Here’s a Wachtell Lipton memo that went out last night from Eric Robinson & Sabastian Niles:
This morning, Institutional Shareholder Services (ISS) issued a note to clients entitled “The IRR of ‘No’.” The note argues that shareholders of companies that have resisted hostile takeover bids all the way through a proxy fight at a shareholder meeting have incurred “profoundly negative” returns following those shareholder meetings, compared to alternative investments. ISS identified seven cases in the last five years where bidders have pursued a combined takeover bid and proxy fight through a target shareholder meeting, and measured the mean and median total shareholder returns from the dates of the contested shareholder meeting through October 20, 2014, compared to target shareholders having sold at the closing price the day before the contested meeting and reinvesting in the S&P 500 index or a peer group.
A close look at the ISS report shows that it has at least two critical methodological and analytical flaws that completely undermine its conclusions:
– ISS’s analysis refers to Terra Industries as one of the seven cases in the last five years where a target had resisted a hostile bid through a shareholder vote on a bidder’s nominees, but the analysis then excludes Terra from its data analysis, by limiting it to targets that ultimately remained standalone. Terra is one of the great success stories of companies that have staunchly resisted inadequate hostile takeover bids, even after the bidder succeeded in electing three nominees to its board, and ultimately achieved an outstanding result for shareholders. As ISS notes, if the pre-tax cash proceeds of the final cash-and-stock offer for Terra had been reinvested in shares of the bidder, Terra shareholders would have seen a total return of 271% from the date of the initial shareholder meeting through October 20, 2014, significantly beating the S&P 500 Index and the median of peers by 181 and 211 percentage points, respectively. Had ISS properly included Terra in its analysis of “The IRR of ‘No’”, the mean return of the seven companies would have beaten the S&P index by 18.4 percentage points (compared to a shortfall of 8.7 percentage points when Terra was excluded) and beaten the ISS peer groups by 10.0 percent (compared to a shortfall of 23.6 percentage points excluding Terra).
– Of the seven cases discussed in the analysis, one was a micro-cap company with a market cap of $250 million (Pulse Electronics) and one was a nano-cap company with a market cap of $36 million (Onvia). The other five companies, including Terra, had market caps between approximately $2 billion – $8 billion, yet ISS treats them all equally. A market-cap weighted analysis would have had dramatically different results. Excluding the micro-cap and nano-cap companies from the analysis, the mean and median returns for the five companies (including Terra) exceeded the S&P Index by 65.4 percentage points and 1.4 percentage points, respectively, and exceeded the respective peer groups by 57.6 percentage points and 20.8 percentage points, respectively.
More broadly, the real world of corporate takeover practice demonstrates that prudent use of structural protections and “defensive” strategies provides boards – and shareholders – with the benefits of substantial negotiating leverage and enhanced opportunity to demonstrate that the company’s stand-alone strategy can deliver superior value.
Here’s news from Carol Bowie, Head of ISS Americas Research:
Some key developments this proxy season suggest that investor sensitivity is growing in regard to perceived windfalls accruing to executives in connection with change in control transactions. For one, this year’s majority supported shareholder proposals included four on the topic of equity vesting related to a CIC. Specifically, proposals at Gannett Co., Boston Properties, Valero Energy, and Dean Foods garnered support from 52.2 percent, 53.1 percent, 56.2 percent, and 60.6 percent of votes cast for and against, respectively, at their 2014 shareholder meetings.
That level of support is a first for this topic, and unprecedented since say-on-pay became the focus of investor concerns about compensation. Shareholder campaigns around the issue of CIC-related vesting, dating from 2010, have evolved from a focus on “double vs. single triggers” (i.e., requiring employment termination, rather than automatic vesting acceleration upon a CIC) to the current proposal language, which asks companies to permit only pro rata, rather than full, vesting of awards in connection with a transaction. The latest resolution has been submitted to a total of 22 companies so far this year, including the four cited above where it was backed by a majority of votes cast. Overall, the 20 proposals for which vote results are available at this writing have averaged 35.8 percent support this year.
At the same time, companies have been increasingly embracing the concept of “double-triggered” CIC related equity vesting–or at least providing an alternative to automatic full vesting as soon as a transaction occurs. ISS’ QuickScore data indicates that the proportion of S&P 500 companies adopting new equity plans that provide solely for automatic vesting declined from 48 to 28 percent from 2012 to 2014. While not as dramatic, the decline has also been significant at companies in the broader Russell 3000 index, where new plans with automatic vesting provisions slid from 55.5 to 42.9 percent over the same period. Instead, equity incentive plans are increasingly providing for the possibility of assumption or substitution of outstanding awards, with any accelerated vesting then linked to an executive’s subsequent employment termination.
While automatic vesting may be declining as “the norm,” many change-in-control transactions–all cash deals, for example–may nevertheless preclude the possibility of awards being assumed or substituted. Thus, investor focus appears to have gravitated to a campaign encouraging only pro rata vesting, based on time served by the executive, in order to avoid “windfall” compensation resulting from the change in control.
The issue remains in flux, but another vote result this year provides further evidence that–despite generally robust investor support for “say on golden parachute” proposals–sensitivity about CIC-related windfall pay remains high. At Time Warner Cable’s June 5, 2014, shareholder meeting, some 40 percent of votes cast opposed the company’s advisory vote on compensation, and compensation committee chair Peter R. Haje also received unusually high opposition–about 23 percent of votes cast for and against.
Given that TWC’s executive pay levels as of 2013 were aligned with company performance, the driver of that opposition is likely a decision made in anticipation of the company’s proposed acquisition by Comcast Inc., to accelerate, to early 2014, grants of long-term incentive shares that otherwise would not have been made to managers (including named executive officers) until 2015 and 2016. The “advance” awards also lacked any performance conditions. Vesting of this extra equity may fully accelerate upon a change in control with employment termination–that will likely enhance the golden parachute packages of many executives, including recently promoted CEO Robert P. Marcus, whose additional grants will contribute about $17 million of the $79 million in total benefits the company reported he could receive upon the merger. A pro rata vesting policy would, of course, curtail some of that and may be the message shareholders wanted to send.
Tune in tomorrow for the webcast – “Anatomy of a Proxy Contest: Process, Tactics & Strategies” – during which experts with different perspectives on proxy contests will catch us up on all the latest: ISS’ Chris Cernich, Joele Frank’s Dan Katcher, Greenberg Traurig’s Cliff Neimeth and MacKenzie Partner’s Paul Schulman.
Since the SEC Chair typically sets the agenda for the agency, I was a little surprised to see this WSJ blog stating that SEC Commissioner Gallagher said that we shouldn’t expect changes to the 13D window “this year or next.” Then again, we’ve been hearing that it might be coming down the pike for years. So it probably is an accurate statement…
In this podcast, Amy Freedman of Kingsdale Shareholder Services discusses her firm’s new report on Canadian shareholder activism-related developments & trends, including:
– Can you describe the level of proxy contest activity in 2014 relative to prior years, and reasons it may be declining or leveling off?
– Based on 2014 takeover activity, what is the BC Securities Commission position on poison pills, and what’s the best guidance for companies?
– What are the current levels & scope of activism in M&A transactions?
– Can you describe the trends in shareholder engagement?
– What activism-related developments & trends do you anticipate going forward, and how should companies prepare?
Here’s news from Davies Ward:
In an update issued last week, the CSA announced that it will not be lowering Canada’s early warning reporting threshold from 10% ownership to 5% as previously proposed. The CSA had proposed lowering the threshold as part of a suite of amendments to Canada’s early warning regime that were proposed in March 2013. In addition to keeping the reporting threshold at 10%, the CSA has decided not to proceed with the proposal to include “equity equivalent derivatives” (such as total return swaps) in determining whether a shareholder has crossed the threshold for early warning reporting disclosure.
The CSA’s announcement will be enthusiastically received by many in the investment community that had broadly opposed several aspects of the proposed amendments, in particular the 5% threshold and the inclusion of equity equivalent derivatives in threshold calculations. In contrast, Canadian issuers had supported the 5% threshold. Among the 70 comment letters that the CSA received, the Managed Funds Association (MFA) and the Alternative Investment Management Association (AIMA) submitted an extensive white paper in response to the CSA proposal opposing these changes. Davies represented MFA and AIMA.
Noting that commenters had generally agreed with the CSA’s objective of enhancing transparency, the CSA stated in its announcement that it will proceed with other elements of the proposed amendments that will enhance transparency by these measures:
– requiring disclosure of 2% decreases in ownership;
– requiring disclosure when a shareholder’s ownership interest falls below the reporting threshold;
– making the alternative monthly reporting system unavailable to eligible institutional investors when there is an intention to engage in proxy solicitation;
– exempting lenders from disclosure requirements if they lend shares pursuant to a specified securities lending arrangement;
– exempting borrowers, in certain circumstances, from disclosure requirements if they borrow shares under a securities lending arrangement;
– providing guidance clarifying the current application of early warning reporting requirements to certain derivatives and requiring disclosure of derivatives in the early warning report;
– enhancing and improving the disclosure requirements in the early warning report; and
– clarifying the time frame to file the early warning report and news release.
The CSA announcement follows a statement last week by a United States Securities and Exchange Commissioner that the SEC is unlikely to tighten Rule 13d, the U.S. early warning regime, by shortening the 10 day disclosure window. Rule 13d requires non-passive investors to disclose ownership of more than 5% in public companies but unlike the Canadian rules allows shareholders a window of 10 days after crossing the 5% threshold to file a report. The 10 day disclosure window allows shareholders to continue purchasing shares after crossing the 5% threshold, in some cases to ownership in excess of 10%.
The CSA intends to publish final rule amendments implementing these changes in the second quarter of 2015.
Here’s news from Richards Layton about the Delaware Court of Chancery awarding $76 million in the Rural/Metro case:
In an opinion assessing damages in In re Rural/Metro Corp. S’holders Litig., C.A. No. 6350-VCL (Del. Ch. Oct. 10, 2014), the Court of Chancery held that a financial advisor, which had been held liable in an earlier opinion for aiding and abetting breaches of fiduciary duty by a board of directors in connection with approving a merger and related disclosures, would be required to pay 83% of the damages to the stockholder class.
Relying on a discounted cash flow analysis, the Court determined that the fair value of Rural/Metro on a quasi-appraisal basis fell short of the merger price by $4.17 per share, and that the damages to the class of stockholders not affiliated with the defendants totaled approximately $91.3 million.
Rural/Metro, its directors and the company’s other financial advisor had settled before trial and obtained “joint tortfeasor” releases, under which the plaintiff class agreed that the damages recoverable against other tortfeasors would be reduced to the extent of the settling defendants’ respective pro rata shares, as permitted by the Delaware Uniform Contribution Among Tortfeasors Law, 10 Del. C. § 6301, et seq.
The Court held that the unclean hands doctrine barred the non-settling financial advisor from claiming a settlement credit as to claims involving that financial advisor’s adjudicated “fraud upon the board,” but that it could claim a settlement credit as to other claims. The Court determined that the record at trial supported a finding that two of Rural/Metro’s directors were joint tortfeasors, but did not support such a finding as to the other directors or the settling financial advisor. Allocating responsibility for the various claims on which liability had been previously found, the Court entered judgment for approximately $75.8 million against the non-settling financial advisor.
Here’s news from Steve Haas of Hunton & Williams: In ev3, Inc. v. Lesh, C.A. No. 515, 2013 (Del. Sept. 30, 2014), the Delaware Supreme Court recently addressed the effect of an integration clause in a merger agreement. The appeal was brought after a Superior Court trial in which a jury awarded $175 million to the former stockholders of a target company who claimed that the buyer breached its contractual obligations relating to post-closing “milestone payments.”
A letter of intent between the parties provided that the buyer “will commit to funding based on the projections prepared by its management to ensure that there is sufficient capital to achieve the performance milestones detailed [in the letter of intent]” (the “Funding Provision”). This portion of the letter of intent was expressly made non-binding. In contrast to the Funding Provision, Section 9.6 of the definitive merger agreement stated that “Notwithstanding any other provision in the Agreement to the contrary… [buyer’s] obligation to provide funding for the Surviving Corporation, including without limitation funding to pursue achievement of any of the Milestones, shall be at [buyer’s] sole discretion, to be exercised in good faith” (emphasis added).
Following closing, the target’s former stockholders sued the buyer after the milestones were not reached and no further payments were made. The stockholders argued that the letter of intent demonstrated the parties’ understanding about the buyer’s obligation to pursue the milestones. In particular, they noted that the letter of intent survived under the merger agreement’s integration clause, which provided, in relevant part, that:
This Agreement contains the entire understanding among the parties hereto with respect to the transactions contemplated hereby and supersede and replace all prior and contemporaneous agreements and understandings, oral or written, with regard to such transactions, other than the Letter of Intent…..
Writing for the Delaware Supreme Court, Chief Justice Leo Strine held that:
The reference to the letter of intent in the integration clause did not convert the non-binding Funding Provision into a binding contractual obligation. Survival is not transformational. Rather, the integration clause’s provision that allowed the letter of intent to survive simply had the effect of ensuring that the expressly binding provisions contained in the letter of intent – which negotiating parties in the merger and acquisition context often expect to survive – would not be extinguished by the integration clause.
As a result, he said the Superior Court erred by allowing the former stockholders to argue to the jury “that the Funding Provision constitutes a contractual promise in itself, or was binding in the sense that it was a condition on [buyer’s] sole discretion” under Section 9.6 of the merger agreement. He noted that the letter of intent might have been relevant to some of the buyer’s potential defenses, but the Superior Court would still have to give the jury “a clear limiting instruction stating that the letter of intent was non-binding and any conflicting provision in the letter of intent could not alter the meaning of § 9.6.”
Here’s a note from Chris Cernich, Head of ISS’ M&A and Proxy Contest Research – it’s derived from a recent M&A Edge research note:
In the five months since Valeant Pharmaceuticals went public with its premium offer for Allergan, and over the three months since Allergan’s largest shareholder began soliciting support to give shareholders a vote on the offer, and during the five weeks since valid consents were delivered from more than a third of outstanding shares requesting a special meeting for that purpose–as well as, apparently, for the remaining three of four additional months before the board is finally required to hold that special meeting and give shareholders a voice–the Allergan board, though refusing to engage with the bidder, has repeatedly reassured Allergan shareholders that it is aligned with shareholders and focused on “enhancing stockholder value.”
We may be about to find out.
Since the Valeant announcement, Allergan has repeatedly indicated it is looking for acquisitions to help create shareholder value. But a large acquisition would also likely kill off the Valeant offer by making Allergan too big–regardless of whether that acquisition actually adds meaningful, let alone greater, value to shareholders. On Sept. 22, media reports began circulating that the board had not only declined an all-cash offer from another potential buyer, but was “in advanced talks to buy Salix Pharmaceuticals” for an all-cash consideration presumably rich enough to persuade the Salix board to call off its planned merger with Cosmo Pharmaceuticals.
Allergan’s largest shareholder, Pershing Square, which has been pushing the Allergan board to engage with Valeant, quickly warned it would sue directors for breach of fiduciary duty if such a transaction were announced. Over the subsequent days, three more of the company’s top 12 shareholders also issued public statements pointedly expressing, as T Rowe Price put it, their “growing concern [at] the corporate governance practices of the Allergan board.”
To point out that the board has authority to approve an all-cash acquisition without shareholder approval is to point out the irrelevant: the question is not what the board can do, but what the board should do.
When more than a third of outstanding shares consent to call a special meeting–particularly amid a thicket of bylaw restrictions so onerous as to nearly frustrate the exercise of that “right”–there’s credible reason to believe that the board should give shareholders a real and binding choice between the buyout offer and the new strategic plan assembled in response.
When nearly a fifth of outstanding shares, increasingly uneasy about the board’s stewardship, feel compelled to publicly reiterate that point, there is a credible argument to be made that the board should give shareholders a deciding vote on any large, buyout-blocking acquisitions if the board is simultaneously rejecting premium offers for the company.
Absent the announcement of a large, irrevocable acquisition, though–absent, that is, an irrevocable breach of faith–shareholders cannot know whether the board’s public professions of alignment were principles or platitudes. They cannot even know, with any certainty, that the board has rejected other compelling offers, or is negotiating a buyout-blocking transaction. They can, instead, only look at the board’s past behaviors, and whether its public statements address or sidestep the significant issues being raised, to gauge whether there is a credibility gap.
That record is not reassuring.
The board’s public response to this highly unusual airing of concern from its major shareholders has been only to reiterate generically its “focus” on “enhancing stockholder value”-with nary a word addressing the more crucial question raised by each of those major shareholders of whether it will enable or frustrate a decisive shareholder vote on the competing strategic alternatives.
Tune in tomorrow for the webcast – “The Art of Negotiation” – during which during which Cooley’s Jennifer Fonner Fitchen, Perkins Coie’s Dave McShea and Sullivan & Cromwell’s Krishna Veeraraghavan will teach you how to negotiate with the best of them in a chock-full of practical guidance program.