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A New Form of Shareholder Activism Gains Momentum
By STEVEN M. DAVIDOFF
New York Times
March 4, 2014, 6:16 pm
The aftermath of the Dole Food management buyout is showing that the new, new thing on Wall Street is appraisal rights. The battle being waged by hedge funds over appraisal rights in the Dole buyout just may be the tipping point, as hundreds of millions of dollars flow to the funds to pursue these actions.
Appraisal rights actions, according to a new paper by two law professors, Minor Myers of Brooklyn Law School and Charles Korsmo of Case Western Reserve Law School, are already skyrocketing in value. Last year, the value of appraisal claims was $1.5 billion, a tenfold increase from 2004. More than 15 percent of takeover transactions in 2013, the paper said, were subject to claims over appraisal rights.
So what are appraisal rights, you ask?
Shareholders sometimes have appraisal rights when the company they own stock in is acquired and they think the price is too low. Shareholders can ask a court to assess the fair value of their shares, with the hope that the court will agree that the price is not high enough and require that the shareholders be paid more.
Appraisal rights are protection for shareholders. If they think the takeover is a poor deal, they can seek a better price in court. Appraisal rights also serve to remind the buyer not to try to underpay. This is a particular problem in management buyouts, which have an air of “inside deal.”
If you followed the $24.9 billion management buyout of Dell, you may have read about the campaign by the activist investor Carl C. Icahn to get other shareholders to exercise their appraisal rights. The campaign fizzled for most shareholders, and even Mr. Icahn decided not to pursue his appraisal rights. This is because appraisal rights are not typically seen as a great remedy for the average shareholder. Shareholders have to pay their own legal fees and, depending on the state where the company is organized, the court can actually award less than the amount in the takeover.
In the Dell case, given that the company looked for other buyers and none came along, appraisal rights did not turn out to be a good option for most shareholders. It appeared that management’s price was probably as much as Dell could get in a sale, given its declining personal computer business. Still, about 2.7 percent of shareholders exercised appraisal rights, including T. Rowe Price.
It turns out, though, that the Dell campaign was a small step in a much larger fight, the one involving Dole Food.
Dole was involved in a management buyout last fall. The company was controlled by its buyer, David H. Murdock, its 90-year-old chief executive and chairman. The offer price of $13.50 a share was viewed by analysts and even some shareholders as underwhelming. At least one analyst put Dole’s fair value at $17.50 a share, and shareholder litigation disclosed that Dole had valued itself for lenders at more than $20 a share.
The Dole shareholder vote was a nail-biter, and the deal passed with only 50.9 percent of the public shareholders supporting it.
A few years back, this would have been the end of it. There is litigation pending, but its outcome is uncertain. And let’s face it, investors raised similar questions about the J. Crew sale to two private equityowners, and J. Crew and its new owners eventually settled a shareholder suit for $16 million. Now, the owners of the preppy clothing company are reported to be in preliminary talks with the Japanese retailer Uniqlo to sell the company at double the price they paid only a few years earlier.
In the wake of the Dole buyout announcement, four hedge funds — Fortress Investment Group, Hudson Bay Capital Management, Magnetar Capital and Merion Capital Group — bought about 14 million shares. They have now exercised their appraisal rights.
The hedge funds are all players in the appraisal game. Magnetar is still dissenting in the Dell case. Merion has filed at least 10 appraisal actions in Delaware, including two challenging the acquisitions of Ancestry.com and BMC Software. Merion is run by a former plaintiffs’ lawyer, Andrew Barroway, who used to be with Kessler Topaz Meltzer & Check, which won a $2 billion judgment against Southern Peru Copper, the largest award of all time in Delaware.
In all, about 25 percent of Dole’s public shareholders have exercised their appraisal rights.
Appraisal rights are risky and expensive, but they also have benefits for a hedge fund with a lot of money. One of the big benefits is that shareholders are generally entitled to statutory interest on the appraisal award at the Fed discount rate plus 5 percent from the time the deal is closed until the award is paid. The Fed discount rate is at 0.75 percent, meaning that the interest rate is 5.7 percent. In this market, that is a good return if you expect to at least get the merger price.
Buying shares and then filing for its appraisal right is also a good place for a hedge fund to park cash it may want to spend elsewhere. This has all been spurred by an earlier paper on the subject by Professors Korsmo and Myers, who found that there were significant returns to appraisal rights in recent years.
As a result, new hedge funds are specializing in appraisal rights. Merion has reportedly raised $1 billion. Another hedge fund, Patchin Value Master Onshore, specializes in filing small appraisal claims for $1.5 million of stock and had filed 16 such actions as of the end of 2013. Conferences are being held that focus solely on encouraging appraisal rights. All of this is driven by the fact that hedge funds are looking for new business outside the mainstream activist sphere.
The Dole appraisal rights battle is also a huge development in takeovers. Buyers can underprice their takeovers, but they are left with the “Dole problem” — the fruit and vegetable producer now has a potential liability that starts at about $190 million, the value of the stock exercising appraisal rights. Its opponents are hedge funds that will not go away lightly. They are going to litigate hard and will need to earn a return.
As a result, the battle over Dole will no doubt make others pursuing management buyouts hesitate before they act.
For now, though, appraisal rights are primarily benefiting the hedge funds. Institutions and individual shareholders are unlikely to plunge in full force, even if T. Rowe Price did so in the Dell campaign.
The question is whether there will be any pushback by companies. We are about to see many more actively litigated appraisal cases in the coming years. There will be complaints by corporations that the hedge funds are simply out to make easy money. Companies may lobby to make appraisal rights even harder to exercise to discourage the hedge funds.
Still, in fights over appraisal rights, you have real players putting their own money on the line. Not all shareholders are going to exercise their appraisal rights, but this is the way to make sure that the future management buyouts are not the Doles of the world, paying an underwhelming price. In other words, this may be the way that shareholders finally assert their power. You can thank the hedge funds for that.
Steven M. Davidoff, a professor at the Michael E. Moritz College of Law at Ohio State University, is the author of “ Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion.” E-mail: email@example.com | Twitter: @StevenDavidoff