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| Best Practices: On The Board |
Wolves at the Gates
Michelle Leder
12/01/2006
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The letter that Florida money
manager Bruce Sherman sent to newspaper giant Knight Ridder’s board of directors
in November 2005 was short and to the point. It stated that Private Capital
Management, the company that Sherman runs, was now the largest owner of Knight
Ridder stock. And, as the largest shareholder, it wanted the company’s directors
to "aggressively pursue the competitive sale of the company."
The letter was a follow-up to a Knight Ridder board meeting
that Sherman attended in July 2005 at the invitation of chairman Tony Ridder. As
Sherman noted in his one-page follow-up letter, he believed that the board had
not taken his suggestions seriously enough. Although the company was financially
healthy and consistently profitable, Knight Ridder’s stock was declining in
value.
TOP VIEW
There are about 90 activist hedge fund managers—with $100 billion
in capital—prowling for underperforming or otherwise vulnerable companies on
which to pounce. These firms buy a significant equity stake, hoping to force
their targets to restructure their boards and management, and, often, put
themselves on the auction block. While many genuinely seek to boost shareholder
value (including their own) over the long term, some are in it for a quick-flip
profit. Boards need to be aware of this threat, and formulate responses—the most
effective of which is to outperform the market. |
Six months later, Knight Ridder, a company that could trace its
roots as far back as 1892, would be gone—the bulk of its assets sold to
McClatchy, a smaller, 149-year-old newspaper company in Sacramento. McClatchy,
in turn, resold some of Knight Ridder’s most prized assets, including the
Philadelphia Inquirer and the San Jose
Mercury News.
The threat of attack from activist hedge funds—a new breed of
managers who believe they can spot untapped value in a company and use
in-your-face, highly public tactics to unlock it—is growing. According to
Taylor Cos., a hedge fund advisory firm in Greenwich, Conn., started by the late
Thomas Taylor, who used to manage money for the Bass brothers in Texas, there
are now about 90 activist hedge funds, more than double the number in existence
three years ago. Their assets under management have climbed sharply, to around
$100 billion, a four-fold increase from 2002, according to the online
information portal Lipper HedgeWorld.
These funds are instigating buyouts and, in many cases,
overhauling the composition of boards. In the first nine months of this year,
according to research from the corporate governance consulting firm
Institutional Shareholder Services, activist hedge funds were successful at
gaining board seats at 70 percent of the 50 largest companies they targeted. The
activist strategy has even spread to Europe, where several new funds have
embraced this decidedly American model. Earlier this year, in a remark echoed by
many European corporate executives, Dutch economic minister Joop Wijn described
such firms as locusts.
Over the past year, the powerhouse corporate law firm Wachtell,
Lipton, Rosen & Katz has issued increasingly dire warnings to its corporate
clients about the dangers posed by these activist hedge funds. Founding partner
Martin Lipton said earlier this year that they were the absolute top issue for
directors. One memo, which the law firm sent in late June, cautioned that: "In
this era of hedge fund activism, the future of hedge fund regulation may impact
the balance of power between public companies and activist shareholders. At this
time, public companies can only hope that some form of hedge fund regulation
persists."
While their ability to demand change remains largely unchecked,
the fund managers themselves argue that they are the good guys, merely trying to
maximize the shareholder value of corporate laggards. They look for overpaid
managers or entrenched directors with little of their own money invested in the
company. A high number of related-party transactions, in which top executives
and board members have multiple business relationships with the company, are
another red flag for these managers. "We don’t really troll using orthodox
nets," says J. Carlo Cannell, whose Cannell Capital fund has targeted about a
dozen companies over the past year. "We’re basically looking for bloated
companies, and that’s a nonintuitive method."
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