By Eric Jackson
07/11/08 - 10:59 AM EDT
Microsoft (MSFT - Cramer's Take - Stockpickr) and Carl Icahn this week effectively upturned the conventional notion that you must negotiate a transaction with another company's board. The software company and the activist investor are essentially bypassing Yahoo!'s (YHOO - Cramer's Take - Stockpickr) board and saying, We're fed up and won't deal with you any longer. Instead, they're negotiating directly with Yahoo!'s shareholders by trying to take control of the board at next month's annual meeting.
The implications for boards, activist investors and future takeover battles are significant. Dumb and lazy boards can no longer stand in the way of the will of shareholders.
Challenging the Conventional Thinking
Martin Lipton, famous lawyer and father of the poison pill, is a popular defender of omniscient and omnipotent corporate boards that, he believes, deserve to be unfettered from answering to shareholders. He has repeatedly spoken out on the perceived dangers of the diminishing power of the board in the face of rising shareholder demands over the last five years.
He and others of his view have argued that because corporate boards are elected each year by the will of the shareholders, these boards should be left to guide the company in its long-term interests. (He omits the fact that 95% of the time they succeed in uncontested elections and the Securities and Exchange Commission has done little to allow for contested elections in the last 20 years.)
Lipton argues that, if each short-term strategic decision must be brought back to the shareholders, almost like a referendum, before a company can act, two major problems emerge. First, the corporation slows down considerably. Second, Lipton says, shareholders will consistently opt for the short-term benefits at the expense of long-term interests.
Here's where Lipton is right. There are many activist investors out there. Some are good and successful; others, not so much. There are more many more activists today than there were five years ago. But most of the new and smaller ones practice what I call "activism by the numbers." They have a stock set of prescriptions for every company: sell the company, launch a share-buyback plan or pay a larger dividend. They believe their target companies can solve all of their problems with a one-size-fits-all solution. Not surprisingly, this approach fails more often than it succeeds, and it is a major distraction for well-meaning companies who have to address these criticisms.
But here's where Lipton is wrong. We still have far too many misguided boards and executive teams destroying shareholder value year after year and then claiming that only they have the true understanding of how their bumbling efforts will, one day, result in long-term benefits. A good case in point is small Canadian semiconductor company Zarlink (ZL - Cramer's Take - Stockpickr). The same board and management team has been in place for much of the last decade. Over that time, the once billion-dollar Zarlink has lost 92% of its market capitalization (vs. a 20% gain for the Nasdaq).
Not surprisingly, one of its 5% holders (who is not traditionally an activist investor) just launched a proxy contest to remove the CEO, chairman and several other directors who have presided over a terrible track record. The incumbents' response: this shareholder is being "self-serving" and is a "short-term" thinker. Presumably, management needs another decade and all shareholders need to be quiet and suffer along.
What Yahoo! Lacks and Icahn Needs to Correct
In my view, Yahoo!'s board has been asleep at the switch for several years now, while continuing to shell out lavish pay for under-sized performance. Icahn and Microsoft are right to make the case against them directly to shareholders, and they will likely succeed in the final vote. If this is a trend we are watching start here -- where activists go around intransigent boards and take their case directly to shareholders -- I say, May the best arguments win.
In the short term, more aggressive shareholders will make boards more hesitant, reluctant to fight activists, more difficult to recruit for, and, according to Lipton, more short-term thinkers. In the long term, however, this discipline will cure a lot of lax and cozy boards.
Details and plans matter more than sound bites. Frankly, both Yahoo! and Icahn have been weak on these since this proxy battle began. Yahoo! incessantly mouths PR-created sound bites about aspiring to be a "must buy" and "start page" with no credible plan for getting there. Then, they turn around and criticize Icahn for not having a plan.
Icahn has left himself open to such attacks. He has a two-part plan: (1) sell to Microsoft and (2) replace Jerry Yang as CEO with an "operator."
The Yahoo! proxy vote on Aug. 1 will hinge on the largest Yahoo! holders. Up until now, although they've been dismayed at the incumbent Yahoo! board, they've worried about Icahn's ability to actually bring Microsoft back to the table and his ability to actually run the company for a period of months/quarters assuming he sacks Yang and President Sue Decker, and as other senior managers continue their exodus from Yahoo!'s Sunnyvale headquarters.
Icahn surprised many this week when he revealed he's lined up the tacit support of Microsoft CEO Steve Ballmer. Icahn now needs to address that second concern. If he can get former head of AOL, Jon Miller, and former head of Fox Interactive Media, Ross Levinsohn, to agree to step in (as he's reportedly trying to do), it would solve the problem well. I expect Icahn will announce some sort of solution for this "leadership" problem in the coming 10 days.
There's no question that Icahn's looking increasingly strong in this campaign, when that wasn't a case only a week ago. Yahoo! knows this. The company's management should begin serious heart-to-heart compromise discussions with Icahn, if it hasn't already.
I give shareholders more credit than Marty Lipton. This Yahoo! battle demonstrates that shareholders can weigh promises of hoped-for long-term benefits from a management team that has lost credibility with the real possibility of a near-term premium for their shares, and make a fair judgment.
It's been painful watching this awkward dance between Yahoo!, Microsoft and Icahn over the last six months. Microsoft needs Yahoo! to make its Online Services Division relevant, and Yahoo! shareholders need to wake up from this four-year nightmare. With any hope, the end is near.
At the time of publication, Jackson was long Yahoo!.
Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.
Friday, July 11, 2008