November 10, 2014

Institutional Investor Services (more commonly known as ISS) is a shareholder- and proxy- advisory firm whose recommendations on pivotal corporate votes are widely heeded in the institutional investor community. ISS recently published a survey of the implications of “just say no” M&A defences for shareholder returns. In light of the pending (18 December) Allergan Valeant vote it examined seven high-profile M&A battles during the five years since the world (tentatively) emerged from the depths of the financial crisis. ISS focused on hostile M&A situations where management has resolutely said “no” to an unwanted bidder and – in the face of sustained interest on the part of the latter – taken matters through to a proxy contest and shareholder vote. (“The IRR Of Saying No”, published 22 October 2014)

Seven high-profile battles were examined:  CF Industries’ pursuit of Terra, Exelon Corp’s bid for NRG Energy, Air Products’ hunt for Airgas, Alimentation Couche Tard’s bid for Casey’s General Stores, Bel Fuse’s pursuit of Pulse Electronics, Roche Holding Ltd.’s versus Euminia Inc., and Symphony Technology Group’s bid for Onvia. In all but one the hostile bidder lost the shareholder vote.

Ownership Constitution

(Note: Airgas and Symphony had significant board ownership – 11% and 11.4% respectively – which bends the average.)

ISS sought to calculate shareholder returns subsequent to management and the board “winning” the fight for control of the company. The first framework deployed by ISS was absolute return.  The median cumulative total shareholder return for the seven companies was 50.4% (over a median period of 3.8 years).

ISS suggests in its paper that “absolute return is a naïve view of the issue”, proposing instead that analyses ought to focus on relative returns to the market as a whole as well as to peer groups. On this basis ISS concludes that total shareholder returns suffers over the half year, full year and period since the proxy vote (an average of 3.6 years and a median of 3.8 years). Indeed the consequences of saying no to a hostile bid were painted as being, on average, dire.

Underperformance Relative To The S&P 500 Underperformance Relative To Their Peers

Five of the seven proxy contests saw increased bid pricing, with Terra Industries seeing CF raise it s price four times for a total of 117%.

ISS argued that “the conventional wisdom is that giving additional time to a board facing a hostile bid improves the outcome for shareholders.” In Cheverny’s view this can come about both tangibly (the delay can allow for the market to acknowledge – via a higher share price –  “hidden value” exposed by management  and/or stimulate a higher competing bid) and intangibly (the delay allows management and the board to lay out their stall and allow for shareholders to make a more informed decision).

Whilst the aggregate data set out by ISS supports a view that shareholders should say “yes” even when management says “no”, there is considerable nuance in the ISS data, some of which can support a far more differentiated view.

In the case of Illumina, a maker of genetic sequencing equipment, this proved to be a textbook study. Despite the 88% premium from the “undisturbed” share price, management responded to a bid with a forceful “no”, supporting this with the argument that Illumina was one of the few makers of equipment for an embryonic market that was clearly set to explode. Over the three and a half years since the proxy vote Illumina has outperformed its peer group by almost 247% (and the market by 257%).

Air Gas, the maker of packaged industrial and medical gases, also rebuffed a suitor  (Air Products – a firm seeking an entrée into the US market) perceived to be unsuitable by arguing that it too occupied a privileged perch in a hard-to-enter industry. Shareholders supported management and the board in the proxy vote, and subsequent thereto AirGas outperformed its peer group by ~21%.

Casey’s presented a different type of challenge for shareholders. In 2010 Alimentation Couche-Tard took a 3.9% initial stake and made an unsolicited offer for Casey’s General Stores, an operator of convenience stores in predominantly rural markets. Couche Tard’s tactics were helpful to management. Firstly, the offer was made without committed financing in place. Secondly, subsequent to announcement of the offer and Casey’s having forcefully represented that the deal undervalued the firm, Couche-Tard sold its stake at $38.43 ($2.43 above the offer price).  Casey’s launched a Dutch self-tender at almost the same price ($38) demonstrating substantial conviction in their point of view. Casey’s produced absolute returns of ~89% subsequent to management’s victory in the proxy vote: slightly better than the S&P 500 but worse than the peer group (which has itself seen data skewed by substantial M&A activity).

In the other situations saying No led to underperformance. Intriguingly, one of ISS’ observations was that the two situations where a “no” victory produced outperformance were also the two companies where there was meaningful share ownership by the CEO (at AirGas 10.4% and at Illumina 1.8%).

As such we are inclined to be much less categorical than ISS about the value – or destructiveness – of “just say no” defences. In our view what is paramount in a hostile bid is the value of clearly articulating the value of an independent strategy and being able to make this case in a compelling, evidence-based manner. An independent adviser can play a critical role in such a process.