Activist Shareholders - PowerPoint Presentation

Slide1

Activist Shareholders & Their Impact on Takeovers

Chapter 14Slide2

background

Berle

and Means’ separation of management and control

-- the dominant view

for decades, assuming a shareholder group made up of dispersed owners each with

small ownership

stakes.

1960s

and

1970s --

institutional shareholders assembled large

stakes, but

their governance role was almost always passive.

1990s to present -- there

emerged a subset

of activist

institutional shareholders

who changed

how takeovers occur. Slide3

Factors influencing current sceneInnovations in computing power and electronic communication made it possible to assemble and absorb large amounts of information.

corresponding decreases in costs of communication among investors

new finance reflected high powered incentives in the assembling and management of large pools of capital

Law followed these developments by facilitating the broader spread of information and relaxing prohibitions on communications as to proxies and tender offers.Slide4

Hedge Fund Activism

Hedge fund business plans (In General)

Investing to deliver above-average market returns

Aggressive economic strategies in various settings

Betting on currency movements, interest rates

Focus on debt securities or distressed firms

Merger arbitrage

Engagement w/ governance as one subset

Seneca, Icahn opposing Blackstone Dynegy deal

CSX/TCISlide5
Slide6

Typology of Hedge Fund Activism

Related to Pending Acquisitions

Blocking acquisition on the Acquirer side

Blocking acquisition on the Target side

Facilitating Target return via Acquirer activism

Related to Changing Company’s Business Plan

Prodding board to make large cash payment

Unbundling i.e. sale/ spin-off

Obtaining board seats (not overall control)

Supporting Generic Governance Changes

Led by other institutional shareholders

Dramatic effect on reduction in staggered boardsSlide7

Pending Acquisitions

Influencing Acquirer Side

What is the motivation?

Managers have paid too much; Empire building

What is the technique?

Exercising acquirer shareholders’ right to vote

Influencing Target Side

What is the motivation?

Management selling too cheaply

Example: Private equity (Blackstone buying Dynegy)

Example: cash out where >50% shareholder

Hedge fund as gatekeeper

What is the technique?

Voting, appraisal, fiduciary dutySlide8

Pending Acquisitions II: Empty Voting

Influencing Target Outcome via Acquirer Activism

Mylan

/King Pharmaceuticals

Where is the profit likely to be?

What is the risk to that profit?

How might investor reduce that risk?

Perry strategy

Protecting a large stake in target

Buy 10% of acquirer

Sell off the financial interest, keeping only the voting interest – problem?Slide9

Empty VotingResponses

Self-interest of counterparties

Hedge funds on the other side

Government regulation

Disclosure

Prohibition

How close to other vote buying?

Diversified

mutual funds netting out positionsSlide10

Changing the Company’s Business Plan

Prodding cash payments, unbundling assets, board representation

Where have you seen that before?

What kind of bidder? Where will value come from?

Technique to Accomplish this

Credible threat to use full-scale proxy fight if manager doesn’t accept advice

Credible threat that other institutional investors will join

What is it not? Buying the companySlide11

Activist s/h on corp governance

subset of institutional investors

pursue

corporate voting to change governance rules of public corporations

more generally

large

pension funds, often the pension funds

of public

employees

Calpers

the California Public Employees Retirement

System

NYCERS, the

New York City Employees Retirement System)

various

other group

supporting reform

in corporate governance.

Slide12

Corp gov s/h activism

Dramatic decrease in use of staggered boards by public companies

2004 – Institutional investors started credibly threatening they would vote against directors’ election at annual meetings if they didn’t ditch the staggered boards

2010 – only a minority of largest US corps have staggered boards

Pills cut back but not so much – pills can be inserted with only BOD actionSlide13

CSX Corporation v. The Children’s Investment Fund Management (UK) LLP

no deal pending

for CSX Corporation, one of the nation’s largest railroad

companies

But

two

large hedge

funds,

including the

Children’s Investment

Fund (most

well‐known hedge

fund in United Kingdom) seek to influence management to undertake

value‐increasing transactions

(i.e. transactions that will produce more cash flow to shareholders.)

two

hedge funds launch a proxy fight in which

they seek

to elect a minority of the board and the right to call a special meeting of shareholders.Slide14

CSX

plaintiff is

corporation

itself

Battle joined

is the company’s effort to get a preliminary injunction for the hedge

funds’ alleged

noncompliance with the disclosure provisions of the federal securities laws.

This

is

not the

Unocal or Revlon pattern of most of

our cases, with

litigation by

representative shareholders

.

More like litigation

pattern of the 1980s before poison pills

and staggered

boards

insulated

a board from having to yield too quickly to contrary shareholder preferences

substance of litigation -- noncompliance with securities regulation requiring disclosure when acquiring 5% or more of a company’s shares or

when undertaking a proxy fight.Slide15

hedge fund’s strategy: political

TCI makes SEC disclosure that

it will acquire a significant portion of CSX, even mentioning

control

But focus -- replacing

a minority of directors

to get influence over company

TCI seeks to name two directors and works with another investor who also seeks to elect

two directors

.

TCI

is actively seeking to get other activist investors involved in the fight (

sometimes referred

to as a wolf pack.)

TCI’s

political strategy

influenced

by seeking

support

of

ISS‐ Institutional Shareholder Services

, (now

part of RiskMetrics) has

achieved an oversized role in takeovers through its advising institutional shareholders how to vote in proxy solicitations, including those that are part of takeovers.Slide16

The hedge fund’s strategy: financial

TCI acquired

a large part of its interest in CSX not by

acquiring shares

but through

swaps

.

This

is a contract between TCI on one side and, in this case,

eight large

financial firms—banks and investment banks

.

The promises made between the

parties essentially

entitled TCI to receive payment from its counterparty equal to what would occur

if CSX

went up in value (the long position) and the counterparties to receive payment from

TCI equal

to the change if CSX went down in value (the short position).

The

result would be that

TCI would be in the same financial position as if it owned the stock, but would have invested

only the fees and quasi- interest it paid for the contract, a result that impacts its possible returns

and losses in the same way as leverage.the counterparties would be expected to hedge their exposure should CSX go up in value (when it would have

to pay

TCI.) To do this it would buy CSX

shares.Slide17

The hedge fund’s strategy: financial 2

impact

of

strategy

on voting

important

to

hedge

fund’s pressure on CSX.

TCI has no voting rights on the investment it has made through the swaps even though it

had the

economic risk as if it had purchased the

stock

The

counterparties, because of

their hedging

, actually will have the right to vote, but having hedged, they have no economic

interest propelling

that vote.

XD

But court

notes (496) that were TCI to

settle its swaps with the banks, it would remove the practical need for the banks to continue to hedge, thus creating

a ready supply of shares should TCI wish to convert its exposure from swaps to actual physical sharesThis important to

court’s

resolution of whether TCI owns the shares for

purposes of

whether it has crossed

threshold

requiring disclosure under

13(d

).

TCI reducing its

counterparties from eight to two reliable parties seems to also influence court’s view of

TCI’s control

over the shares in the name of its counterparties.Slide18

Disclosure

Two separate parts of the federal securities law

implicated

.

disclosure

required when proxies are solicited

(Section

14(a) of the

Securities Exchange

Act)

disclosure

required when one has acquired 5% of a

publicly traded

company

(13(d

) added to the Securities Exchange Act by

the Williams

Act in 1968).

The

materiality questions end up being the same for both, so

focuses

on

13(d) claims. 13(d) claims turn

not on whether the disclosure made in the filing was sufficient, but whether the hedge funds had delayed nine months in making the necessary filing by arguing they did not have beneficial ownership of

the shares

to which the swaps related and because they were not part of a group until December.Slide19

Disclosure holdings

The court finds against the hedge fund on both of these claims

.

concludes

interests represented by the swaps should

be counted

in determining whether TCI had crossed the 5% threshold.

(The

question of what is a group for purposes for making tender offer filings was

high profile

issue in tender offer

law in

the period after enactment of the Williams Act, but has

received less

attention

recently. )

Here court concludes

that

TCI and 3G were a group long before their December

filing

thus they

did not give

the other shareholders the required notice required by 13d.Slide20

remedies

court finds two violations of the federal disclosure

provisions designed

to give shareholders information about 5% shareholders that could lead to

possible takeovers

.

Remedy?

remedy proposed is

sterilization

of the shares acquired during the period of the insufficient

disclosure

would

impact a hostile raider’s effort to win a showdown

with management

.

Here

the impact

less

since control

not

at issue.

court concludes that there is not irreparable harm essential to obtain injunctive relief in the form of sterilization.

The court grants injunction restraining further violations of Section 13(d)

more

than a slap on the

hands?

Cf. Topps case