Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 199

Lessons from a famous shareholder activist battle

In today’s world of proxy advisers, divestment campaigns and ‘two-strikes’ voting, shareholder activism has become mainstream. That wasn’t always the case, and Jeff Gramm’s Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism provides a fascinating account of how this trend developed over the past century.

One of the most famous was Carl Icahn's pursuit of Phillips Petroleum, and even today it provides lessons for boards, management and shareholders.

During America's merger wave of the 1980s, 22,000 merger and acquisition (M&A) deals were brokered, but the small percentage of hostile acquisitions garnered the lion's share of attention. It was different to the previous waves because it was driven by the rise of Drexel Burnham and Michael Milken, who used the large, highly liquid niche market in junk bonds to fund hostile takeovers.

One such takeover was of oil company Phillips Petroleum (now a combination of ConocoPhillips and Phillips 66). In 1984 Phillips was trading in the mid-to-upper $30 range. After becoming the largest individual shareholder in Phillips Petroleum, corporate raider T. Boone Pickens launched a hostile tender offer to buy an additional 15% of the company at $60 per share. Phillips management counter-proposed with a complicated recapitalisation plan. It would pay Pickens $53 per share, entrench current management and commit Phillips to asset sales to fund a reduction in debt, increased dividends and an additional $1 billion in share repurchases.

The result? Management remained in place, Phillips’ share price fell 18% to the low $40s and Pickens walked away with $53 a share in cash and all expenses covered.

Enter Carl Icahn. His activism strategy centred on taking large positions in what he saw as undervalued businesses, seeking control then attempting to realise the valuation gap. One of his key motives for going after these companies was to highlight a lack of accountability at the board level.

Icahn knew that Pickens was an astute energy investor who was prepared to pay $60 per share. This, combined with an enraged minority shareholder base whose investment value had dropped to $45 per share, gave Icahn an opening, but he needed a lot of cash. Enter Milken, who raised $4 billion for Icahn and claimed he was 'highly confident' Drexel could raise more if needed.

Armed with the Drexel cash, on 4 February 1985, Icahn sent a letter to the Chairman and CEO of Phillips Petroleum, William C. Douce. Apart from announcing that he owned 5% of the company, making him one of the largest shareholders, he said the recapitalisation plan was 'grossly inadequate'. He said that if Phillips did not offer $55 each for the outstanding shares, he would use a leveraged buyout to buy Phillips for $55 a share: $27.50 in cash and $27.50 in subordinated notes. If Phillips were to reject the two options, Icahn would wage a proxy war to defeat the recapitalisation and make a hostile tender for the company.

Use of the poison pill

In an offensive / defensive two punch, Phillips promptly sued Icahn for violating proxy solicitation and anti-manipulation rules. At the same time, Phillips’ management sweetened the proposed recapitalisation to feature a new preferred stock dividend and a cash repurchase plan.

In a move that reverberates today, Phillips also introduced a 'rights plan' – one of the first versions of what we now know as a poison pill. If a buyer crossed the 30% ownership, other stockholders would convert each share into $62 worth of senior debt in Phillips paying 15% interest. The buyer would be left owning a dangerously over-leveraged company with $7 billion of short-term debt. As Gramm puts it: “…it served as a sharp repellent”.

Douce underestimated Icahn. The next day Icahn sent a letter announcing his intentions to initiate a tender offer for 25% of Phillips common stock. This, along with his 5% stake, would trigger the poison pill. On 13 February 1985 – less than three months after Pickens had put Phillips in play - Icahn commenced the tender for Phillips at $60 per share, contingent on shareholders voting down the recapitalisation plan. According to the New York Times, ‘Without using the word, Icahn said he would not accept greenmail, that is, would not sell his stock to the company unless the same offer was made to all shareholders.’ Shareholders believed Icahn and voted the plan down.

Less than a month later, Phillips announced it had lost the recapitalisation plan entirely. It settled with Icahn, eliminating the plan to put shares in the employee trust and covering Icahn for $25 million in expenses. Icahn walked away $50 million wealthier in just 10 weeks. He had avoided the poison pill by leaning on shareholders to accept his version of the truth.

How is the Phillips case relevant for investors today?

Pickens and Icahn realised that management’s actions were affecting Phillips’ market valuation, creating an anomaly that could be exploited. Pickens believed the anomaly was so large that he offered around a 55% premium for the stock. The same is true today. If the market doesn’t recognise the intrinsic value of a company, then a businessperson can - in the form of a corporate action like a takeover.

Although lawyers and company management can do their best to fend off what they may see as corporate raiders, poison pills and other protective measures may not be effective if the board doesn’t have the support of shareholders. If shareholders don’t feel that value is being maximised they won’t give the company their support.

Finally, corporate raiders like Icahn were helped by Milken but they were also assisted by a larger group of passive, institutional investors, who failed to act against management decisions that would leave shareholders worse off. With more money flowing into index and passive investment vehicles now, it means active, institutional managers need to monitor their investments in businesses more carefully. They should not simply outsource corporate governance issues to proxy advisers, but think about the calibre of the management team and board of directors steering the capital allocation decisions in the business. If there is a lack of accountability for bad decisions then institutional managers need to step up and question the board and management.

It is bad enough when active managers run portfolios that resemble the index. It is worse when they behave just as passively in matters of corporate governance.

 

Annabelle Symons is an Analyst at PM Capital. This article reflects the opinions of the author as at the time of writing and may change. PM Capital may now or in the future deal in any security mentioned. It is not investment advice.

1 Comments
Mike
April 29, 2017

Interesting read @AnnabelleSymons.

I look forward to your next post

 

Leave a Comment:


RELATED ARTICLES

Why investment stewardship matters for long-term investors

Review exposes the blunders of a broken structure

Why gender diversity matters for investors

banner

Most viewed in recent weeks

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 581 with weekend update

A recent industry event made me realise that a 30 year old investing trend could still have serious legs. Could it eventually pose a threat to two of Australia's biggest companies?

  • 10 October 2024

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Investment strategies

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Economy

US election implications for investors and Australia

The return of Donald Trump to the US presidency brings the prospect of more US tax cuts and deregulation, but also more tariff hikes, trade wars and policy uncertainty. Here's what it means for markets going forward.

Retirement

The rising tension between housing debt and retirement balances

Australians are taking more mortgage debt into their 60s than ever before. Retirement planning assumptions haven’t adapted and could result in future income projections that ultimately disappoint retirees.

Investment strategies

Why megatrends can deliver big upside (and downside)

The magnitude and duration of society's most important trends are often underestimated. While these trends are usually touted as a tailwind, one in particular could have dark consequences for many assets.

Property

Fixing the construction industry house of cards

Australia needs to build new homes like never before but construction firms keep going belly up. Unless regulators act now, consumers will continue to carry the can.

Investment strategies

How investor portfolios have become riskier versus history

Risk in portfolios has dramatically increased as time horizons have shortened and investors have piled into equities. It's resulted in a growing disconnect between what investors need and what the financial industry is delivering.

Shares

The abacus, big data and a brief history of indexing

Equity indices have evolved over time, led by step-changes in our ability to manipulate data. Despite the rise of passive investing, they weren't initially meant to be investment tools.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.