In early December the big Boston-based hedge fund Highfields Capital Management disclosed that it had bought 8 percent of Stilwell Financial, parent of struggling mutual fund company Janus Capital Management. Highfields, which manages about $2 billion of Harvard University's $17.5 billion endowment, said it wanted a few changes made.
In its 13(D) filing, the $5.2 billion fund stipulated that it might recommend that Stilwell sell one or more of its businesses, elect new directors, consider a merger or sale and drop takeover defenses. Led by former Harvard Management Co. trading star Jonathon Jacobson and hedge fund veteran Richard Grubman, Highfields has a reputation for shaking up companies it deems undervalued.
Stilwell had already announced a major reorganization that called for combining its operations into one company that would market and distribute investment products under the battered but still familiar Janus Capital Management name. Mark Whiston, president of retail and institutional services, is to become the new CEO. And to cut its debt, Stilwell is trying to sell its 33 percent stake in DST Systems, a provider of investment management services.
These measures, however, weren't drastic enough for Highfields. On December 2 the hedge fund retained the investment bank Blackstone Group to develop a more radical plan. Under consideration: one or more acquisitions or divestitures, or a more sweeping reorganization.
"We're open to hearing about their concerns," says a spokeswoman for Stilwell. As of mid-December no meeting had been scheduled between Highfields and the company. Yet in a regulatory filing on December 6, Stilwell indicated that it was in fact contemplating a number of divestiture alternatives for DST (including selling the stake back to the company) and that the new management team would be reviewing all aspects of Stilwell's business, "including future equity grants, bonuses and existing employment agreements."
No-nonsense, seize-the-board, put-the-company-in-play, do-whatever-it-takes-to-increase-the-stock-price corporate activism is coming back into style -- and hedge funds are at the cutting-and-slashing edge. Of course, a few hedge fund managers have been getting on CEOs' cases for years. But never before have so many funds had so much capital to back up their kvetching -- or so many disgruntled shareholders to cheer them on from the sidelines or join in the fray.
"Hedge funds have always been willing to state their opinions and get managers to make changes and go as far as to threaten action," says Walter Denby, senior vice president at proxy solicitor D.F. King & Co. "Now we're seeing an increase in their willingness to carry through with the threats, either by communicating with other shareholders or through proxy fights."
They are becoming the ultra-assertive inside agitators of shareholder activism -- getting in the faces of top corporate executives; filing 13(D)s after gaining control of 5 percent or more of a company's stock and boldly stating their bill of grievances; aggressively badgering companies to rescind takeover defenses, like poison pills and staggered boards; pushing top managers to seek outside buyers, recapitalize their companies or repurchase shares; and often running for company boards themselves to champion reform from within.
Fund managers "need to rekindle shareholder activism,"declares Mario Gabelli, whose firm, Gabelli Asset Management, runs about $22 billion, including $1 billion in hedge funds. The money manager is currently embroiled in a dispute with BKF Capital Group, the holding company for investment firm John A. Levin & Co. Last spring Gabelli sponsored a nonbinding resolution calling on BKF to dispose of its poison pill. Even though the measure passed, BKF has adamantly refused to dismantle this takeover defense. In mid-December Gabelli was threatening to turn up the heat. "We will become more active," he says. "Especially with removing the poison pill -- I have to talk to my lawyers and figure this out."
Activism by hedge funds can act as a prod to institutional investors to bring their weight of money to bear. "There is a mystique created when the hedge fund investor speaks up," says Bruce Goldfarb, a senior managing director at proxy solicitor Georgeson Shareholder Communications. "They get the ball rolling." The list of activist hedge funds is long and growing: Highfields Capital; New York City private partnership Steel Partners II; Dallas-based Newcastle Partners, which has done several proxy battles alongside Steel Partners II; Naperville, Illinoisbased Financial Edge Fund and Parsippany, New Jerseybased Seidman & Associates, which both specialize in thrifts; New York City's Ramius Capital Group, whose general partners include former senior Wall Street bankers; P. Schoenfeld Asset Management, also in New York City; and San Franciscobased ValueAct Capital Partners, which runs about $650 million spread over only a dozen investments at any time. What corporate raiders were to the 1980s, hedge fund managers may be to this decade.
Hedge funds are perfectly suited for the rough-and-tumble work of corporate activism. Free to buy and sell whichever stocks they please, they can pick their battles, concentrating on small- and midcap companies in lagging industries that snap to attention when a fund buys a big chunk of their stock. And whereas many managers of mutual funds, which are often part of large corporations themselves, shy away from ruffling feathers at companies for fear of being cut off from the information flow or, worse, losing out on a prospective pension mandate, hedge fund managers, who tend to hold stocks for only a short time, can be as brazen as, well, journalists. Former Enron Corp. CEO Jeffrey Skilling, after enduring a round of blunt questions during a conference call when the company was riding high, called Highfields' Grubman an "asshole."
Activism can be an endurance test. In late 2000 P. Schoenfeld founder Peter Schoenfeld made what he thought would be a straightforward arbitrage investment in Willamette Industries after it received a $48 per share offer from fellow forest products producer Weyerhaeuser Co. Willamette, however, rejected the offer. Instead of selling his shares right away, Schoenfeld went behind the scenes to try to persuade the board to entertain the offer. Although the hedge fund manager concedes now that Weyerhaeuser's offer was not "full price," his hope was that Willamette would throw open the bidding.
Instead, the company dug in its heels. Weyerhaeuser decided to go hostile. At Willamette's June 2001 annual meeting, Schoenfeld voted successfully to replace several of the company's directors with Weyerhaeuser nominees. But Willamette had a staggered board, so that only about one third of the members came up for reelection in any year.
As the standoff wore on, Schoenfeld became convinced that Willamette's management was determined not to sell to its archrival. Although Weyerhaeuser upped its offer to $50 a share, Willamette responded by negotiating to buy Georgia-Pacific Corp.'s building products division for an undisclosed price as an antitakeover ploy; the acquisition would make Willamette harder for Weyerhaeuser to swallow whole.
The gambit made Schoenfeld and many other investors edgy, because the division was understood to harbor a potential asbestos liability. "It was a scorched-earth tactic," Schoenfeld insists now. He fired off letters to Willamette's board and called CEO Duane McDougall and CFO Greg Hawley. "The first time I spoke with the CFO in June 2001," says Schoenfeld, "I told him, 'We're dead serious.' He said, 'I know.'"
Nevertheless, Willamette stood firm. In December 2001 Weyerhaeuser raised its offer to $55 a share, only to have it rejected. Schoenfeld sent a public letter to Willamette chairman William Swindells Jr., threatening to nominate three candidates to the ten-person board at the next shareholder meeting. "We continue to believe that a majority of your shareholders will not tolerate your intransigence," Schoenfeld wrote.
Schoenfeld's forthright action helped to galvanize other investors. The California Public Employees' Retirement System sent its own letter calling for the company's board to abandon discussions with Georgia-Pacific. "Willamette's board is running away from a merger with Weyerhaeuser that is in the best interests of shareowners," Mark Anson, CalPERS's CIO, asserted in the letter. "Their ill-considered move to purchase Georgia-Pacific Building Products pales in comparison to Weyerhaeuser's bid, which creates long-term value."
Then, in early January, veteran risk arbitrageur Guy Wyser-Pratte sued Willamette, CEO McDougall and several board members. He charged that the company's directors had breached their fiduciary duty to shareholders by rejecting Weyerhaeuser's bid without "informed consideration"of the proposals and without engaging in good faith negotiations. He also sought to block Willamette from completing its defensive deal with Georgia-Pacific. Other lawsuits soon followed.
Schoenfeld insists that he did not orchestrate the attack on Willamette. In any case, combining forces seemed to work. On January 28, 2002, the two forest products giants agreed to a $6.1 billion merger, at $55.50 a share for Willamette. "If there were no activists, the board might have felt less pressure," says Lise Shonfield, an analyst with J.P. Morgan Chase & Co.
Hedge fund managers often aim for a more collegial but firmly hands-on approach to promoting reform. Jeffrey Ubben, who launched San Franciscobased ValueAct Capital with two partners in 2000, typically scoops up 5 to 15 percent of the shares of a company that he believes has a strong basic business but needs better management. Many of Ubben's candidates are "roll-ups" -- companies that have made several acquisitions within their industry.
But he steers clear of basket cases. "I have no interest in buying 10 percent of a crappy business and saying, 'Sell it!'" he says. "Half of the time they sell it, and half of the time you get stuck [holding the stock]. It's dangerous. You can be active for activism's sake, but it must be a value situation that is proven. You are only as good as the businesses you buy."
Once Ubben buys into a company, he tries to work closely with management, often winding up on the board. Several times he has called in a consulting company -- Portsmouth, New Hampshirebased Synergetics Installations Worldwide -- to assess the problems and help devise and implement new procedures. "They help the businesses stabilize their processes, identify the bottlenecks and make changes," Ubben explains.
Last fall Synergetics completed an assignment for Ubben at Per-Se Technologies, which processes insurance claims for doctors. The hedge fund manager owned 4.2 million shares, or about 14 percent, of the Atlanta-based company, whose stock had tumbled from $55 a share in the late 1990s (when it was called Medaphis) to $2. The chief reason: Per-Se had embarked on an ambitious expansion drive that led it to snap up lots of inefficient mom-and-pop processing centers. The company lost nearly $65 million on continuing operations in 1999 and a further $22 million in 2000.
Synergetics spent the first ten weeks of its ten-month project turning a Per-Se office into a hyperefficient prototype that could be replicated by the company's other offices. The consultants also dramatically improved Per-Se's physician retention rate by providing better service. "We are implementers, not recommenders," says Synergetics president and COO James O'Neill.
Per-Se moved into the black in late 2001, and by last year's third quarter reported $6.9 million in operating profits. As of mid-December, the stock had rebounded to $9, giving ValueAct a paper profit of $16.8 million.
Hedge funds that gang up on companies have found strength in numbers. Steel Partners II, run by former risk arbitrage analyst Warren Lichtenstein, has doggedly pursued its activist agenda, often in partnership with Mark Schwarz, sole general partner of Newcastle. In 1999 the pair waged a successful proxy fight to force defense contractor Aydin Corp. to sell out to rival L-3 Communications Corp. for $70.5 million. Lichtenstein and Schwarz mounted another proxy campaign in February 2002, this time to take over the board of industrial power-equipment maker SL Industries and force a sale. And in 2002 Steel Partners II and MM Cos., an investment vehicle of private investor Seymour Holtzman, installed representatives on the board of entertainment company Liquid Audio and thereby blocked its sale to Alliance Entertainment. The company now plans to liquidate -- a better deal for investors.
Richard Lashley and John Palmer of Financial Edge and Lawrence Seidman of Seidman & Associates worked separately but follow a similar modus operandi: maneuvering their way onto boards of thrifts and not-so-gently nudging the institutions into the arms of acquirers. In this often lucrative endeavor, their firms usually have unofficial allies in hedge funds and institutional investors that simultaneously invest in the same thrifts. Lashley reports that as a result of this massing of share power, he only needs to buy 2 or 3 percent of a thrift's stock to launch a proxy contest. "This is a unique industry," he says. "Everyone owns these stocks."
Lawrence Seidman divulged, in a recent regulatory filing, that since 1995 he has launched proxy contests involving seven thrifts or banks, and that all but one later sold at significant premiums to their book values and earnings. He reckons that in his career as a hedge fund manager he has been involved in proxy contests at 12 banks or thrifts that wound up being sold.
"I've lost more than one contest," says Seidman. "But I never go away." CEOs, take note.
Personal glimpses: Highfields Capital
Like political activism, corporate activism suffers its share of setbacks. Just ask one of the biggest -- and most aggressive -- activist hedge funds: Highfields Capital Management, No. 13 in Institutional Investor's ranking of the 100 biggest hedge funds (II, June 2002). The Boston-based fund, which is at the moment applying pressure to the parent company of Janus mutual funds (story) -- and boasts a string of successful interventions -- took on Reader's Digest Association last year and came away bloodied.
In March 2002 Highfields upped its long-held stake in troubled Reader's Digest to 3.5 percent of class-B voting shares and 9.6 percent of class-A nonvoting shares. (The publishing company designed its dual-share system to preserve control by the founding Wallace family's foundations.) Highfields offered to swap the nonvoting stock plus $3 per share for all of the voting stock held by the Lila Wallace-Reader's Digest Fund and the DeWitt Wallace-Reader's Digest Fund, the largest shareholders. At the time, the A and B shares were both trading at about $21.
Highfields' goal, according to a Securities and Exchange Commission filing: to get rid of the company's arrangement of voting and nonvoting shares by combining them into one class and getting the company to focus on existing businesses that should be grown, run for cash or sold. The hedge fund's interest, the filing declared, was "only in accelerating the turnaround of the issuer."
The Wallace Funds rejected the offer even after Highfields lifted its offer premium per share from $3 to $5. Reader's Digest had its own plan. Responding in part to Highfields' pressure, the publisher proposed a recapitalization: The two classes of stock would be merged into one, reducing the Wallace-Reader's Digest funds' voting power from 50 percent of outstanding shares to 14 percent.
The funds would also sell 3.6 million of their 6.2 million B voting shares to Reader's Digest Association for $27.50 a share in cash -- a 24 percent premium to the market price. The remaining holders of voting stock, including Highfields, would also be offered a 24 percent premium, but in stock. Highfields' activism appeared to be paying off.
However, sideshows were taking place that would soon complicate matters, particularly considering that the publisher's business was suffering from the recession, the aftermath of the 9/11 terrorist attacks and the anthrax scare (which hampered direct-mail activities). In March 2002, one month before Reader's Digest proposed the recapitalization, it agreed to pay $760 million, cash, for Reiman Publications, a Greendale, Wisconsin, publisher of cooking, gardening, country lifestyle and nostalgia magazines and books.
Reader's Digest planned to borrow $950 million for the acquisition and for the $100 million payment to the Wallace funds for their voting shares. Highfields objected strenuously to the payment to the funds. In a press release, the hedge fund called the 24 percent premium out-and-out greenmail. "For the company to pay, and the funds to accept, this payoff squanders any hope for change and seriously endangers the future of Reader's Digest," Highfields railed. "It is clear that there is a long way to go before there is a level playing field between the owners of corporations and boards of directors who desire to entrench themselves by interfering with shareholder franchise."
People familiar with Highfields (the firm declined to comment) say it was also unhappy that Reader's Digest decided to borrow money and use the funds to buy Reiman rather than to repurchase shares. "Highfields wanted one class of stock, but not the acquisition cost," observed one institutional manager who got out of the stock earlier in the year. "They wanted the company to repurchase stock," he said at the time. "Unless someone white-knights the company, management screwed it up."
Stockholders were expected to approve the selective share buyback and the Reiman purchase at a special shareholders' meeting scheduled for August 14. But it had to be postponed indefinitely when the Delaware Supreme Court reversed the Delaware Chancery Court's denial of an injunction filed by disgruntled shareholders to block the impending recapitalization. The high court instructed the lower one to enjoin the recapitalization pending a trial on its merits.
Then on October 16 Reader's Digest trotted out a new recapitalization plan. The Wallace funds' voting power would be reduced from 50 percent to 13 percent, while the holders of the nonvoting stock -- those outside the funds -- would wind up with 74 percent of the voting power. The company also bought 4.6 million B shares from the funds for $100 million, or $21.75 per share, to prevent the deal from being dilutive. The A stock would wind up with 79 percent of the voting power.
The B shares jumped from the $16.60 they'd sunk to on October 9 to $20 on the news.The recapitalization was approved in mid-December, with the A shares trading at roughly $16 and the B shares at $19.52. This was still far below the more than $28 per share that Highfields had paid in aggregate for all of its A and B shares, which were trading for roughly the same price when it began buying them.
What does Highfields plan to do with its shares now? Like rapt readers waiting for the next issue of Reader's Digest to arrive in the mail, investors can only have patience until the hedge fund's next SEC filing. -- S.T.