How Benjamin Graham Revolutionized Shareholder Activism
Today, Benjamin Graham is known primarily as Warren Buffett’s investing mentor and the author of multiple classics about value investing. Toward the end of his life, in the 1973 edition of “The Intelligent Investor,” Graham wrote, “Ever since 1934 we have argued in our writings for a more intelligent and energetic attitude by stockholders toward their managements”.
Even before the 1934 publication of his first book (co-written with David Dodd), Graham had shared his wisdom regarding the rights of shareholders through the financial press of that era. Graham’s 1932 series of articles for Forbes -- which featured headlines such as “Are Corporations Milking Their Owners?” and “Should Rich Corporations Return Stockholders’ Cash?” -- is probably his most notable contribution.
Like much of Graham’s investment wisdom, his writings regarding shareholder activism remain relevant in our time. They are especially pertinent, given recent high-profile disputes between activist shareholders and well-known public companies. Among other recent examples are the efforts of David Einhorn’s Greenlight Capital Inc. to force Apple Inc. (AAPL) to distribute more of its cash to shareholders, and Carl Icahn’s campaign to obtain more-favorable buyout terms for Dell Inc. (DELL) shareholders.
Apple and Dell are two of the most renowned U.S. brands of the early 21st century. Eighty-seven years ago, John D. Rockefeller’s Standard Oil Co. had a similar status, and Graham analyzed its associated companies as investment opportunities. Rockefeller remains the wealthiest American in recorded history (in inflation-adjusted terms), and he was also the highest-profile businessman of his time, widely known for both his philanthropy and, according to some, a penchant for aggressive business tactics.
Regarding the latter, under the Sherman Antitrust Act, the U.S. government curtailed what it viewed as Rockefeller’s monopolistic practices by splitting Standard Oil into 34 corporations in 1911. Among these independent entities was Northern Pipe Line Co., one of eight companies responsible for transporting crude oil to Standard’s refineries. In 1926, pipeline companies were required to file forms with the Interstate Commerce Commission. A young Ben Graham had reviewed Northern Pipe Line’s somewhat-cursory financial report, which provided barely a sketch of a balance sheet. Graham took a train to Washington and examined the company’s full-length filings in the commission’s record room. It would prove to be a fateful trip.
Graham discovered that, unbeknownst to its shareholders, Northern Pipe Line held $95 per share in railroad bonds and other liquid assets. Meanwhile, its stock was trading at only $65 per share. “Here was I, a stout Cortez-Balboa, discovering a new Pacific with my eagle eye,” Graham recalled decades later. “After all these years, I’m still amazed that no one in the brokerage business thought of looking at the ICC data.”
Indeed, Graham had single-handedly discovered extraordinary hidden riches tucked inside the shares of the former Standard Oil affiliate. So, throughout the remainder of 1926, his partnership purchased a large block of shares, amounting to a stake of about 5 percent.
However, Graham would soon discover that mere persuasion wouldn’t be enough to induce Northern Pipe Line’s management to loosen its hold on this excess treasure. In fact, management intended to thwart Graham’s request to distribute $90 of the company’s $95 per-share surplus of liquid assets, even though, as Graham argued, the company was generating annual revenue of $300,000 while carrying $3.6 million in railroad bonds that were unrelated to its normal course of business. So, distributing most of these assets to their rightful and legal owners -- Northern Pipe Line’s shareholders -- made eminent sense. Nonetheless, management wouldn’t budge, leaving Graham with no recourse but shareholder activism.
At Northern Pipe Line’s 1927 annual shareholder meeting, Graham took his argument directly to the shareholders. Management was able to foil this maneuver, citing the technicality that Graham had failed to bring someone to “second” his motion. Graham was undeterred, and by Northern Pipe Line’s 1928 conference, he had petitioned the support of so many other shareholders that he had proxies for almost 40 percent of the company’s shares. Although management tried to resist, it was compelled to accept Graham’s election to the board and, shortly thereafter, distributed $70 per-share of excess liquid assets to Northern Pipe Line shareholders. Graham’s partnership was the second-largest of these shareholders. The largest was none other than the Rockefeller Foundation, controlled by John D. Rockefeller.
Graham would soon learn that, not only did Rockefeller approve of his campaign, but its success had inspired the aging tycoon to adopt an activist stance himself. Citing the Northern Pipe Line example, Rockefeller, whom Graham met on three occasions, reached out to the other former Standard Oil affiliates with excess liquid assets on the books. The Rockefeller Foundation still held large positions in these companies and Rockefeller himself was eager to make immediate use of these shareholder distributions to expand his nonprofit organization. Reluctantly, these entities made the requested shareholder distributions.
This ripple effect throughout several Rockefeller-associated entities is one reason why Graham’s triumph, known as “The Northern Pipeline Affair,” helped cement his reputation as both an exceptional analyst and a highly effective activist. In 1932, he wrote, shareholders “have forgotten also that they are owners of a business and not merely owners of a quotation on the stock ticket.”
This was sage advice in 1932, and remains so today.
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