1. The Risk for Valeant’s Long-Term Investors; Ackman’s Bid Underscores the Danger in Shareholder Fatigue

    The Risk for Valeant’s Long-Term Investors; Ackman’s Bid Underscores the Danger in Shareholder Fatigue

    The battle between activist investor Bill Ackman and Allergan Inc.’s CEO and board of directors over Valeant Pharmaceuticals takeover bid of Allergan, the maker of Botox, has created a lot of sound and fury over corporate governance that could leave Allergan shareholders with the sagging faces down the road. 

    Ackman and Valeant recently increased their $47 billion offer for Allergan to $54 billion – only to be rejected for a third time by Allergan’s CEO, David Pyott.

    Claiming that Pyott has a “disabling” conflict of interest and that the Allergan board has been unwilling to even discuss the potential merger with Valeant, this week Ackman decided to go straight to Allergan’s shareholders.  He filed a proxy calling for a special meeting for the purpose of unseating six of those board members and effecting certain amendments to the company’s bylaws.

    The Ackman-Allergan battle highlights a growing phenomenon in corporate America that could have troubling consequences for shareholders who aren’t paying close enough attention. 

    It goes something like this: activist investors like Ackman, Dan Loeb, and Carl Icahn swoop in and invest in fairly high-profile companies that they believe are undervalued.  They make substantial share purchases and then find flaws in those companies – often corporate governance issues or missteps by the board or management – and utilize the power of the 24-hour news cycle to promote their positions. 

    The result follows a familiar pattern: a drawn-out battle with the company’s board with both sides lobbing verbal grenades at each other in a very public forum, threats of ‘poison pills’, a proxy fight, and then a settlement, which usually involves representatives of the activist investor receiving seats on the company’s board.  The stock’s value increases, and the activist investor and shareholders walk away happy.  

    The Ackman-Allergan case seems to be following this trajectory.

    The problem with this scenario is that the average shareholder often assumes that any corporate governance issues raised by the activist investor have been addressed in the settlement.

    But the reality is that most activist investors care very little about the corporate governance of these companies – they care about making money.  More often than not, underlying corporate governance issues get swept under the rug of a settlement, because once investors have made their money, there is little incentive for them to make a long-term commitment to remedy any lingering concerns.

    What happened at Yahoo with Dan Loeb illustrates this phenomenon.

    Loeb waged a months-long campaign against Yahoo to change the board and leadership.  Loeb’s hedge fund, Third Point, engineered a settlement after a long proxy fight and Loeb, Michael Wolf, and Harry Wilson were added to Yahoo’s board.

    A little over a year later, after forcing out CEO Scott Thompson and hiring his replacement Marissa Mayer, and after navigating the sale of some of Yahoo’s stake in Alibaba and using the money to buy Yahoo stock, Loeb, Wolf, and Wilson resigned. Third Point sold 40 million shares – up more than 85% by that point -- earning about $1 billion. 

    Loeb walked away making a fortune, but did he leave Yahoo in a position for strong future growth?  That’s an important question yet to be answered. Two of Yahoo’s current directors were members of Yahoo’s board back in 2012 -- when Loeb so strongly criticized the board as living in an “illogical Alice-in Wonderland world.”

    Ackman’s salvo towards Allergan raises a valid argument that is a growing concern for many corporations – namely the splitting of the roles of CEO and Chairman.  Ackman states that Pyott’s “disabling conflict of interest is due to the likely loss of his leadership role and employment at the company if a change-in-control transaction were to be consummated.” If Pyott is not an independent director, should he really be leading the company’s strategic direction?

    Long-term shareholders should be cognizant of the fact that when the Ackmans and Loebs of the world inject themselves into a company, make a lot of noise, and then move on to their next investments, the changes necessary for the long-term health and well-being of the companies they leave may not have been made. What happens the next time a potential merger or acquisition presents itself to Allergan?  Is an Imperial CEO like Pyott the right person to assess the opportunity and lead the discussions?

    Average shareholders have the real incentive to ensure that the companies they invest in have top-notch corporate governance.  They must listen to the issues raised by activist investors and carry the torch for good governance when the sound and fury die out after the activist investor leaves to find another opportunity to make a quick fortune.

     

    Allergan shareholders would be wise to keep this in mind.

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