In July, Tampa-based Intermedia Communications let it be known that it was going to raise cash by selling some non-core assets, the prize being its controlling stake in Digex. WorldCom, rebuffed once by Intermedia, instead offered to buy Intermedia and take de facto control of Digex without any premium being paid to Digex shareholders. Now some of these shareholders are suing, claiming that Intermedia's board did not look out for their interests.
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In July, struggling competitive local exchange carrier (CLEC) Intermedia Communications (Nasdaq: ICIX) put the word out that its 54% stake in web hosting company Digex (Nasdaq: DIGX) was for sale. Intermedia wanted to raise cash through the sale so that it could keep its head above water on its core local telecommunications services. Intermedia, like most CLECs, was mowed down when the credit markets tightened and investor sentiment became much less forgiving of companies not generating positive cash flow. With its cash-losing operations, $3 billion in debt and negative shareholder's equity, Intermedia had to do something -- and fast. WorldCom (Nasdaq: WCOM) offered $120 per share for Digex ($7.6 billion), which was rejected. WorldCom then offered to buy out Intermedia itself. This would give WorldCom a controlling interest in Digex, since a deal harking back to Digex's spinoff from Intermedia gave the latter control of 94% of the voting interest of Digex. Intermedia's share price soared upon announcement of the deal while Digex shareholders watched in horror as one form of exit strategy -- direct sale of the company -- was taken from them by an external entity. Minority shareholders quickly mounted legal challenges, unhappy that the six directors who overlap and serve on both Digex' and Intermedia's boards placed Intermedia's and their own interests above that of Digex and its shareholders. WorldCom and Intermedia paid little attention to the suits, pressing on with their merger plans in spite of a market that has more than halved both of them in the interim. Earlier this month the Department of Justice approved the merger on the condition that WorldCom sell off all of Intermedia's assets -- save its controlling stake in Digex. Angry Digex investors strike back It was a fairly significant blow to WorldCom, but moreso to Intermedia. However this turns out, investors should look at the lessons of this situation and apply them to their own analysis. Certainly there were a number of Digex shareholders who did not even realize that the majority of its shares were owned by another company. Unfortunately, this is not easy to find out. The best way is to check the "Risk Factors" section of the company's 10-K. In the case of Digex, there is a risk factor headed by the following: "DIGEX IS CONTROLLED BY INTERMEDIA, WHICH COULD INVOLVE MULTIPLE RISKS FOR YOU AS A STOCKHOLDER." Make sure you know who controls your company
The shareholder suit drew blood on Wednesday when a Delaware judge said he would make a ruling on the merger sometime before December 18. If he blocks the merger, Digex will immediately be in play for other suitors. The shareholders are also asking that damages be paid in proportion to the loss they've suffered due to the merger agreement. (Digex is currently valued at $1.6 billion, down some 65% since the agreement was inked.)
You also always have the option of calling a company's investor relations department to ask if the company is controlled by another. In these cases, you must assume that where the parent company's interests are in direct conflict with that of its investee -- and, by extension, you -- the parent company's needs will most likely take precedence. This is not to say that their fiduciary obligation to you is limited; just that when push comes to shove, your position is at a disadvantage.
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