America's boardrooms are heating up as proxy fights increasingly erupt at some of the market's leading companies. Targets currently in turmoil include Motorola (NYSE:MOT), Applebee's (NASDAQ:APPB), and WCI Communities (NYSE:WCI). Are proxy fights a good thing for investors, or mostly a benefit for hedge funds or wealthy agitators like Carl Icahn? Let's take a look.
Ready to rumble
As a shareholder of a public company, you have the right to vote on key matters: electing directors, choosing a new auditor, or even selling the company. Federal law requires that a company send you a proxy statement -- usually stuffed with complex, intimidating information -- before an annual or special meeting.
Shareholders can use their proxy votes to influence a company, and perhaps even take control. The frequency of such proxy fights has increased over the past four years:
|
Year |
Proxy fights |
|---|---|
|
2003 |
76 |
|
2004 |
42 |
|
2005 |
55 |
|
2006 |
98 |
|
2007 (as of April 19) |
70 |
If one company wants to buy another, and the target resists, a proxy fight is one way to break the deadlock. To elude defenses such as poison pills or golden parachutes, the suitor -- provided it owns a sufficient number of shares in the company it wishes to buy -- will call for a special meeting, then propose its own slate of directors for election. If the suitor wins a required number of seats, the target company can then unwind the defenses and vote for the buyout. That's exactly what Oracle (NASDAQ:ORCL) did in its hostile takeover of PeopleSoft.
Over the past few years, hedge funds have also begun to use the proxy system more often. Hedge funds are loosely regulated investment vehicles that tend to take minority equity stakes in a company, usually holding those shares for a year or less. With $1.5 trillion and counting in assets, it's no surprise that the hedge fund industry has started about 44% of the 70 proxy fights thus far in 2007.
Hedge funds have a fairly standard approach to proxy fights. First, they buy a stake in the target -- usually 5% or more of its outstanding shares. This requires the fund to file a Schedule 13D with the Securities and Exchange Commission (SEC), putting the target on notice. It also signals a variety of other hedge funds to buy up shares, helping to provide a stronger base of support for a shareholder vote.
The activist hedge fund often writes dour letters to the target's management team and board, emphasizing how the company has underperformed and needs to take quick action. In some cases, this analysis can actually be in-depth and informative, as was Richard Breeden's letter to the board of Applebee's.
Next, the hedge fund may purchase more shares, request a shareholder ledger, and ultimately submit a slate of its own directors.
It's a grueling process for the target company, prompting some to agree to settlements with the pursuing hedge funds. Carl Icahn agreed to withdraw his slate of proposed directors for Temple-Inland (NYSE:TIN) once the company promised to spin off its financial services and real estate divisions. Since the start of the proxy fight, Temple-Inland's stock has climbed 18%. In other cases, the target company may sell itself to a private equity firm, or even a competitor, as Triad Hospitals did.
For activist hedge funds, a proxy fight can be expensive and time-consuming as well -- but that could soon change. "It seems that proxy fights will increase because of proposed changes in regulations," said Lyle G. Ganske, a partner at Jones Day and co-chair of its global M&A practice, in a recent Fool interview with me. "The SEC is moving toward electronic distribution of proxy materials as well as giving access of the proxy to activists."
Do proxy fights benefit individual investors?
I analyzed a database from FactSet Research Systems to study proxy fights from 2006, excluding several penny stocks. The return for companies embroiled in such battles averaged only about 7%, while the S&P 500 returned almost 14%.
Proxy fights did produce a few big winners; Reliant Energy (NYSE:RRI) shares increased 123% after Seneca Capital launched its proxy fight. But the conflicts also spotlighted several disasters, such as defunct subprime operator New Century, whose stock price plunged roughly 98% in the wake of the recent mortgage mess.
It's smart to understand how proxy fights work, but don't assume they're a good system for investing. Proxy battles often target struggling companies with volatile stocks. Rather than investing on this or any other single factor, Fools are best served by studying a stock's fundamentals instead.
Further fightin' Foolishness:
Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is currently ranked 1,784 out of 28,166 in CAPS. The Fool has a disclosure policy.
