Friday, June 09, 2006

Shareholder Activism

There is a tremendous article in the Investment Dealer Digest entitled "Retaking the High Ground" which gives an excellent backdrop on the rise in corporate activism that we witness today. Access to this article is for Fierce Finance subscribers, another great service that highlights current thinking in finance.

Discussions about the benefits or drawbacks of activist investors makes the moniker "Fierce Finance" quite appropriate.

Few managements appreciate the highlighting of their shortcomings, their failures, their misappropriation of funds, or their misallocation of capital. For most individual investors, the proxy statement gets tossed into the trash, the proxy vote itself is rarely cast, and managements press on, relatively secure that their position if not sinecure remains largely beyond reproach.

Today's Wall Street Journal (subscription required) highlights the plight of Friendly Ice Cream (FRN) shareholders and what appears to be an eyeless or at least heedless board if these allegations are true.

To quote the article: "Two weeks ago, a judge dealt Friendly a harsh rebuke. Rejecting its
motion to dismiss the suit, Massachusetts Superior Court Judge John
Agostini said Friendly hadn't investigated Mr. Blake's claims in good
faith. He lambasted directors for 'lockstep loyalty' to management and
for being 'largely oblivious' to their obligation to police dealings
between Friendly and the chairman's other company."

Many managements prefer that shareholders do the "Wall Street Walk" in other words, simply sell the security and move on. Managements and Directors may respond to your letters, may listen politely, or impolitely in the case of of the Home Depot board which decided to sit out the most recent annual meeting.

As the IDD article highlights, the playing field is changing. The framework of corporate governance is the new field of battle...lobbying of management and other large shareholders, inciting public opinion, and utilizing the court system is all fair game. As the article states, these weapons, are all in the cause of effecting change that benefits the company and certainly benefits the investor.

According to the article, the percentage of dissident victories has ratcheted up 59% so far in 2006 up from 58% last year and only 40% in 2001.

The article highlights the fact that the playing field has changed with Sarbanes-Oxley, which despite the rigor and expense that it brings to companies, has "injected a dose of caution, conservatism, and downright nervousness into boards."

Some of the hedge funds that have engaged in this type of activity are clearly in it for short-term victories and have little regard for the long term propects of the company. Companies that rely too heavily on the financial engineering aspects of large Dutch tenders and resultant weakening of balance sheets have done little to create long term value. A prime example of this was Reebok where Paul Fireman's Dutch tender for 25% of the company (instituted the day after showering management with stock options) showed high regard for financial engineering but little understanding of dealing with the operational and marketing difficulties of the business. I have expressed concern about Cracker Barrel's response and significant re-leveraging to the desires of Nelson Peltz' hedge fund.

Investment bankers, always eager to earn a fee, for the most part remain true to the managements that have greased their palms in the past. Loyalty to clients is admirable, but robbing shareholders of their rights is despicable. The poison pill and the staggered board defense are obvious methods of entrenching management but other procedural defenses are beoming prevalent such as limiting a shareholder's ability to call a special meeting or act by written consent.

Not all hedge funds are the dirt bags or short term interlopers that some investment bankers fear. Not all activist shareholders are hedge funds either.

In my own experience as an institutional investor, I have had to confront several managements and boards whose bankers have taken an adamant adverse position from the get go. Some board members were willing to listen. Most investment bankers provided little more than blather and sought ways to undermine the rights of the minority shareholders.

Fortunately, as a long term investor who was joined by fellow long term investors, we were able to militate other shareholders and the school of public opinion.

Managements that attempt to entrench themselves such as Vishay and numerous others are telling shareholders that they do not want us to be their partner. In cases of such disenfranchisement, there is little that one can do except put your capital elsewhere. Why belong to a club that has nothing but disdain for you and your rights?

However, in cases where you do have a vote that means something, VOTE. Let managements know where you stand. If returns on assets and capital are below that of the industry, express your views to management and the board. Let large shareholders know of your views. In short, get involved.

Change can be glacial and patience can be needed. Influence takes time. But if the business has a reputation, has a core competency, and can be improved, the battle is worth it.

I was, with the support of many other shareholders, able to effect significant change in a number of my portfolio holdings. This occurred at a time when such activism was viewed as radicalism. Under the umbrella of Sarbanes-Oxley, such change has actually become easier.

Disclaimer: Neither I, my family, nor clients have a current position in Friendly, CBRL, Home Depot or Vishay Intertechnology.


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