Upcoming Proxy Season

Vol 24/5

Fasten Your Seat Belts

The coming proxy season promises to be an interesting one.  Investors — both professionals as well as individuals — have become increasingly incensed over the loss of value to their portfolios, poor corporate management decisions, executive compensation and so on; the list is seemingly endless. This is leading to the desire for a greater voice in governing the companies in which they are invested.  What this means is that corporate leaders might have to put in for combat pay as they confront the upcoming proxy season.

It is anticipated that there will be a rise in shareholder activism along the lines of what restaurant chain Denny’s is currently facing.  A group of Denny’s largest shareholders recently criticized the restaurant chain’s top leaders, saying they plan to launch a proxy fight to add three of their own members to its board of directors.  The group, called the Committee to Enhance Denny’s, took CEO Nelson Marchioli to task, saying Denny’s management has “failed.”  They added, “We believe the board should have admitted years ago that Denny’s CEO, Nelson Marchioli, will not be able to turn around the Company.  We believe that his poor operating and capital allocation records speak for themselves.  To add insult to injury, the Denny’s board has generously rewarded management despite poor stock price and financial performance.”

Led by investment firms Oak Street Capital Management and Dash Acquisitions, the group owns about 6.5 percent of the company’s outstanding shares, making them one of Denny’s largest shareholders. “If the status quo is maintained, we are deeply concerned that the Company’s future will mirror its past,” the group wrote. “Shareholders cannot afford to allow the board and management to have more time to implement an effective strategy. We will not linger on the sidelines at this critical juncture.”  In a lengthy letter, the investors said they hope to add Patrick H. Arbor, Jonathan Dash and David Makula to the board during the company’s 2010 shareholder meeting. They said they hope their candidates would work to cut costs by $15 million, adjust management’s bonus system and work to reverse trends keeping diners away from the chain’s 1,500 locations.
Key issues expected to dominate this proxy season are:  executive compensation (a perennial favorite) and director nominations (the end of the corporate “buddy system” is at hand).  Not to be discounted are the issues likely to be raised by socially-responsible investors (everything from animal rights to carbon emissions, etc.).

The heightened levels of investor anger may be helped by the recent regulatory changes that may make it easier to force corporate change. For instance, corporate managers now need to contend with the Securities and Exchange Commission’s recently-enacted NYSE Rule 452. Previously, brokers were allowed to vote the shares they hold in custody for clients, and historically voted in favor of management’s proposals and board nominees. This reliable base of support diluted the votes of activists. However, the new regulations preclude broker voting, and, as a result, managements and directors will face greater challenges to their proposals and more support for shareholder proposals.

In preparation for the proxy season, corporate managers are advised to check their vulnerability to an attack by dissident shareholders:
 

  • Look in the mirror:  Take a good hard look at your company.  How does it measure up vis-à-vis its peers?  Check your growth rates, profitability and key ratios.  Also, does your company have “hidden assets” or strong cash balance?  These could attract the attention of activist groups.
  • Does “The Street” understand your company?  Companies that have complex stories are often misunderstood by investors.  Confusion can create a value gap, one that can be easily exploited by activists looking to realize value.  Check investors’ knowledge and understanding of your company by undertaking a perception study, which could uncover misperceptions that could be corrected through remedial activity. Your goal is to achieve a fair valuation, one commensurate with the company’s standing and prospects.
  • Peer activity:  Are mergers taking place within your industry?  If so, why?  Are these negotiated transactions or unfriendly deals? Note the deal prices and premiums. 
  • Defensive check:  Understand your company’s defensive measures and determine how vulnerable you are.  Your SEC counsel can be helpful in this matter.
  • Maintain a dialogue with investors:  If you sense your company is vulnerable, you should “bond” with your institutional shareholders and sell-side analysts (a good practice regardless).  Often, they will be in a position to hear rumors and whispers on “The Street” about emerging issues.
  • Run a fire drill:  Communications strategies for dealing with activists should be a part of your crisis program.  The team should be in place as well as various communications protocols and “standby statements.”  Meet frequently to review and update the program as well as to discuss the latest deal activity (you can use these situations in simulated war games).
  • Build a team:  Should an activist surface, you will need to assemble a team of advisors.  These might consist of an investment bank, a law firm experienced in takeover battles, a proxy solicitor, an outside IR firm, among others.  It might be wise to assess the field and visit with some of them well in advance of an occurrence.

The best defense is a good offense.  Maintaining an open dialogue with the investment community is perhaps one of the best ways of garnering support for management’s strategies while generating a reservoir of good will and enhancing management’s credibility.  Embracing this position will help reduce the threat of investor activism.