Activism Might Have an Antitrust Problem
Of all the fringe conspiracy theories in the financial world, my favorite is the theory that it is or should be illegal for investors to own shares in multiple companies in the same industry. It is lovely, first of all, because it is so dramatically kooky: It would irreparably render illegal the most basic architecture of modern finance, like diversified mutual funds and, especially, index funds. The whole modern push toward low-cost diversified investing would be gone; in a flash, we'd be back to the dark ages of expensive and risky stock-picking.
But it also has a sneaky appeal. There is something a bit weird about so many public companies, which are theoretically locked in the bitter struggle of capitalist competition against each other, all being owned by the same half-dozen mutual fund complexes. It is not entirely crazy to look at those complexes and see the old-timey "trusts," dressed up in modern financial theory. If BlackRock and Vanguard and Fidelity own shares in every big company in an industry, why should they want those companies to compete hard against each other? And if the shareholders don't want it, why should the managers compete? If you worry that U.S. companies are increasingly being managed on the behalf of a unitary shareholder class, at the expense of workers and consumers, well, you are not alone. The U.S. Department of Justice might even be with you.
The Justice Department's antitrust lawsuit today against ValueAct Capital isn't exactly an endorsement of that fringe theory. But it is something. It moves that theory a bit closer to the mainstream, and provides a lot of ammunition to those who worry that cross-ownership and shareholder-focused capitalism could be bad for competition.
The background here is that there is a law, the Hart-Scott-Rodino Antitrust Improvements Act of 1976, that requires an investor to notify the government before it buys more than about $76 million worth of the stock of a company. This gives the government the chance to block the acquisition if it thinks that it's likely to reduce competition. Given that purpose, the HSR Act is mostly aimed at mergers and acquisitions by competitors, and there is an exception for investors who buy less than 10 percent of the stock of a company "solely for the purpose of investment," because that is unlikely to create a monopoly.
But no one quite knows what "solely for the purpose of investment" means. We talked last summer about an antitrust lawsuit against Dan Loeb's activist hedge fund, Third Point. In that case, the Federal Trade Commission took the view that Third Point's activism at Yahoo disqualified it from using the exemption. Third Point disagreed, and the case was settled with no admission of wrongdoing, no financial penalty, and a certain amount of bemusement all around. The thing is, whatever you think about the "solely for the purpose of investment" stuff, Third Point was just obviously not harming competition by buying 5.15 percent of Yahoo. More than that: Third Point's involvement in Yahoo probably made it more competitive. Two of the five commissioners dissented from the FTC's decision to go after Third Point, arguing that its purchases "presented absolutely no threat of competitive harm" and that activism "often generates well-documented benefits to the market for corporate control."
But the Third Point case perhaps paved the way for the Justice Department's case against ValueAct. In 2014, Halliburton agreed to buy Baker Hughes, its competitor in the oil-field services industry, though the deal remains under antitrust review today. According to the Justice Department complaint, after the deal was announced, ValueAct started buying stock in both companies, crossing the $76-million-ish threshold in Baker Hughes on Dec. 1, 2014, and in Halliburton on Dec. 5, and ultimately getting to about $2.5 billion in stock between the two companies.
But ValueAct didn't initially file an antitrust notification under the HSR Act for either company, presumably because it thought its purchases were "solely for the purposes of investment." You can see why it might think that. It wasn't doing much. And it was buying shares in a company that was being acquired. There isn't a lot of scope for activism there; you can't really advocate too many strategic changes for Baker Hughes when its strategy is to merge out of existence. I mean, you could advocate one strategic change -- to block the merger -- but ValueAct didn't do that. It liked the merger. It told investors that it would be "a strong advocate for the deal to close," and sat back and waited for that to happen.
Eventually the deal looked less likely to close (because the Justice Department opposed it for antitrust reasons), and ValueAct became more activist in Baker Hughes, filed an HSR, and sold down its Halliburton stake. But the question in the Justice Department's case is whether ValueAct owned Halliburton and Baker Hughes "solely for the purpose of investment" starting in about December 2014, before the merger started looking risky. The Justice Department says no, citing ValueAct's plans to advocate for the merger:
Although the memoranda ultimately shared with investors watered down the words used to describe ValueAct’s activist strategy, they still emphasized that purchasing a stake in Halliburton and Baker Hughes would “increase probability of deal happening” and would allow ValueAct to be “a strong advocate for the deal to close.” ValueAct identified this as one of three “key considerations” supporting its investment decision. A contemporaneous email among ValueAct partners remarked that if Halliburton’s shareholders threatened to vote against the deal, ValueAct’s “position in HAL should be meaningful enough to have a substantial role in those conversations.”
ValueAct also intended to help restructure the merger if it hit roadblocks. On December 16, 2014, ValueAct’s CEO emailed his partners: “if we own both we can drive new terms to get the deal done if weird [expletive] is happening.” ValueAct also expressed this view in its memos to investors: “In the event of further fundamental dislocation or regulatory issues, it is possible the deal would need to be restructured and we believe ValueAct Capital would be well positioned as an owner of both companies to help develop the new terms.”
ValueAct also "established a direct line to senior management at both Halliburton and Baker Hughes and met with them frequently from the time it started acquiring stock," discussed the business with them, and offered “to speak with any of [Halliburton’s] top shareholders about [ValueAct’s] view of the merger prior to the vote.”
The Justice Department views all of this as evidence that ValueAct's purchases "did not qualify for the narrow exemption from the requirements of the HSR Act for acquisitions made solely for the purpose of investment." ValueAct strenuously disagrees, saying in an e-mailed statement:
ValueAct strongly believes in the most basic principles of shareholder rights. This includes having a relationship with company management, conducting due diligence on investments, and engaging in ordinary course communications with other shareholders. As a result, we see no alternative but to contest the Department of Justice’s action and will vigorously defend our position.
Sure, demanding board representation or mounting a proxy fight is something more than "solely for the purposes of investment." But just talking to management and other shareholders isn't. If you are a big investor, talking to management is just a basic part of your job, a necessary condition of any investment: It would be irresponsible to invest $2.5 billion -- especially in two companies with a merger pending -- without talking to management and other shareholders. If "solely for the purposes of investment" forbids sharing ideas with management and other shareholders, or even supporting management in decisions that it has already made, then almost no actual investments qualify.
I suspect that the Justice Department would more or less agree, perhaps grudgingly, that talking to management and other shareholders doesn't, in general, disqualify an investor from the "solely for the purposes of investment" exception. But you can still see why it doesn't like what ValueAct did here.
First of all, ValueAct clearly set itself up as an advocate for the Halliburton-Baker Hughes merger, and the Justice Department, pretty clearly, doesn't like the merger. From Bloomberg News:
The filing offered an unusual glimpse into the Justice Department’s skepticism about the deal. "ValueAct established these positions as Halliburton and Baker Hughes were being investigated for agreeing to a merger that threatens to substantially lessen competition in numerous markets," it said in the ValueAct complaint.
If the Justice Department thinks that the merger is anticompetitive, it can try to block the merger. But if it thinks that the merger is anticompetitive, then it stands to reason that ValueAct's purchases and advocacy of the merger were also, derivatively, anticompetitive, so why not go after ValueAct too? This isn't like the Third Point situation, where an activist advocated for more competition; here, the activist wanted a merger that the Justice Department dislikes.
Second, ValueAct did this:
In presentations, ValueAct has explained that it likes “disciplined oligopolies” and looks to invest in businesses in “[o]ligopolistic markets, high barriers-to-entry.”
That has nothing to do with anything, really, but the Justice Department nonetheless included it in the complaint because it sure is suggestive. Aha, says the Justice Department. You like uncompetitive industries. We'll have to keep an eye on you.
Third, ValueAct didn't just buy shares in Baker Hughes, the target. It also bought shares in Halliburton, the acquirer. Those companies had agreed to merge, yes, but that merger was still subject to antitrust approval; until the deal was approved, they were still notionally fierce competitors. But ValueAct obviously wanted them to combine, and talked about using its position in both companies to smooth the merger process. Given its situation -- buying shares in both companies after the merger was announced, in anticipation of the merger closing and the companies combining -- it presumably had little interest in fierce competition between the two firms.
If you believe in my favorite fringe theory, those are all big red flags. You have a big investor that talked explicitly about preferring "oligopolistic markets," that bought large stakes in two companies in a concentrated industry, and that used its stakes to push for those companies to complete a merger that the Justice Department is worried will reduce competition. You couldn't ask for better evidence that shareholder-focused capitalism and cross-ownership reduces competition.
Of course the core of that theory is that large diversified mutual funds reduce competition, and this case has nothing to do with large diversified mutual funds. ValueAct isn't a diversified mutual fund; it's a concentrated value/activist fund that owns something like 14 stocks. It is big for a hedge fund, with more than $16 billion under management, but it is orders of magnitude smaller than BlackRock and Vanguard and the other fund complexes that own vast swaths of every U.S. public company. It is also far more active in governance and management than those fund complexes typically are.
But you have to start somewhere, and ValueAct's size, concentration and activism make it a useful test case. If the Justice Department wins this case -- and ValueAct has said it will fight -- then that will likely have a chilling effect on other investors. Conversations with management and other shareholders, which have normally been considered part of ordinary-course investing that qualifies for an antitrust exemption, will now be suspect. But not all conversations will be equally suspect. Pro-merger conversations, conversations between a company's managers and its competitors' shareholders, and activism by self-consciously pro-"oligopoly" investors will, I suspect, be particularly risky. Activities that the antitrust authorities like -- pushing breakups, competition, etc. -- may be safer.
It is an odd and ugly test case, but it sure does look like a test case. The theory that the dominance of a shareholder class has reduced competition among real companies seems to be getting traction. But that is a vague and diffuse theory, driven by statistical analyses and theoretical mechanisms rather than clear stories and written evidence. But with ValueAct, the Justice Department can tell a story in which a powerful shareholder used its cross-ownership of two competitors to advocate for an anticompetitive result. If the antitrust authorities are worried about shareholder capitalism reducing competition, and want to do something about it, this is as good a place to start as any.
My second-favorite is the one about Vanguard's taxes.
Einer Elhauge at Harvard Law School would say: not irreparably.
The number changes every year, but it was $75.9 million as of December 2014 and $76.3 million as of February 2015, the times relevant to today's ValueAct case. (See paragraph 42 of the complaint, which appears to be off by a year.) It is now $78.2 million.
Third Point is an activist fund with a small concentrated portfolio. An activist's incentives are to push its portfolio companies to be more competitive -- which may be why activist involvement in a company is bad for that company's competitors.
Sometimes the FTC brings antitrust cases, sometimes the DOJ does. It is just one of those mysteries. (Just kidding, there is probably a reason, but it is a mystery to me and all in all I'd rather keep it that way.)
It filed a Schedule 13D with the Securities and Exchange Commission when it exceeded 5 percent of Baker Hughes, disclosing that it had bought the shares "for investment purposes," and that it had no particular plans for Baker Hughes though it reserved the right to talk to management, think about the company, and perhaps formulate plans for the future. It didn't get above 5 percent in Halliburton, so it never filed a Schedule 13D.
ValueAct filed an amended Schedule 13D in December 2015 related to Baker Hughes, stating that it and its managers "intend to have conversations with members of the Issuer's management and board of directors to discuss ways to enhance shareholder value," including by potentially asking for a board seat. According to a ValueAct spokesman, it also made an HSR filing on Nov. 28, 2015: It couldn't do much about the shares it had already bought, but now that it had gone activist, it sought antitrust approval before buying any more shares. Meanwhile ValueAct sold down its Halliburton stake: It went from $1.3 billion worth in September 2015 to $562 million at the end of the year, and got below $76.3 million by the end of January 2016.
Here's another line that has nothing to do with anything, but that was presumably included in the complaint because it is funny:
For example, on December 5, 2014, the day Master Fund’s holdings in Halliburton crossed the HSR Act threshold, a ValueAct partner wrote an email to ValueAct’s CEO about Halliburton: “Wonder if it would be possible to get the VRX [Valeant Pharmaceuticals] comp plan in from outside the board room?” The CEO responded “Yes. Good idea.” (ValueAct had recently convinced management to change the executive compensation plan at another of its investments, Valeant Pharmaceuticals.)
That was in 2014. The Valeant executive comp plan is somewhat less beloved these days.
Oh, sure, after they'd already agreed to merge, but that is a detail.
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