August 19, 2014

U.S. Mid Year Activism Review: Slow Start, Big Finish

From ISS: The resurgence in proxy contest activism that began in 2012 appeared to have stalled by Q1 of 2014 when only two contested situations went to a shareholder vote, compared to eight in the first quarter of 2013. Both of these contests, however, were resounding dissident routs of incumbent boards. At The Pantry, the dissident won all three contested seats and dissident nominees outpolled management candidates by as much as a 6-to-1 margin. In a repeat consent solicitation to remove the entire board of CommonWealth REIT, more than 81 percent of outstanding shares (up from 70 percent in the first go-around seven months earlier) consented to the removal of all incumbent directors, even though this left the company without a board for as long as two months until a special meeting to elect replacements was convened.

Contested elections rebounded in the second quarter of 2014, however, with 20 contested meetings–significantly more than the 16 which went to a vote in Q2 2013, though still short of the high-watermark of 24 in 2009. Continuing a trend from 2013, moreover, the size of the targets increased. In 1H 2014, a significant number–seven of the 22 total contested elections–had market capitalizations greater than $1 billion, versus eight billion-dollar-sized targets in the same period for 2013. There were, however, considerably fewer pint-sized proxy combatants–only 18 percent of the targets were below $100 million in 1H 2014, versus 50 percent in 1H 2013. The median market cap of targets in 1H 2014 thus grew to $260 million, nearly double the $141 million median for the same period in 2013.

Dissidents continued to win at least one seat, through a vote or last-minute settlement, more often than they lost, but the 1H 2014 “win” rate, at 59 percent, was more in line with the mid-50’s rates in the 2009-2012 time period than insurgent investors’ blistering 68 percent “battling average” in 2013.

Multi-front Campaigns
Fueled by an influx of investment dollars (chasing 2013’s best-in-class hedge fund return) and new entrants drawn to the space, the 2014 season featured a number of hydra-headed activist challenges. Unlike past piling-on efforts where hedge funds were drawn to targets by the blood in the water caused by the initial contact, these multi-dissident situations often featured competing visions for changes in corporate strategic direction at target companies.

Darden Restaurants
At Darden, dissidents Barrington Capital and Starboard each separately urged the company to undertake a number of strategic initiatives, including monetizing the real estate assets of its largest restaurant chains, Red Lobster and Olive Garden, through a sale-leaseback transaction. When the company announced, instead, that it would sell or spin the struggling Red Lobster business–an action which might void the sale-leaseback strategic option–Starboard launched a three-stage activist campaign. First, Starboard sought shareholders’ written consent to call a special meeting. Next, Starboard planned that shareholders would vote on a non-binding proposal requesting that the board not execute a sale or spin off of Red Lobster prior to the 2014 annual meeting unless such a transaction was also ratified by a vote of shareholders. In the third step, Starboard would nominate a dissident slate at the annual meeting.

In April, Starboard delivered written consents from a majority of outstanding shares supporting its request for a special meeting. Several weeks later, however, the board–acting within its legal purview but with clear disregard for the strong mandate shareholders had already provided through the written consent process–announced it had agreed to sell Red Lobster to Golden Gate Capital for $2.1 billion in cash. The transaction would not be subject to a shareholder vote. Starboard announced it would now seek to replace the entire board at the 2014 annual meeting which has historically been held in the fall.

Sotheby’s also faced a hydra-headed hedge fund challenge. The auction house was first singled out in July 2103 by Mercato Capital, which targeted the company’s cost structure and capital allocation practices. A month later, Dan Loeb’s Third Point filed a 13D. While the company eventually made a number of changes–including naming a new CFO and announcing a special dividend– it was unable to satisfy Third Point that the board had a sufficient sense of urgency about either its cost discipline or the need to adapt its business to new and emerging opportunities.

Marcato, which never “settled” with the company, did not ultimately run a proxy contest. However, Third Point did, highlighting the discrepancy between the board’s defense that 2013 was a “record” year and the evidence of the financial statements. Third Point’s campaign was bolstered by the revelation that directors, in emails unearthed by Third Point’s legal challenge of the company’s discriminatory, two-tiered poison pill, freely admitted to one another that the board had become “too chummy” and the dissidents’ case for change had merit. A settlement days before the shareholder vote added all three dissident nominees to an expanded board.

Near Misses
Many of the season’s most highly anticipated contests failed to materialize as directors and senior managers at target companies sought to short-stop challenges by offering board seats or making other moves to boost stock valuations. The poster dissident for such peaceful settlements was Carl Icahn. By February it was clear once again that Icahn, himself already past the mandatory retirement age set by many boards, still had issues he wanted to discuss publicly with some of them.

At Apple, whose net cash position had grown to more than $150 billion, Icahn announced a proposal that the company return capital more aggressively to shareholders by repurchasing at least $50 billion of its own shares in fiscal 2014. The company had been ramping up its return-of-capital program over the previous two years, initiating a $10.5 billion annual dividend and several repurchase programs; based on its recent history, it appeared on track to repurchase at least $32 billion in 2014 even without Icahn’s help. In mid-February, the company announced it had repurchased $14 billion in shares in response to a share price drop after its 1Q earnings report, bringing its 12-month total repurchases to $40 billion. Icahn, helpfully noting that this left ample cash reserves to “keep going,” announced he would not present his proposal at the annual meeting after all.

Icahn then turned to eBay, announcing he would nominate two candidates and make a non-binding proposal to spin off the PayPal business. He then surfaced a number of governance issues within the board itself, including the many potential conflicts of interest that arose from having directors with significant economic interests in so many other tech companies. In particular, he highlighted eBay’s sale of the Skype business several years earlier to a consortium which included an eBay director, and which quickly resold Skype at a significant profit: the question, Icahn emphasized, was whether directors on the eBay board, and perhaps other tech sector boards, were too conflicted by their own outside business interests to act in the best interest of public shareholders. Then, somewhat inexplicably, peace broke out. On April 10, the two sides announced Icahn was dropping both the proxy contest and the precatory proposal, and the company was adding an additional, mutually-agreed independent director.