Here’s the buzz from Tulane:

  • Deal-makers are optimistic about M&A, despite the potential for changes to the conditions in China and Europe that have spurred activity in recent years, and the uncertainty surrounding corporate tax reform in the U.S.
  • JP Morgan thinks a $100 billion all-cash deal is possible, partly because buyers aren’t really using equity despite rising markets.
  • Advisers can’t always control their clients, let alone their opponents. “You don’t know whether you’re going to get the mensch or the schmuck,” Joele Frank says of activists, and often one investor can be both. Steve Wolosky points out that the same is true of management teams.
  • Everyone is getting on better and early settlements are being encouraged, so say Joele Frank and Dan Burch, of MacKenzie Partners.
  • Appraisal rights are likely to become exercised more frequently.
  • No-one understands what Greenlight Capital hopes to achieve at GM.
InsiderMonkey (CC BY-ND 2.0) David Einhorn
David Einhorn InsiderMonkey (CC BY-ND 2.0)
Greenlight Capital

On that note, Tuesday was an exercise in déjà vu for both the activist and the company involved in what might be the year’s strangest activist campaign.

Greenlight Capital, a $9 billion fund run by investment soothsayer and poker player David Einhorn, has borrowed heavily from a thesis it pushed at Apple four years ago to launch an ambitious campaign for change at General Motors. For the storied automaker, that makes two major activist campaigns since it emerged from bankruptcy following the financial crisis. Not surprisingly, both sides were able to issue detailed presentations within a few days of private talks ending in disagreement.

Greenlight certainly has the beginnings of a case; at the start of this week GM had the weakest price-to-earnings ratio of the S&P 500. To solve the problem it has proposed that existing shareholders are granted special dividend shares, which they could sell to more yield-minded buyers or keep. Dividend shareholders would receive the current $1.50 annual payout, while the remainder of any future profits would go to ordinary shareholders, likely in the form of buybacks. The exact form is unprecedented, although it slightly resembles the concept of preferred shares.

GM said in a lightning-fast response that it had reviewed the proposal with external advisers, including three investment banks, and dismissed it as unworkable. At best, it argued the two different share classes would create capital allocation dilemmas for management, with each class likely to favor different priorities. The worst-case scenario, it said, is that ratings agencies impair the company’s creditworthiness because the dividend would be treated as a fixed and obligatory cost, like debt, a prospect Fitch, S&P and Moody’s gave credence to on Tuesday. GM argues it might be legally obliged to maintain the dividend. A crisis could land GM in a similar position to Fannie Mae and Freddie Mac, failed mortgage guarantors that hedge funds believe should now be handing profits over to investors. Dividend shares could be pitted against GM’s bondholders and ordinary shareholders were the company to fall into dire straits.

At best, the two different share classes would create capital allocation dilemmas for management, with each class likely to favor different priorities. Investors could also buy the dividend stock and sell the ordinary shares short if guidance worsens. That might even worsen earnings ratios from their current low levels. Then there are other devilish details that would take some time to work through – Greenlight says its proposals would allow dividend shareholders to block a takeover, despite a much smaller pool of votes. Granted, a takeover of GM looks unlikely now, but in 15 or 20 years’ time, who knows?

The problem with Greenlight’s proposal is that it assumes the company’s capital structure is the reason for its low valuation. The company anticipated this in its statement, saying the proposal “would not help GM sell more cars, drive higher profitability, or generate greater cash flow – nor would it address the fundamental sector factors affecting GM’s stock price.” Indeed, the auto industry is caught in a transition period where it is yet to become clear whether the likes of GM have sustainable businesses, or the answers to automation and ride-sharing technology.

When Greenlight pushed Apple to do something similar, that company was also in a funk, partially attributable to the transition from Steve Jobs’ leadership to the less well-known Tim Cook. The same opportunity drew Carl Icahn into the stock, leading to a big increase in share repurchases, a stock-split and, despite some ups-and-downs, a tremendously successful couple of years for investors. Some of that undoubtedly had to do with capital returns, but GM has been no slouch on that front. Since 2012, it has returned $25 billion to shareholders.

Greenlight’s thesis is predicated on the idea that investors want very specific types of security and would prefer to choose between a yield play and a value one. That may be true for hedge funds, and theoretically could be for passive managers, which own the whole market, and can manage risks in their own portfolios. In practice, however, an index fund might view the separation as damaging to the business – many now talk about sustainability on a regular basis – and hasty. In the long run, valuations should be efficient, so why force things in the short term? Moreover, the individual share classes might be valued at lower price-to-earnings ratios than currently, if the idea fails to take off.

Greenlight has indicated it is willing to stake its name on the idea. As well as its presentation, posted on its public website Tuesday, it has nominated four as-yet-unnamed directors. That seems likely to be a precautionary response to advance notice bylaws, however. Greenlight has only fought one U.S. proxy contest, some 14 years ago. Even with Schulte Roth & Zabel – coming off the back of wins at Marathon Petroleum and Tiffany & Co – guiding the fund, a lengthy campaign would be a tough ask and would damage or distract CEO Mary Barra, whom Einhorn has praised.

Nonetheless, the idea of a disalignment of investor outlooks is one reason large-cap activism is likely to persist. Managers have done a good job of getting on top of the other, informational asymmetries, by reviewing their businesses against typical activist ideas, but it is hard to think of an example of the former where the problem has been solved by a quick fix, other than a takeover. All of which counts against Greenlight’s specific proposal.

Article by Activist Insights