May 9, 2014

Surveying the M&A and Contest Landscape

Here’s news from Chris Cernich, ISS’ Head of M&A and Proxy Contest Research, and Juan Bonifacino, ISS Analyst, M&A and Proxy Contest Research:

Proxy contests for board seats are usually the story during the U.S. proxy season–but now it looks like mergers are becoming the bigger story. In some ways they’re a more beguiling story, as they change every day. Four weeks ago, the biggest contest was likely to be Charter Communications challenging the merger vote between Comcast and Time Warner Cable, as a way of getting Charter’s own bid back into the running. Now, however, the companies have announced a three-way deal in which Comcast would buy a number of subscribers the other two are shedding as part of the regulatory requirements of the merger.

There’s a vote coming up at Zales, on the sale to Signet, on May 29. No Zales holders have yet come out against the deal–it does carry a 41 percent premium over the unaffected price. But the deal is only worth $950 million, and the total premium Signet will pay, in dollars, is $275 million. When the deal was announced, by contrast, Signet’s own market cap, instead of falling, rose by $1.5 billion–one-and-a-half times the total purchase prices for Zales, and more than 5 times the “premium” Zales shareholders will get.

Bill Ackman’s Pershing Square recently announced it had purchased 10 percent beneficial ownership of Allergan in support of a bid–which had not yet been announced–by Canada’s Valeant Pharmaceuticals. It’s more complex than the press headlines, but, at a high level, Valeant is offering $48 in cash and 0.83 Valeant shares for every Allergan share held–nearly $46 billion on the date of announcement. The offer represented something like a 30 percent premium to share prices before Pershing Square began its rapid accumulation program in Allergan shares.

Allergan, which just held its annual meeting May 6, hasn’t said anything about the offer yet. Given the unsolicited bid, made publicly and with what seems to be very hard sell tactics, a good board of directors will take some time considering the options for the company. Allergan has also adopted a poison pill, which isn’t unusual. Most companies have one on the shelf for just this reason: to keep an unsolicited bidder and its allies from accumulating a control position while the board is trying to negotiate the best offer. And a pill allows a well-functioning, well-intentioned board time to find other potential bidders who might be willing to pay more.

The thing Allergan shareholders will want to watch is what the board does while it has the pill in place. Sometimes boards do nothing, because the pill itself removes the direct need to take decisive action. Sometimes, though, they use the time afforded by the poison pill very well, and shareholders benefit enormously. Once patent protection on a drug runs out, the pricing power of the branded drug falls off significantly, and generics take its market share. Valeant’s business model, which has been very successful, is to acquire products with dwindling patent protection and milk their remaining patent life even as it positions them to compete more effectively with generics once they’re off patent. The company spends very little on things, like Research and Development, that don’t contribute to that business model.

Pershing Square’s role in all this, which has caught investors’ attention, has even spawned a few law firm notes pointing out that it’s not insider trading; your own plans to make a bid aren’t “insider information” when it comes to buying or selling the target’s shares. And there is a long precedent for things like this–a hostile bidder often buys a “toehold” (2-3 percent of shares, not 10 percent) in advance of its bid for a number of reasons, including that the toehold can help offset the expense it’s going to incur in running a campaign to win over shareholders. Pershing actually raised a new $4 billion fund specifically for this investment, and Valeant agreed to invest in the fund, which gives it some of those same “toehold” advantages.

This action by Pershing Square has felt to many observers like there’s something not altogether aboveboard about it, although it has led to a reconciliation between Ackman and Carl Icahn. The genesis of this reconciliation, apparently, was when Icahn said on CNBC two weeks ago that he didn’t see “anything illegal” in Pershing Square’s actions.

While the Allergan situation appears unlikely to go to a proxy contest at this point, ISS is tracking 18 contests scheduled for May and June, plus three that took place in April:

– At Cracker Barrel, shareholders rejected the proposal by Biglari Holdings to sell the company.

– At Sensient Technologies, it looks like–because strangely the company didn’t put out a press release–none of the four dissident nominees proposed by FrontFour Capital were elected.

– And in the consent solicitation at Darden Restaurants, Starboard got the 50 percent support it needed to call a special meeting. ISS expects to see that meeting–where Starboard will propose a restriction on the sale or spin of the Red Lobster business prior to the Fall annual meeting–within about 60 days.

Commonwealth REIT’s will hold a special meeting on May 23 to elect new directors nominated by shareholders. At the company’s February consent solicitation, Corvex and Related got more than 80 percent of shares to consent to remove the entire board. So far, for the May meeting, only Corvex and Related have proposed candidates, and there is nothing to suggest that these elections will be contested.

Following press reports that the hearing on Sotheby’s poison pill had uncovered emails from one director saying, in effect, that Dan Loeb of Third Point Capital, the dissident, was right, the board was “too chummy” and performance and compensation had become a problem, Sotheby’s and Third Point agreed to a settlement that will see the addition of all 3 dissident nominees to the board. The company adjourned its meeting to a yet-unspecified later date.

Several other proxy contests are on the horizon:

– Morgan’s Hotel Group, where the dissidents cite, amongst other things, some significant failures to follow through on commitments to shareholders.

– Intevac, where the dissidents believe the company’s “venture capital” strategy and capital allocation have driven long-term underperformance.

– Griffin Land & Nurseries, where Mario Gabelli’s GAMCO is seeking two seats and has a proposal to convert the company into a REIT or MLP structure

– Poage Bancshares, where Joe Stilwell’s fund is seeking one of nine board seats;

– GrafTech International, where the largest shareholder, Nathan Milikowski–a former director the board declined to renominate in 2013–is seeking three of seven seats.

There are also be six contests with meeting dates the week of May 19, which is “peak week” for US proxy season:

– Telephone and Data Systems, where GAMCO is seeking two of the four seats electable by non-controlling shareholders. The controlling shareholder elects an additional eight directors;

– Harvard Illinois Bancorp, where Stilwell is also seeking a seat;

– Solera National Bancorp, where two retail investors are separately seeking board seats;

– Anworth Mortgage REIT, where the dissident is seeking one seat; and

Endeavor International, where the dissident wants one of seven seats. Interestingly, the lead dissident at Endeavor is the chair of Morgan’s Hotels, who got there through a proxy contest last year. Now he’s being targeted for removal from the Morgan’s board by a different hedge fund in another proxy contest a week earlier. His uncle, moreover, is one of three directors targeted in the proxy contest at Sotheby’s.