Time Warner Feels The Force Of Shareholder Power

How a wary SEC--and mad-as-hell investors--shot down a `coercive' financing plan

This is to advise you that the Board of Directors of Time Warner Inc. has reviewed its plan to build common equity through its previously announced rights offering in light of comments and objections received from certain stockholders and the Securities & Exchange Commission . . . and has approved certain revisions to the original rights offering proposal.

--July 12 letter to shareholders

With those leaden words, the world's biggest communications company closed an extraordinary chapter in its history. In just over five weeks, Time Warner was forced by a shareholders' revolt and regulatory pressure to turn tail: On July 14, the humbled company replaced its highly unorthodox plan to issue 34.5 million new shares--priced at $63 to $105 depending on how many stockholders participated--with an underwritten, $80-a-share deal. "This could be a seminal event in the shareholder movement," says David F. Eisner, senior vice-president of Providence Capital Inc., an adviser to two angry institutions.

It's hard to think of another recent episode that incited more vehement shareholder opposition--unless it's Time Inc.'s 1989 decision to reject a $200-a-share bid from Paramount Communications and purchase Warner Communications instead. Still smarting over that, Time Warner shareholders of all stripes--money managers, pension funds, mutual funds, banks, trustees, and individuals--sprang into action, setting off an avalanche of protest.

SLEW OF SUITS. They complained to the company, the SEC, and the press. They asked their investment managers to object. They sued in 14 separate actions. Nineteen members of the Council of Institutional Investors (CII) wrote to Time Warner's investment banks, asking the likes of Merrill Lynch Chairman William A. Schreyer and Salomon Brothers Chairman John H. Gutfreund to explain their participation in the deal. Says CII Executive Director Sarah Teslik: "This is a watershed event, not only because it was effective but also because more than the usual suspects participated."

Ultimately, SEC opposition to the pricing mechanism was the deal-killer. Says SEC Chairman Richard Breeden: "Fundamentally, the structure did not comply with the Securities Act of 1933." Still, there's no question that shareholders made a difference.

Such universal opposition was hardly what Time Warner expected on June 6, when Co-Chief Executive Steven J. Ross announced the rights offering. Immediately, some shareholders voted with their feet: Time Warner stock dropped almost five points in 24 hours.

But not Cliff Hinkle, for one. The executive director of the Florida State Board of Administration, along with two public pension-fund managers in Louisiana, sued to halt the deal. "The structure meant you had to make an investment decision without knowing what price you'd pay," he says. "We didn't want that precedent to be set."

Not Dale M. Hanson, for another. The CEO of the California Public Employees' Retirement System had been stewing because he hadn't fought Time when it spurned Paramount, a move that cost CalPERS more than $55 million. In mid-June, CalPERS hired Providence Capital to "see what could be done."

And not plenty of major money managers, who blasted the deal publicly and to Time Warner. "No one had ever dreamed up a coercive equity financing before," says Capital Guardian Trust Chairman Robert G. Kirby. "We told them we didn't like it." That's what Providence Capital heard when it canvassed holders of more than 40% of Time Warner's stock. Only one, INB Financial Corp., the fiduciary for more than 1 million shares, joined CalPERS as a client of the investment bank. But most seemed to favor Providence Capital's plan to ask Time Warner to switch to a fixed-price deal.

FAT FEES. Even so, for a while, Ross, Co-CEO Nicholas J. Nicholas Jr., and other Time Warner executives persisted in believing that shareholders opposed the plan because they didn't understand it. Indeed, the deal was extremely complex. But explication didn't help. When Providence Capital, with CalPERS' O. K., made a presentation to CII's executive committee on June 27, members "got more upset as they understood it more," says one attendee. They saw the plan's sliding scale, designed by Merrill Lynch, as coercive, and they hated the fat fees bankers would get--up to $145 million.

As a result, CII decided to pressure Wall Street with letters to the bankers. Says one letter from the AFL-CIO to Merrill's Schreyer: "Your role in promoting a `blind' rights offering of this nature is troubling because many of the hundreds of Taft-Hartley pension funds we represent rely on your fiduciary judgment to invest the retirement savings of millions of our members and retirees."

By early July, complaints were pouring in to the SEC--including a six-page missive from Providence Capital that questioned the legality of the pricing scale and the adequacy of disclosure. But the SEC needed little prompting: Its staff had raised problems with the pricing mechanism in June. Although the agency had approved a few similar deals, the SEC thought Time Warner's issue violated the 1933 Securities Act because its price range was so broad, which effectively kept investors from knowing the price at which they were committing to buy. Just as bad, investors were penalized if too many subscribed. "This method was coercive," says a senior SEC official.

The SEC had another problem, too--the same one that troubled many institutions: If Time Warner got the go-ahead, who else would follow? With troubled banks and insurance companies looking everywhere for new capital--not to mention other cash-hungry companies--would this deal become the financial vehicle of the `90s?

Still, Time Warner wasn't giving up. In a meeting with staff from the SEC's legal, market-regulation, and corporation-finance units, its attorneys tried every imaginable argument. They enlisted support from Louis Loss, a Harvard University professor emeritus considered the dean of securities lawyers. Then, after a long conference call with Linda C. Quinn, the corporation-finance division's director, in which she outlined her objections, Time Warner's legal entourage--including in-house counsel, outside counsel, and attorneys for each of the eight investment banks in the deal--decided to descend on the SEC in Washington. On July 9, they met with Breeden, Quinn, and others. Breeden objected, too--but said he wouldn't make his final decision until the next day.

When Breeden called on July 10, the news was bad: He wouldn't budge. "The plan was an unprecedented structure, and it failed to provide the fundamental information necessary for shareholders to make an informed decision," Breeden says. Still, he made it clear that Time Warner was welcome to bring the matter before the full commission.

All along, investor sentiment was converging: If Time Warner needs the money--and it does if it's going to make a $4.3 billion payment due by March, 1993--it should switch to a smaller, fixed-price transaction. It was at this point, say sources close to the company, that the shareholder dissent was pivotal. Rather than try to win the debate with the SEC, further delaying its strategic plans, Time Warner chose to capitulate.

On Monday, July 8, Time Warner asked Salomon to design an underwritten, fixed-price deal. A Salomon team did, presenting its plan to raise $2.8 billion to Ross at his Manhattan apartment on Wednesday night. When Gutfreund said Salomon would underwrite up to half of the deal at $80 a share--and asked for a day to seek the rest--Ross shook hands. The board signed off on Friday; the SEC followed on Monday.

NEW CONVERTS. Both Time Warner executives and stockholders are bruised. But many shareholders believe they have proven a point: When they act cohesively, they can influence management even outside the proxy season. In fact, the experience may have made some new converts to activism, particularly among private institutions. Some say they will reward six-month-old Providence Capital by giving the broker-dealer trading business. Says Providence President Herbert A. Denton: "That's a tacit admission that they like what we are all about."

Shareholders wish Time Warner was converted, too. Says INB Senior Vice-President P. Roger Kumler: "We hope this is the first step of management recognizing that the company has to be run with an eye to shareholder value."


Did Time Warner's capital-raising plans split its top management?

BUSINESS WEEK has learned that Co-CEO Nick Nicholas opposed the original rights issue and favored an offering akin to the current plan. Co-CEO Steve Ross, however, strongly argued for the sliding-scale deal. When the plan went before the board, Nicholas backed it. After what director Henry Luce III calls "surprisingly little discussion," it was approved unanimously. Nicholas has kept a low profile since the deal was announced.

But he may not gain for having been right. Insiders see Nicholas as too numbers-oriented and believe Vice-Chairman Gerald M. Levin is now a Ross ally and a rival to Nicholas. Time Warner is mum.