arguing that Duke as a whole is actually trading at a “modest premium” to a broader regulated comparable valuation group.

Yet that does not mean Elliott’s valuation multiples cannot be reached by the three separate companies. Wolfe Research analysts acknowledged in a May 17 report that Florida and the Midwest “would require an M&A premium” to reach the valuation indicated by Elliott, but the two businesses are likely to be “M&A candidates on their own.”

Too late?

With Duke’s annual meeting taking place next May, a proxy contest seems out of the question for now.

Some of Elliott’s criticisms do ring true to analysts, however. Duke made some missteps historically, including a failed investment in Atlantic Coast Pipeline, which was canceled in July 2020 due to high regulatory uncertainty.

And although a full-blown separation is unlikely in the foreseeable future, analysts think Elliott’s pressure could lead the company to make further marginal improvements. “While we are not initially persuaded that the Elliott plan has unearthed significant hidden value, we still would not rule out an activist dialog leading to further value-enhancing portfolio management around the edges,” Arnold said.

Elliott has a strong track record in achieving its breakup demands, however. Over the past three years, Elliott targeted at least nine companies with breakup or asset sales demands, including AT&T, Crown Castle, and Whitbread as well as utility companies Sempra Energy and Energias de Portugal.

Of the 30 resolved public demands for either asset sales, company divisions, or spinoffs, 18 were at least partially successful, according to Activist Insight Online data. The most recent success is the breakup of AT&T, which the activist had been advocating since 2019. In the utility sector, Elliott was successful in pushing Sempra to streamline its portfolio by pursuing asset sales.

In recent years, Elliott has also shown it can be very patient and amenable. At AT&T, it waited for a few years to see its thesis executed and reversed course on the appointment of John Stankey as CEO. It was rewarded for that judgment when Stankey chose to unwind a deal he had once supported. At Marathon Petroleum, the activist publicly campaigned on and off for a spinoff of the retail business Speedway since 2016. The company agreed to sell the unit in August 2020.