Monday, 2 March 2015

Delistings: trust issues

Good article in The Financial Times: "Management Buyouts: Trust issues".

Management Buyouts are sometimes called delisting exercises in the Malaysian context.

In a typical company, investors wonder if the chief executive is competent. A tougher question emerges when the chief owns a big chunk of the shares: is the boss trustworthy? This week the founder of electronic music festival company SFX Entertainment, Robert Sillerman, offered to buy out the 60 per cent of the company he does not own, for $4.75 per share. The shares traded at $12 at the end of 2013. Still, the offer may well succeed - the bosses of Dole Food and Dell both won approval for their recent buyouts.

The dilemma with management buyouts is this: the boss has the inside perspective on the value of the company. Knowing where the bodies are buried puts them in a position to exploit the ignorance of Joe Public. Aggrieved shareholders of Dole Food claimed that its chief executive, who owned a 40 per cent stake, took advantage of a lull in the share price. In the case of Dell, the recent strong rally in the shares of HP - a very similar business - suggests Mr Dell timed his purchase well.

Shareholders have some protection against exploitation. Independent directors can negotiate on the behalf of public shareholders. Deals can require a majority of unaffiliated shareholders to vote in favour. Management buyouts often face a higher standard of review in deals in case of a legal challenge. Increasingly, shareholders demand "appraisal rights", where a judge decides if the deal price was fair.

Still, companies with big insider shareholders do not necessarily underperform in aggregate. A 2012 study by ISS found single-class "controlled" companies (where control is defined as ownership of 30 per cent of the shares) outperformed non-controlled companies as well as dual class controlled companies. The theory behind investing in companies where the chief executive has a big stake is that management and shareholders have the same interests. That is not always how it works in practice.

The above mentioned protection against exploitation in the Malaysian context:
  • Independent directors are not known for standing up against the boss: they are chosen by the boss and their fees are paid by him. Also, independent directors could simply be the golf buddies or former classmates of the boss. There are some exceptions, but they are rare, and (often) not published. Enforcement against independent directors for failing their fiduciary duty in this matter is almost non-existent, I can't recall a single case.
  • Legal challenges are very rare, they can be costly, taking a long time to conclude, not a good prospect for minority shareholders who will anyhow have a problem to band together like in a class action suit.
  • Appraisal rights: they depend on an independent valuation. Unfortunately, I have seen too many "independent" valuations that were extremely favourable for the boss. Enforcement agencies (SC and BM) often do not like to question these valuations, is my experience, even when they appear to be highly unfair. Some independent valuers have been punished, but very rarely so.
In other words, unless there are some vocal fund managers who own at decent stake of the company, it is usually a very unequal fight. Bosses are of course very aware of this. 

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