October 30, 2006

2006 M&A and Proxy Fights

From ISS’s 2006 Postseason Report: Not long ago, mergers and acquisitions advisers routinely viewed transactions as “in the bank” immediately upon the announcement of a deal. While regulatory concerns could occasionally scuttle a deal, the shareholder vote was usually a foregone conclusion. But today, thanks to hedge fund activists, a shareholder vote can be very much in doubt.

Consider the Novartis buyout of Chiron earlier this year. Novartis originally offered $40 per share and then raised its bid to $45. After CAM North America and ValueAct Capital opposed the deal as inadequate, Novartis ultimately agreed to pay $49 per share, and shareholders approved the transaction with 85 percent of votes cast. While detractors contend that hedge funds have short-term trading interests that diverge from the interests of companies and their long-term investors, examples such as Chiron indicate ordinary investors can benefit from the efforts of hedge funds.

The Chiron case also illustrates the crucial role that hedge funds played this past year in M&A. Hedge funds also helped produce a record year for proxy contests. The most notable fight occurred at H.J. Heinz, where Nelson Peltz’s Trian Group hedge fund fielded a five-nominee slate. Despite a $13 million effort by management to woo institutional investors, the dissidents won two seats. While Heinz had the support of labor investors and the California Public Employees’ Retirement System, Peltz, who described himself as an “operational” activist, won support from ISS and two other proxy advisory firms. Heinz was not Peltz’s only target this year. In March, he persuaded the board at Wendy’s International to install three of his nominees.

A confluence of trends has opened the door to these hedge fund activists. First, high-profile M&A disasters like the AOL-Time Warner merger and numerous academic studies have established a new conventional wisdom among investors that a significant percentage of deals destroy shareholder value. Second, high-profile scandals, such as Enron, WorldCom, and Tyco International, have made shareholders more cynical about the decision-making processes of directors. Lastly, investors and regulators have begun to pay more attention to how fiduciaries vote shares. Today, institutional shareholders who consistently defer to management may be accused of abdicating their fiduciary duties.

Hedge funds, with their growing economic clout (an estimated $1 trillion in assets under management worldwide), have become the catalyst for the new world order of M&A and proxy fights. While union and public pension funds have long voiced concerns over golden parachutes or the labor impact of a proposed deal, hedge funds maintain a laser focus on shareholder value. After all, fund managers get paid 20 percent of any shareholder value they can “help” create.

Such thinking is even spreading to an unlikely quarter: traditional asset managers. These managers have long preferred to work behind the scenes and sell their shares if their concerns were not remedied. But lately, some asset managers have taken the first tentative steps toward activism. In the Chiron buyout, dissidents were joined by Citibank’s asset management arm, providing legitimacy to the activists’ cause. To the extent that other traditional investors follow that lead, the power of hedge funds to bring change to companies will only increase.

Mergers and Acquisitions

As of mid-September, 308 U.S. M&A transactions had gone to a shareholder vote. In all of 2005, there were 402 transaction votes, according to ISS data. Other notable mergers and acquisitions from the past year included:

Guidant’s Acquisition by Boston Scientific: In November 2005, Johnson & Johnson and Guidant announced that they had agreed to cut the price that Johnson & Johnson would pay to acquire the medical device company after Guidant recalled products and announced deteriorating sales. The new price was $63 per share, 17 percent less than the $76 per share Guidant shareholders had expected. In December, Boston Scientific started a bidding war for Guidant. Guidant announced in January that it had agreed to be acquired by Boston Scientific for $80 a share in cash and stock. Shareholders of both companies approved the transaction in March with more than 97 percent of votes cast. In September, Johnson & Johnson, which received a $705 million break-up fee, sued Boston Scientific and Guidant, contending that Guidant leaked confidential information. Boston Scientific contends that the lawsuit has no merit.

Sprint Nextel’s Acquisition of UbiquiTel: In April, UbiquiTel, a seller of wireless phone service under the Sprint brand, agreed to be acquired by Sprint Nextel for $10.35 per share. The total deal was valued at approximately $1.3 billion (based on $1.0 billion in equity value plus $297 million in net debt). Deephaven Capital Management (an 18 percent shareholder) submitted a filing expressing its opposition to the offer price. Shareholders approved the merger in June.

Armor Holdings’ Acquisition of Stewart & Stevenson Services: In late February, Stewart & Stevenson Services, which makes and services military vehicles, announced that it had agreed to be purchased by Armor Holdings for $35 per share. In March, Oshkosh Truck announced it had participated in an auction process and had bid $35.50. Oshkosh also stated that it was prepared to offer a higher price, but it was barred by a standstill agreement from making an offer after the process concluded. In April, Ramius Capital (a 5 percent shareholder) urged Stewart & Stevenson’s board to waive the standstill provisions and permit other parties to make a superior proposal. Shareholders approved the $1.14 billion transaction by more than a two-thirds vote in May.

Micron Technology’s Acquisition of Lexar Media: Lexar Media and Micron Technology agreed to merge, with Lexar shareholders receiving 0.5625 shares of Micron common stock per Lexar share. Billionaire investor Carl Icahn and hedge funds Elliott Associates and Glenview Management opposed the deal, arguing that the price for their Lexar shares was too low. In response, the companies agreed to swap shares at a higher exchange ratio (0.5925 Micron shares per Lexar share), a 5 percent increase from the initial ratio. Glenview supported the revised deal, but Elliott and Icahn opposed it. The $801 million transaction was approved narrowly by Lexar shareholders in mid-June.

Notable International Transactions

In one of the year’s biggest international transactions, Dutch-based Mittal Steel merged with Arcelor of Luxembourg after Arcelor shareholders rejected a competing bid from Russia’s Severstal. Arcelor agreed to the € 27 billion ($34.5 billion) transaction in June after months of acrimony. The combined company, which now holds 10 percent of global steel production, plans to expand in India and China. The fight for Arcelor, along with Enel’s overtures for Suez and other hostile bids in Europe, inspired France and Luxembourg to adopt legislation to permit “poison pill” takeover defenses.

In a significant trans-Atlantic deal, Lucent Technologies agreed to merge with French telecom firm Alcatel. Lucent shareowners will receive 0.1952 of an American depositary share of Alcatel for every common share of Lucent that they hold. Upon completion of the €8.6 billion ($11 billion) merger, Alcatel shareholders will own approximately 60 percent of the combined company and Lucent shareholders will own about 40 percent. Shareholders at both firms voted to approve the transaction in early September, despite concerns that Alcatel was overpaying for Lucent.

Also this year, six mining companies were involved in a flurry of competing transactions. Toronto-based Inco sought to acquire fellow Canadian nickel producer Falconbridge in a friendly acquisition, but faced a rival bid from Xstrata, a Swiss coal producer. In May, Teck Cominco, a Canadian zinc producer, launched a hostile bid for Inco. Phelps Dodge of the United States joined the fray with a friendly offer for Inco. CVRD of Brazil, the world’s largest iron ore producer, jumped with its own hostile all-cash offer for Inco. Falconbridge decided to accept Xstrata’s offer. Teck pulled out in August, and Inco’s board recommended that shareholders vote for the Phelps Dodge cash-and-stock offer. In early September, Inco and Phelps Dodge canceled the $18.2 billion deal after concluding from early proxy returns that the transaction would not receive the necessary two-thirds approval from Inco shareholders.

Other international transactions in the news include: German energy giant E.On’s offer for Endesa of Spain; the competing bids for Euronext by the NYSE Group and Deutsche Boerse; the merger of European autoway operators Autostrade and Abertis; Sears Holdings’ effort to buy the remaining shares of Sears Canada; and the merger of Tattersall’s and UniTab in Australia.

Surge in Proxy Contests

So far, it appears that 2006 will be a record year for proxy fights. According to FactSet Research Systems’ Web site, there were 80 proxy fights during the first six months of the year. That exceeds the 54 fights in all of 2005, the 40 contests in 2004, and 74 contests in 2003. (SharkRepellent counts a proxy contest once an investor files a notice of an intent to submit proxy materials, so its numbers are higher than other firms that track only fights where actual materials are filed.) In addition to proxy fights, there have been 122 other activist campaigns this year where shareholders have advocated for stock buybacks, increased dividends, sale of the company, or other change, according to SharkRepellent.

Another factor that has led to more proxy fights has been the gradual erosion of poison pill plans, classified boards, and other takeover defenses. Fifty-four percent of S&P 500 companies don’t have poison pills, while a majority of S&P 500 directors likely will be subject to annual elections by the end of 2006, according to ISS data.

This season, hedge funds have been successful in many of their dissident campaigns. According to investment bank Morgan Joseph, hedge funds have won board representation in 35 percent of their campaigns.

While the Heinz proxy fight generated significant attention from investors, many proxy fights have settled before going to a vote. By mid-August, 31 proxy fights tracked by ISS had culminated in a settlement. So far this year, 21 proxy contests have gone to a vote, as compared with 18 in all of 2005, according to ISS data.

The most notable company to settle a proxy fight this year was Time Warner, which reached an accord with Carl Icahn in February. Icahn, joined by Franklin Mutual Advisors, SAC Capital Advisors, and JANA Partners, raised concerns about the company’s strategy to release value for shareholders. In early February, Icahn and his allies presented a report that called for Time Warner to be split into four publicly traded companies and to buy back at least $20 billion of stock. A week later, Icahn and the company announced a settlement, under which Icahn agreed not to run a minority slate, while management committed to increase the size of a share buyback, slash additional costs, and appoint two new directors. The Time Warner case is a prominent example of a recent trend of hedge funds banding together to advocate for governance, strategic, or financial change.

Other recent settlements include Acxiom’s settlement with ValueAct Capital, the agreement by Pep Boys to nominate four directors proposed by Barrington Capital Group, and the settlement that Topps reached with Pembridge Capital Management and Crescendo Partners.

Settlements between issuers and activist shareholders are typical of the compromise a target company will “choose” when it becomes clear that it will lose a proxy fight. With a settlement, the issuer may be able to extract some concessions from the dissidents (usually a board seat or two) that it was unlikely to have obtained if the original slates had gone to a vote. Moreover, the company is able to save face by not officially “losing” the contest. At the same time, the dissidents often can get everything they asked for and appear reasonable, which can only enhance their options in future negotiations.

In addition to Heinz and Time Warner, other noteworthy proxy fights included:

BASF’s Hostile Tender Offer for Engelhard: German chemical giant BASF launched a proxy contest for five seats on Engelhard’s classified board along with a hostile tender offer. Engelhard, a New Jersey-based firm that makes pollution control equipment, countered by offering a recapitalization plan that called for a $45 per share cash self-tender for up to 20 percent of its shares. BASF originally offered $37 per share and then raised its bid to $39. On May 30, three days prior to the scheduled meeting, Engelhard announced a merger agreement with BASF and recommended that investors accept the German firm’s $5 billion offer. Shareholders subsequently tendered more than 90 percent of the shares.

Massey Energy’s Proxy Fight With Third Point: Massey Energy operates coal mines in West Virginia, Kentucky, and Virginia. Third Point nominated two directors, arguing that the board needed a “new voice.” Third Point claimed that the company has “massively” underperformed industry benchmarks and had “lavished” compensation on its CEO. Management argued that its strategic plan has contributed to a significant increase in shareholder value in the past five years and that the board had been responsive to shareholder concerns. After a dispute over vote results, the company agreed in July to allow the dissident nominees to join the board and to reimburse some of their legal fees.

InfoUSA’s Proxy Fight With Dolphin: Dolphin LP sought the election of three nominees to infoUSA’s board. The dissidents faced an uphill challenge because CEO and Chairman Vinod Gupta and his family owned 43.6 percent of the Nebraska-based mailing list company. Dolphin argued that the company has performed poorly since 2001 and has traded at multiples that are below those of its public peers. Management countered that it delivered 4 percent organic revenue growth in the first quarter of 2006 and was implementing a strategic plan to position the company for continued growth. The incumbent directors narrowly survived, winning at least 50.7 percent approval in May. Dolphin reported that investors not affiliated with management supported the dissident slate by a 13 to 1 margin.