I agree with the judge. Why do we both think Burkle is more likely to win the proxy vote than Riggio, even though Riggio owns more shares?
Because the contest between Burkle and Riggio comes down to two questions. One: Will Aletheia vote for Burkle? And two: Who will RiskMetrics support?
Will Aletheia Vote for Burkle?
There is no doubt Aletheia, which owns 15.93% of Barnes & Noble, will not vote for Riggio. But will Aletheia vote for Burkle? Or will it abstain? Some lawyers tried to raise doubts about this at the poison pill trial. They didn’t do a good job. Everybody knows Aletheia will vote for Burkle. Even Burkle admitted: “(Aletheia) will give (me) a good listen.”
The head of Aletheia, Peter Eichler, didn’t say he had a thrill going up his leg when he heard Burkle speak. But he came close: “At his deposition, Eichler gushed over Burkle, and made clear that for him, the chance to talk investments with Burkle was equivalent to an aspiring songwriter getting to trade licks and lyrics with Dylan…Eichler expressed his view that Barnes & Noble would be fortunate to have Burkle on its board…(and described) the opportunity to spend time with Burkle as ‘very exiting’…stating that lunch with Burkle was ‘so much fun’ that Eichler ‘could have sat there for 10 straight hours nonstop.’”
Some lawyers tried to raise doubts about Aletheia’s ability to vote its own shares. I found the arguments silly. Strine did too. Aletheia can vote its own shares. It said so in its SEC filing. Aletheia doesn’t normally vote in this kind of contest. However, it has a specific shareholder value enhancing exemption that fits here. So Aletheia will vote for Burkle. Together, Burkle and Aletheia own 35.11% of Barnes & Noble.
How Many Shares Do Riggio and Burkle Control?
There have been a lot of different share ownership numbers reported by the press. I understand the confusion. But the best source is the 14A filed by Barnes & Noble on the day the board announced it was evaluating “strategic alternatives”. This document has the actual share count owned by each party on June 30th. The record date for the annual meeting is Monday, August 16th. So, the only difference between these numbers and the votes we seen at the September 28th meeting will be whatever buying and selling took place over the last six weeks. Otherwise, what you see in that 14A are the exact numbers.
Barnes & Noble has a total of 58,856,320 shares. All directors and officers of the company combined own 22,674,944 shares. Burkle owns 11,291,213 shares. And Aletheia owns 9,373,192 shares. The 14A does not show rank and file Barnes & Noble employee ownership. However, the judge said all other employees of Barnes & Noble own 6% of the company.
For now, I’m going to assume Aletheia votes with Burkle and Barnes & Noble employees vote with Riggio. Later, I will discuss both those points. But, for now, let’s see how the shareholder body breaks down on those party lines.
Riggio Party: 26,206,323 share
Burkle Party: 20,664,405 shares
Unaffiliated: 11,985,592 shares
And as a percent of the overall vote:
Riggio Party: 44.53%
Burkle Party: 35.11%
The above numbers are calculated in the most favorable way possible for Riggio. They assume every Barnes & Noble employee will vote for Riggio. And they assume no one will forget to vote. How likely is that?
I think Barnes & Noble employees will overwhelmingly vote for Riggio, because he has fostered a culture of employee dependency. I think a lot of Barnes & Noble employees, more than at almost any other public company, can’t imagine life without Riggio. They know what the situation is in the book business. And they will assume, whatever Burkle says, that he will close stores and cut jobs. They feel more secure with Riggio. And the board’s announcement about evaluating “strategic alternatives” may make them think there’s still hope they might cash out somewhere down the road, even if Riggio wins the election.
Still, it is improbable that anyone can get 100% of the votes of any group no matter how loyal. Realistically, Riggio can’t count on literally 100% support from Barnes & Noble employees. Even if Riggio could count on 90% support from Barnes & Noble employees, that would still leave him more than 6% short of a majority. So, even under the rosiest assumptions for Riggio, he still needs more than 30% of the unaffiliated votes.
How likely is that?
I don’t know. But I think it’s a lot less likely after Thursday’s poison pill trial ruling.
Who Will RiskMetrics Support?
Although Barnes & Noble won the case, the judge’s opinion probably hurt Riggio among unaffiliated Barnes & Noble voters. There’s no doubt the ruling hurt Riggio’s chances of gaining the support of the once and future Institutional Shareholder Services, called RiskMetrics for now. RiskMetrics is an influential proxy advisory firm. It tells investors how to vote their proxy. A lot of funds blindly follow what RiskMetrics tells them to do.
As the judge said: “All of the experts in the case make a point that might make the object of their commentary blush. All say that one of the key factors in the outcome of a proxy contest will be the recommendation of the firms that provide institutional investors with the recommendations about how to vote, the so-called ‘proxy advisory firms’ and in particular, one such firm, RiskMetrics…Although RiskMetrics often disclaims that its clients blindly follow its recommendations, the reputable proxy solicitors who testified in this case both agree RiskMetrics exercises a great deal of influence over the vote of many of its clients and that these clients often hold an important part of the available vote in contests.”
Judge Strine also wrote that “all of the experts” agree “that the proxy advisor RiskMetrics is most likely to support Yucaipa’s slate over management” and “all of the experts in this case agreed that RiskMetrics was much more likely to support an insurgent slate than the management slate.”
The judge’s own ruling makes that even more likely. For instance, he determined that Barnes & Noble’s lead independent director, Michael Del Giudice, is not an independent at all: “...on the limited record before me I cannot conclude that the business and political ties between Del Giudice and Riggio render Del Giudice independent of Riggio…therefore, the Barnes & Noble board is comprised of a bare majority of independent directors. But, in my view, it also continues to have a good deal of the feel of the board of a controlled company.”
In the face of the expert testimony and the judge’s conclusions regarding Del Giudice, Riggio, and the feel of a controlled company, it would be very hard for RiskMetrics to support Riggio over Burkle. Furthermore, the fact that this proxy battle is being covered by the press and that the press has read Strine’s opinion, makes it obvious that RiskMetrics will expose itself to media scrutiny if it supports Riggio. I don’t think RiskMetrics wants to read a headline like: “In Surprising Move, Proxy Firm Deals Blow to Burkle’s Hopes”.
Therefore, RiskMetrics is even more likely to support Burkle after the judge’s ruling than it was before the poison pill trial began. The fact that Riggio is quoted as saying he needed the board’s permission to buy 45% of the company because “at 33% we are at risk” hurts too. That’s equivalent to saying the board needed to allow a creeping takeover to prevent a creeping takeover. To the board’s credit, it did not seriously consider Riggio’s idea. But it still makes it very hard for RiskMetrics, or any corporate governance watchdog, to tell anybody they should vote for Riggio. And it’s Riggio’s name on the ballot in September.
What Happens if Burkle Wins the Proxy Fight?
If Burkle wins the vote, Barnes & Noble founder Len Riggio will lose his board seat. Burkle can only win 3 of the board’s 9 seats, because Barnes & Noble has a staggered board of directors. Each director serves for 3 years. In theory, that means the Riggio party will be in control for at least another year, even if they lose the September 28th vote. In practice, if the Burkle party wins September’s election, the Riggio party will be the opposition party. And the Riggio party won’t be in a position to oppose much. It will be clear to everybody that any active opposition by the Riggio party would cause them to lose their board majority in 2011. A Burkle win in September would turn the 6 remaining pro-Riggio directors into lame ducks.
Could a Defeated Riggio Board Block a Takeover Bid from Burkle?
Some people think the staggered board means leftover Riggio directors can delay a takeover bid from Burkle for another year, even if Burkle wins the election. In theory, that’s true. In practice, it almost never happens. If Burkle wins in September, he will be allowed to make a bid. Strine cited this point in note #229 of his opinion: [i]There are “very few examples” of incumbent directors holding out against a hostile bid after the bidder won the first round of elections…and in this case, if Yucaipa were to propose a bid, the Rights Plan is subject to a stockholder vote before the end of this year.
Remember, Riggio is on the ballot in September. If Burkle wins, Riggio loses. It’s hard to imagine a decapitated, rump Riggio board refusing to let Burkle present a takeover bid to shareholders. The Riggio party could try to keep the poison pill. But Burkle put a resolution raising the pill to 30% on the September ballot. It’s likely that if Burkle wins his 3 board seats, that resolution will pass too. And the current Riggio board said it will put the poison pill to a shareholder vote. In theory, the rump board could delay a Burkle bid. In practice, it won’t.
What is the Most Likely Scenario?
Even at this point, the most likely scenario is usually an agreement between the insurgent, Burkle, and the incumbent, Riggio. The two parties almost reached a settlement. But it fell apart at the last minute. If anything, that actually suggests a settlement is less likely here. Coming close to reaching a settlement and letting the press know before actually shaking hands is a bad sign. It means the deal probably fell apart because of a totally lack of trust. That means Burkle and Riggio are less likely to come to terms on a purely rational basis. There is more personal distrust here than in a lot of proxy fights.
For investors, the most likely scenario is clearly a buyout of some kind. The board has already announced it is exploring strategic alternative. Both Burkle and Riggio have said they might make a bid for the company.
Even if that wasn’t the case, most proxy fights at staggered boards with poison pills end in a buyout. These are tough fights. The combination of a staggered board and a poison pill is about the toughest obstacle for a proxy fight to overcome. Throw in a 30% owner who also happens to be the founder, and well, it doesn’t get any harder than that. The fact that someone is willing to seriously consider such a fight is a clear sign that a buyout is more likely.
The judge cites one paper in his ruling that shows that 40% of situations such as the one Barnes & Noble is now in end up with the company being taken out within 9 months of the proxy vote. Within 2 and a half years of the proxy vote, that number rises to 53%.
In other words, even when there is only a hostile bidder like Burkle, a successful proxy fight usually results in a takeover. Here, of course, Riggio is also interested in bidding for the company.
But what happens after the proxy fight – and what still might happen before – is a topic for another day.
The Barnes & Noble proxy fight series continues tomorrow with another article.
Disclosure: Author owns shares of Barnes & Noble (BKS).
Source: Strine’s opinion
This is the third article in Geoff Gannon's ongoing series covering the Barnes & Noble proxy fight. For additional background read Why Would Anyone Buy Barnes & Noble Stock at $15 a Share? And Who is Ron Burkle? Why Does He Want to Control Barnes & Noble? And How Does He Know Charlie Munger?
Look for the fourth article in Geoff Gannon's ongoing Barnes & Noble series tomorrow.