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UPC and Hostile Takeovers

We haven't seen these in quite awhile now, have we? It's been so long we don't know if the attorneys even know what templates to use.

Ok, we have seen a few hostile tender offers and similar deals in the past few years, although many fewer than we enjoyed decades ago. What we haven't seen lately is a proxy contest that seeks to pressure a BoD to accept or at least negotiate a hostile offer.

Now we have two, the first ones under universal proxy card (UPC) for the proxy contest part. UPC should change the dynamic in interesting and yet unclear ways. We suspect UPC could help companies in these situations, but we don't really know.

WH and M

First, Choice Hotels (CHH) wants to acquire Wyndham Hotels (WH). We really haven't seen this in a long time: a US public company launching a proxy contest to acquire another US public company. CHH began in April 2023 with a private cash and stock offer amounting to around $90/share, when shares were trading under $70. It began a public tender offer in October 2023. After months of faltering communication and a couple of increases in the offer, on January 21 CHH disclosed it notified WH of its intent to nominate candidates to replace all eight incumbent directors.

Next, Arkhouse Fund wants to acquire Macy's (M). Now this brings back memories! a big fund taking private a distinguished company in distress! In December 2023 Arkhouse offered $21/share, when shares were trading under $18. It owns 4.4% of "economic exposure" to M, will work with Brigade Capital to fund the offer, and stated it will consider increasing the offer with the chance to undertake some due diligence. (Just this week Arkhouse did increase it to $24/share, but based on the recent earnings release rather than due diligence.) After a couple of months of resistance, on February 20 Arkhouse disclosed it notified M of its intent to nominate nine candidates for election to the fourteen-person BoD.

Now What?

Both WH and M typically run their AGMs in May. Of course BoDs can and do move these around to suit their needs, which at this point for both companies appear to be to preserve their seats. So, this may take awhile longer depending on how company and activist support begins to fall into place.

WH and CHH both filed preliminary proxy statements. WH didn't disclose anything particularly interesting, while CHH did:

  • CHH owns about 1.4% of WH and is limited by anti-trust law to any increase
  • CHH notified WH of two alternate nominees, if some of the original eight nominees cannot finish the contest
  • CHH will pay each nominee $50,000 for serving on the slate
  • CHH budgeted $750,000 plus expenses for proxy solicitation.

Frugal fund managers marvel with envy at spendthrift public companies that undertake a proxy contest.

Neither Arkhouse nor M have yet filed preliminary proxy statements. M disclosed it scheduled the AGM for May 17, 2024 with a record date of March 21, 2024. It seems to want to give itself some flexibility, although it also allows investors to influence the BoD election by acquiring shares in the next couple of weeks. In an interview, Arkhouse noted it plans to nominate nine candidates to allow for a slight margin over an eight-person majority on the 14-person BoD. It has not yet identified the nine incumbents it plans to oppose, which we would expect to see in its preliminary proxy statement.

Back to Binary?

Recall the fundamental logic of UPC: it transforms a BoD election from binary to continuous. Rather than choosing between the activist and the company plan, a shareholder can vote according to how much change they want in the company. In this way shareholders express with greater precision how they want a BoD to look.

In the typical proxy contest under UPC, shareholders choose the company, the activist, or some of each. Earlier we wrote:

  • The shareholder that agrees exactly with an activist about how to improve a company will contentedly vote for the activist's nominees;
  • The really unhappy shareholder that demands extensive change will support all of an activist's nominees, and wish the activist sought more; and
  • Most important, the mildly unhappy shareholder that wants just a little change can easily and directly support only some of the activist's candidates, commensurate with its desired change at the company.

Of course, a completely delighted shareholder that adores the company will support its incumbents.

Hostile takeovers like these two seem to revert to giving shareholders a binary choice. Shareholders can either accept or reject the activist financial offer and tender into the deal or not. How do shareholders, activists, and companies think about the proxy contest part?

Suppose a shareholder supports the activist, CHH or Arkhouse. So, they want WH to support the CHH tender or M to accept the Arkhouse offer. Then, the shareholder votes for all eight CHH directors or all nine Arkhouse directors. If enough shareholders do this, then the activist gains control of the BoD, and the deals move forward.

Of course, if a shareholder opposes the activist, then they vote for all eight CHH incumbents or all fourteen M incumbents. If enough shareholders do this, then the incumbents remain in place and refuse the financial offer. At that point CHH or Arkhouse increase the offer, pursue other tactics, or go away.

Now, suppose a shareholder votes for some of the activist candidates, but not all of them - the upshot of UPC. Then, it gets interesting. Also, here our two examples might diverge a little.

It does little (but not nothing) for CHH or Arkhouse if shareholders elect only a few of their nominees. One or two activist directors might advocate to the incumbents for the activist financial offer. It also signals some degree of dissatisfaction with the BoD. At the same time most of the incumbents just won a BoD election, so they have solid evidence that most shareholders oppose the activist.

If the activist wins a majority of the BoD, but maybe not all the seats it seeks, then it should mean shareholders like the financial offer. Here, CHH has a little more room than Arkhouse. It needs only five of its eight candidates to win a majority while Arkhouse needs eight of its nine candidates. With that majority, it seems likely but not certain that a deal moves forward.

We wonder why, in the case of a hostile takeover, a shareholder would vote for only some of the activist candidates. It does convey "mildly unhappy" (see above), but it doesn't really help the activist. Either the activist wins a majority and can move forward with its deal, or it doesn't and needs to do something else. An activist thus needs a substantial or even complete win.

However, the company can give up even a few incumbent seats and continue to oppose the activist. A shrewd company will thus encourage shareholders to support the entire incumbent slate, and also acknowledge that shareholders might vote for even some activist candidates.

The proxy solicitation process and communications strategies and tactics might become a little unfamiliar. Much to activists' eternal frustration, a company typically opposes the activist without regard to cost. We have yet to see what WH plans to spend on this, but the CHH preliminary proxy provides a clue, and it should be considerable. Yet, WH (or M) might also admit shareholders seek a voice and some change. They could encourage shareholders to express themselves accordingly and vote for a couple of activist candidates.

As we have shown before, UPC demands an activist oppose specific incumbents, corresponding to its challengers. This makes a proxy contest more personal than before. Otherwise, shareholders will disperse votes among all incumbents, diluting the impact of votes for the activist and against the company. These two proxy contests may confound this factor.

A proxy contest within a hostile takeover becomes more about the takeover, and less about the individual directors. An activist just needs control, or enough control to push its deal though. Sure, Arkhouse will optimize its results by running its nine candidates against nine specific incumbents. Still, shareholders will likely care less about relative capabilities of incumbents and challengers, and more about what BoD gets to the preferred outcome, a deal or not.

What does a possible settlement of the proxy contest look like? We can't see either CHH or Arkhouse accepting anything less than BoD control, and can't see WH or M agreeing to that. Again, binary outcome, not a continuous situation that allows for a compromise between the parties. As in past decades, the BoD vote will likely determine the outcome of the takeover.

Look, it's early, there's only two cases right now, and all these observations and analyses could change. We plan to monitor these closely, and see what else we can learn about shareholder decision-making and voting under UPC.

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For further information, or to discuss a specific activist situation, please contact:

Michael R. Levin

[email protected]