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TICKER - HSBC In The Crossheairs Eric Knight Takes On The Bank - And Tilts At Suez

Eric Knight made his name battling Royal Dutch­Shell Group and French utility Suez.

Eric Knight made his name battling Royal Dutch­Shell Group and French utility Suez. Now the activist investor has targeted another of the world's biggest companies, HSBC Holdings. Knight insists the global banking group's shares are undervalued by as much as 50 percent and that it suffers from an "incoherent" strategy. "Something needs to change," says Knight, 48.

As in previous campaigns, Knight is engaged in a war of words. Most recently, he met with HSBC senior nonexecutive board member Simon Robertson in London to ask for a review of HSBC's strategy. Robertson, former head of investment bank Goldman Sachs Europe and nonexecutive chairman of Rolls-Royce, rejected Knight's demands.

"The board believes the current strategy of the group will lead to an enhancement in shareholder value," says Robertson. Shares of the bank, which announced record pretax profits of $22 billion in 2006 and $14.2 billion in the first half of this year, are up 5.8 percent, to 934 pence, since Knight began agitating in early September.

Knight, who is backed by the largest public pension fund in the U.S., the California Public Employees' Retirement System, says he is "relaxed" and undeterred. He now wants to meet Stephen Green, HSBC's executive chairman, he says. An HSBC spokesman says no meeting is scheduled.

Knight, whose firm, Knight Vinke Asset Management, manages some $1.5 billion in assets, has called for Green to stand down as executive chairman. He has also targeted the bank's "unclear and possibly misleading" incentive schemes, its exposure to the U.S. subprime market and its lack of growth in emerging markets. HSBC's shares are traded on the Bermuda, Hong Kong, London, New York and Paris stock exchanges.

"We all take these issues very seriously and quite personally," says Sandy Flockhart, CEO of the Hongkong and Shanghai Banking Corp., HSBC's Asia-Pacific unit, adding that when it acquired Midland Bank in the U.K. in 1992, it had a market capitalization of $4 billion. It's now about $107 billion. "I think that's pretty good growth," Flockhart says.

Knight says he sees signs HSBC's management is responding to his pressure. A September presentation at a Hong Kong investors' forum by Green and Flockhart called "Our Vision" suggests "they sense the need for greater clarity in respect to their strategy," he says.

Knight is not focusing his attention solely on HSBC. He has bought another small stake of less than 1 percent in Suez, the French utility that last month approved a government-brokered merger with state-owned Gaz de France. (The French government retains a 35 percent stake in GDF Suez.) Knight has a long history of investing in Suez. He first bought shares in the group at the end of 2004 and then campaigned for a restructuring.

The French government needs to learn that "behaving in a shareholder-friendly way is not necessarily contrary to the French national interest," Knight says. In a recent interview with Institutional Investor Senior Editor Jo Wrighton, Knight explains his battles with both HSBC and Suez and how he's adapting to the new regulatory environment in the U.K.

Institutional Investor: What kind of support have you gained for your campaign against HSBC so far?

Knight: I'm in London seeing about 40 of HSBC's largest institutional shareholders. It's going very well. So far only two investors have refused to meet with us, and everyone is listening carefully to what we have to say. There is a clear consensus that the issues we are raising need to be addressed. HSBC has tremendous upside.

Senior HSBC nonexecutive director Simon Robertson rejected your call for a strategic review. What does that mean for your campaign?

We met with Simon Robertson and Rona Fairhead [an independent nonexecutive director and chief executive of the Financial Times Group] on Wednesday, September 19, at 5:00 p.m. in London. A fax came through to our office 45 minutes before the meeting, which I subsequently read, saying they weren't going to do the review. This doesn't suggest they had an open mind. But that doesn't bother me too much. It's like the Suez campaign in March 2005. We sent all the evaluation materials to the board of Suez, and they announced after their board meeting that strategy was not something for small shareholders to get involved in and that it was the prerogative of the board. Yet within five months they had bought out the minority shareholders of Electrabel, just as we were asking them to do. What's more important is what is actually happening rather than what the board is saying.

What next?

I've asked for a meeting with Stephen Green -- I haven't heard back yet, but I'm sure I will. In the meantime we will continue meeting with institutions, which will take about three weeks.

What would be the best outcome for HSBC shareholders?

The stock has underperformed for 15 years. We believe this is largely because of an incoherent strategy. We are looking for greater strategic focus. The company should give shareholders the prospect of making a good return over the next five to ten years. I have an enormous degree of confidence that we will get there, but it may take some time. In 12 months, I suspect, they will have made some changes on the governance front and on the strategic front. We will be watching them very closely, as will other shareholders.

Why did you decide to invest in Suez again?

Suez has done everything we asked them to do. When the stock price went down again, we bought more shares. Now we're waiting to see what they will do. Today the stock price is where we said it should be [about 40 ($57)]. And Suez is planning to sell off the environment business, which is exactly what we said they should do. I think it would make more sense for Suez to get rid of the stake in the environment business completely. It would have a much better future as a proper, independent company.

You have said that the real boss of Suez resides in the Elysée Palace. Is that bad news for investors?

Having a large shareholder like the French Treasury can be good if it pushes the company to do what it should do, such as to properly leverage the balance sheet and get rid of the environment business. Suez' having a "new boss," Nicolas Sarkozy, might not be a bad thing.

Regulated companies like Suez-GDF are capable of sustaining high levels of debt. There is tremendous stock market value in increasing the group's leverage, and that would be applauded by the international investment community and would benefit all shareholders, including the French state.

How are you having to adapt to the new regulatory environment governing activist investors?

The U.K.'s Financial Services Authority came out with new guidelines in May this year that made clear that activist investors' intentions need to be considered price-sensitive. So in the case of HSBC, we had to make a public statement about our intentions before speaking to other investors to avoid making them insiders. It's the first time any activist investor has put out a statement saying they intend to speak to other investors. We've set a precedent that I think others will have to follow.