Take Your Best Shot, Punk

Corporate boards have devised elaborate new defenses against activist hedge funds

Hedge funds are usually savvy operators, but sometimes even they get outmaneuvered by a simple tactic. New York-based Pembridge Capital Management LLC wanted change at iconic trading-card outfit Topps Co. and was set to nominate three directors. Before its annual meeting on June 30, Topps appeared to meet one of Pembridge's key demands when it hired investment bank Lehman Brothers Inc. (LEH ) to explore a sale of its candy unit. So the board asked Pembridge to withdraw its nominees, which it did. Then, on Sept. 12, the company announced that it wasn't selling the candy business after all. Pembridge had fallen victim to one of the newest defenses thrown up by companies desperate to fight off tough demands or a takeover -- a ploy called the head fake. Topps did not return phone calls asking for comment.

After four years of rising shareholder activism, companies are striking back. Not only are they fighting a rearguard action to keep classic takeover defenses such as poison pills -- which companies use to dilute a raider's stake by issuing new shares to friendly shareholders -- but they're also devising ever-more-subtle maneuvers to beat back would-be acquirers. Tactics range from stalling dissidents by half-heartedly pursuing a deal to avoiding the election of new directors by not holding an annual meeting. An especially potent defense: Letting the company's largest creditor demand immediate payment in the event of a takeover. Says Chris Young, director and co-head of M&A research at Institutional Shareholder Services in Rockville, Md.: "If there's a particular threat, companies will resort to a takeover defense in the short-term."

Companies are doing exactly that because they face an exploding number of activist hedge funds. Financier Carl C. Icahn has banded together with hedge funds to agitate for change at Time Warner Inc. (TWX ) Hedge funds have won recent proxy contests at Blockbuster Inc. (BBI ) and fund-management firm BKF Capital Group Inc. (BKF ) And they've secured key concessions after threatening proxy fights at energy outfit Kerr-McGee Corp. (KMG )and health-care provider Beverly Enterprises. (BEV )

The onslaught from hedge funds is stimulating the creativity of companies trying to thwart what they decry as quick-buck artists. After investing nearly $200 million in Little Rock information-management company Acxiom Corp. (ACXM ) -- and watching its stock price drop -- San Francisco hedge fund ValueAct Capital LP approached the company in May about adding a director to its board. The next month, Acxiom's board unveiled an unusual policy: It barred investors with a significant holding in the company from serving on the board "due to the possibility of conflicts of interest." What's more, the rule didn't affect any existing directors.


ValueAct says the policy simply protects the status quo. "It becomes a takeover defense," complains managing partner Jeffrey W. Ubben. "My guess is that [Acxiom Chairman and Chief Executive Charles D. Morgan] has never been challenged by his board." Without dissenting voices, the board can easily turn down buyout offers, Ubben adds. In July the board rejected ValueAct's bid for the part of Acxiom it didn't already own for $23 a share, a 25% premium over the market value at the time. On Oct.24, ValueAct upped the offer to $25. Acxiom declined to comment.

Delaying Securities & Exchange Commission filings also can be an effective defense, even if unintended. In July, 2004, Chicago-based health-club chain Bally Total Fitness Corp. (BFT ) agreed to drop a tough poison pill to avert a proxy battle with Los Angeles hedge fund Liberation Investment Group LLC. Liberation, which owns 8% of Bally's shares, believed this cleared the way for a sale of the unprofitable company. A month later, though, Bally said it had discovered accounting glitches and would have to review several years of results. The company hasn't filed a financial report with the SEC since, allowing it to put off its annual meeting under SEC rules. Activists say such a move is sometimes intended to avoid elections that could change control of the board. Finally, on Oct. 6, Liberation won a lawsuit in Delaware, where state law mandates no more than 13 months between annual meetings, forcing Bally to hold its meeting on Jan. 26. A source familiar with the matter says the postponement of the annual meeting was "not in any way, shape, or form anything I would categorize as a takeover defense."

In addition to tardy SEC filings, confidentiality agreements shielded Bally from hostile takeovers. In May it put its Crunch Fitness division on the block. But to have a look at Crunch's books, prospective buyers had to sign an agreement not to make a hostile bid for the parent.

More suits are likely as new defenses are tested. A 1985 court case that pitted oil company Unocal Corp. (UCL ) against financier T. Boone Pickens set the precedent. The Delaware Supreme Court ruled that directors must show they had good reason to think a "threat to corporate policy and effectiveness existed." Moreover, they must show that the defense is "reasonable in light of the threat posed." Onerous defenses that simply entrench boards won't fly.

The new devices to fend off unwanted suitors are popping up at the same time that companies are only slowly dismantling their traditional defenses, despite post-Enron efforts to curb them. Since 2002 the number of Standard & Poor's 500-stock index companies with a staggered board -- which prevents shareholders from replacing a majority of directors in one election -- has fallen only 13%, to 266, according to researcher FactSet TrueCourse Inc. (FDS ) In the same period the number of S&P companies with a poison pill has dropped just 14%, to 260.

Companies say they need these defenses for a simple reason: While activist hedge funds sometimes portray themselves as shareholders' guardian angels, companies argue that they're anything but. Selling a company may let a hedge fund book healthy returns in one year, companies say, but those gains may come at the expense of a much larger payoff for shareholders over the long term. "This has raised the question of whether such short-term investors should be entitled to shareholder rights in outright conflict with long-term investors," SEC Commissioner Roel C. Campos told a recent hedge-fund conference.

Of course, not all hedge funds are short-term investors. ValueAct Capital, for example, invests for three to five years. Moreover, securities laws don't ascribe different rights to shareholders based on length of ownership. "The whole idea that you need to get tenured as a shareholder is preposterous," says Robert L. Chapman Jr., a principal at El Segundo (Calif.), hedge fund Chapman Capital Management LLC.

The new techniques don't always succeed. Burton Capital Management LLC, a Greenwich (Conn.) hedge fund, wanted to appoint new directors and management at Englewood (Colo.) printing company Cenveo Inc. (CVO ) after its stock price had fallen 53% in five years. But Cenveo's board would have none of it. On Apr. 17 directors voted to let the company's largest creditor demand immediate payment of $763 million in debt if shareholders appointed new directors without the board's approval. The message to Burton: Replace us, and you'll inherit a ruined company. But Burton continued to pursue a proxy fight. It finally reached a settlement with Cenveo on Sept. 9 and got the directors to approve its eight nominees to the board. Cenveo officials didn't return phone calls.

The new corporate arsenal may have the unintended consequence of emboldening activists who enjoy a good fight. Chapman, one of the most feared activist hedge-fund managers, recently returned from a sabbatical and is preparing to relaunch his fund next year with up to $500 million. "We're putting together a war machine," he says. "By the time we get over a few billion dollars under management, no company will be safe."

By Justin Hibbard in San Mateo, Calif.

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