Value to EBITDA

Back when I was discussing the Kraft/Cadbury acquisition in my entries in this blog, I spoke -- as the interested parties there were speaking -- of the P/E ratio, historically an important metric for stock pickers, investors, acquirers, executives who are in part compensated in equity, and gurus.

I believe the gist of that discussion was that over time, the "E" in P/E has acquierd a specific meaning, reflected in the more elaborate acronym EBITDA (earnings before interest, taxation, depreciation and amortization.)

Now it is time to return to the subject to mention that the P part of the P/E ration is in the process of a more radical redefinition. It is not stock price but "enterprise value" that figures in the emerging metric. Here's a discussion from the website of the Stern School of Business at New York University. The "enterprise value" is defined as the combined market value of all securities issued by the enterprise. Why? Because this allows for apples-to-apples comparisons. Different firms will have different balances of debt to equity, i.e. bonds to stock, and these differences would skew price-to-earnings.

Does this help in, say, the discussion of an impending acquisition? Presumably acquirers would look for a low enterprise multiple, because they are going to be buying up that stock and becoming responsible for the payments on those bonds -- they want a sizeable earnings stream in return. If a P/E or P/EBITDA multiple is used instead, the responsibility for the target company's bonds falls out of the picture, or never gets into it.

You can see here how "Seeking Alpha" applied the idea, four years ago.

The Mervyn's Deal from 2004 reverberates

Back in 2004, Target's sold the Mervyn's department-store chain to a group of PE investors led by Cerberus. (Faille's first law of finance: Cerberus has one of its many canine heads in everything!)

Mervyn's declared bankruptcy in 2008. (Didn't everybody?) But in Mervyn's case, ticked-off unpaid creditors decided it was all Target's fault. Target had structured the sale so as to strip to valuable real-estate holdings from the transaction, so that Mervyn's thereafter was required to make lease payments on land it had previously owned. Inflated lease payments, say the ticked-off creditors.

The estate trustee has apparently brought an adversary action against Target through the bankruptcy court. I say "apparently" because I haven't done a serious search via PACER for the actual papers yet, so I'm relying on news accounts. Said accounts tell me that Judge Kevin Gross of the U.S. Bankruptcy Court in Wilmington, Del., said the complex series of transactions should be viewed as a single deal, one that had "devastating" consequences on Mervyn's creditors, and he denied the motion to dismiss.

Last year, William Ackman tried to use a proxy fight to persuade Target to turn the land under its stores into a real-estate investment trust. His slate of nominees for the board was defeated, though. I wonder if Ackman has a cheering interest in this lawsuit one way or the other?

Cascade Financial

Craig Skotdal, one of the twelve directors of Cascade Financial, is unhappy with his fellow members.

Twelve sounds like an unwieldy size for a corporate board, but so far as I can tell yet that is not one of Skotdal's points. Rather, he is unhappy because his fellow board members don't know enough about banking (Cascade is the 8th largest community bank in Washington State) and as a consequence they are too subservient to bank management.

Skotdal has put forward his own slate: three nominees whose presence on the board would improve this situation: Tom Rainville, Arnold Hoffman, and Christian Sievers. The next annual meeting takes place next month.

David Duce, who chairs the corporate governance and nomination committee of the board, has sent a rather snippy letter to Skotda's lawyer, Gary F. Linden, expressing wonder that these candidates were willing "to be interviewed only as a group and only with your law firm present. As Mr. Skotdal is well aware, this is not consistent with the Nominating Committee's practices for evaluating board candidates...in light of your clients' recent actions, the disregard for procedures with which Mr. Skotdal is charged as a sitting Director with enforcing, and the lack of cooperation we have received in trying to assess the qualifications of your candidates, we are left to conclude you have no interest in working cooperatively."

In news that may be related, the SEC also recently refused Cascade's request for a no-action letter, in connection with a shareholder proposal submitted by Ed C. McRory. [A no-action letter is a more-or-less informal green light for a contemplated corporate action. A corporation asks the agency -- if we do X, can we proceed on the understanding you will take no enforcement action? So in this case the SEC said that it could not proceed on that understanding.]

Ed McRory, a shareholder, wants the next meeting to vote on a resolution requesting a compensation policy that "restricts the future granting, enlargement or enhancement of any golden parachute plan...."

Cascade, in a letter December 29, 2009, asked for no-action go-ahead concerning its planned exclusion of this proposal from the proxy materials, because it is (a) vague and indefinite, (b) relates to the company's ordinary business operations, and (c) has already been substantially implemented.

In a response March 4, 2010, the SEC said that it does not believe that the proposal is vague, or that it has been substantially imlemented. Accordingly, it can not be omitted from proxy materials on either of those grounds. The case with the claim of "ordinary business operations" is a little more complicated. If the proposal is meant to apply only to "senior executive compensation," then it is not an interference with ordinary business relations, and this contention too fails. The company was required to give McRory a chance to amend the proposal making clear that it is so restricted, and it can proceed with its proposed exclusion if and only if he refuses to do so.

Stern Hu's admission

Word has been leaking out in drips and drabs all this week about the non-public trial of the four Rio Tinto executives I wrote about last weekend.

There has been no judgment yet, so far as I know, but Stern Hu is reported to have admitted accepting bribes. See Business Week's coverage here.

The prosecution has asked for leniency, so it would appear that Stern Hu's confession is part of a deal. It also seems that Stern Hu's case has outshined that of his co-defendants in the attention the matter is receiving, presiumably because he is the only one who is a citizen of another country (Australia), and thus his trial alone is a diplomatic issue.

What I would ask all to remember about this situation is that what looks like a bribe from one point of view looks a lot like the successful pay-off of extortion from another. Indeed, consider (just by way of hypothesis and clarification) the possibility of bribing a security guard at the border to get one's self and/or friends out of a country run by an oppressive regime.

Back to reality though: my understanding is that all four of the Rio Tinto defendants shall learn their fates on Monday -- and that it is also on Monday that Hu's wife Julie will be allowed to see him for the first time since his arrest in July 2009.

Apache Corp.'s lawsuit

One of the big issues that is developing within the anual-meeting season this year is the disputation of supermajority requirements.

As of February 15, I'm reliably informed, there have been 26 proposals filed by investors that would repeal existing supermajority requirements as they apply to bylaws, corporate transactions, and other matters. Some supermajority requirements go as high as 80%. John Chevedden, a California-based shareholder activist, has made this a particular crusade.

One issuer, Apache Corp., filed a lawsuity against Chevedden in federal court in an effort to exclude his supermajority proposal. Apache, an energy company headquartered in Houston, contends that he failed to provide sufficient proof of ownership. A federal judge held a hearing in the case and the parties submitted their briefs earlier this month. The judge, on March 10, ruled in Apache's favor, though narrowly. Apache can exclude Chevedden's proposal.

But it could have been much worse for Chevedden and shareholder activists in general. Apache employed for the purpose of this lawsuit an SEC rule, 14a-8, about documenting share ownership for the purpose of submitting a proposal, requiring a letter from the record holder of the securities, usually a broker or a bank.

The United States Proxy Exchange filed an amicus brief on March 5 taking Cheveden's side, arguing that Apache has interpreted the rule, and the phrase "record holder," too narrowly.

USPX is a non-government organization, incorporated in Massachusetts, structured in the manner of a Chambver of Commerce, and dedicated to facilitating shareowner rights, primarily through the proxy process.

The judge's opinion rejected Apache's arguments about the SEC rule, and the decision will allow shareholders who want to raise issues such as the amendment of a supermajority rule to do so in the same way they have long done so, without having to document the decision via a letter from the DTC, as per Apache's theory.

Senate Banking Committee

Although all of the public attention and drama has focused on the health care legislation, there is news about the financial-reform bill as well.

Yesterday, March 22, the Senate Banking Committee voted in favor of the bill formulated by Christopher Dodd, of Connecticut, the commitee's chair. The Committee was split along party lines, 13 to 10.

The bill is similar to one the House of Representatives passed in December 2009, also with a split along party lines.

One important addition that this bill has and that one didn't is the Volcker rule: the prohibition of certain activities for banks that accept retail deposits. In some sense this is a return to the old Glass-Steagal Act. But not really.

Glass-Steagal created a wall between banks on the one hand and brokerage activities on the other. That is the wall that came crumbling down in the late Clinton period and this bill would not attempt to erect it anew. It would make some what more discriminating bans than that. Still, whether it would work, toward its presumed goal of limiting systemic risk, and how it would work, in specific administrative terms -- these are not easy questions to answer.

Interestingly, the Obama administration itself was late to pick up on the cause of the "Volcker rule." It showed no interest in the matter until after Scott Brown won his election in Massachusetts. Thereafter, it wanted to re-assert its populist cred, and this seemed to be an easy way to do that.

Presidential Life

Presidential Life Corp., a life insurance company based in Nyack, New York, has reported a profitable first quarter, and the likelihood of a proxy contest.

This has attracted my special attention for a trivial personal reason: I was born in Nyack, spent a lot of time there during summer school vacations as a boy, and try to keep an eye on goings-on along the western bank of the Tappan Zee.

Anyway: year-to-year comparison. Presidential Life (Nasdaq: PLFE) lost $2.7 million in the fourth quarter of 2008. But they turned that around, and have reported a profit of $12.2 million for the last quarter of last year.

In between there, in the spring of 2009, Herbert Kurz, who founded the company back in 1965 and who had been CEO since, stepped down. He may be getting tired of playing golf, though, because he now says he plans to nominate his own share of directors in advance of the next shareholders' meeting.

What (other than that golf gets boring) is Kurz' beef? He contends that during his stewardship he instilled in the company a culture of frugality, which is why the company has lasted as long as it has, but that the new leadership consists of a bunch of spendthrifts.

There will be more on this going forward, I'm sure.

China v. Four Rio Tinto Execs

On July 5, 2009, four Rio Tinto employees, one of whom is a citizen of Australia, were arrested in Shanghai for corruption and espionage. The Rio Tinto Group is a diversified, British-Australian, multinational mining and resources group with two headquarters -- one in the UK, the other in Melbourne, Australia. Rio Tinto was founded in 1873, and is named for the site of its first mine, on the Rio Tinto river, in Huelva, Spain.

The four defendants are to be put on trial this week. Their names: Liu Caikui, Ge Minqiang, Wang Yong, ands the Australian citizen, Stern Ho. They were initially charged with stealing state secrets, which is a capital offense. Perhaps in response to diplomatic protests from Canberra, that charge was dropped, and they stand accused now of taking bribes and related acts of corruption.

Foreign businesses will be looking carefully at the trial as an object lesson in the risks of doing business in the People's Republic.

Question: is this trial really just revenge for the failure of the Chinalco deal? Chinalco is the major Chinese state controlled mining enterprise that offered in early 2009 to make a major infusion of cash into Rio Tinto in return for ownership interest in certain assets. Stockholders in Rio Tinto didn't think they were getting a fair shake, and the deal never went through.

Hell hath no fury like a dragon scorned?

Three brief items

1. Lion's Gate has adopted a poison pill

Lion's Gate is the film and TV studio named after the "Lion's Gate" in Greater Vancouver, Canada, where the studio got its start. It is responsible for movies like The Haunting in Connecticut and Precious. It is also trying to fend off the unwanted attentions of Carl Icahn.

To that end, it is adopted this defense.

2. Part of Dodd's bill involves proxy votes

There will be a lot of talk about Christopher Dodd's plan for the reform of financial regulation in the days ahead. One intriguing fact is that Dodd has no reason to court popularity back home in Connecticut. He has already announced he will not run again. So he has come up with this.

3. Cedar Fair postpones its meeting

Cedar Fair Entertainment Company, a leader in regional amusement parks, water parks, etc., has announced the postponement of the special meeting of "unitholders" that had been planned for this week. That meeting, which will consider and vote on a merger agreement with affiliates of Apollo Global Management, has now been scheduled for April 8, 2010. The company also tells us that "additional information regarding the meeting, including time and location, will be provided at a later date.

Happy St. Patrick's Day, everyone.

Fairpoint bankruptcy

After writing the last two entries regarding Lehman Brothers I'm still in a post-bankruptcy-power-struggle kind of mood.

Bankruptcy is usually seen as an end. It takes a certain usefully skewed angle of vision to see it as a beginning. In that spirit, I observe that FairPoint Communications Inc. has won approval of its amended disclosure statement with a judge's order letting the bankrupt telecommunications provider begin soliciting votes on its reorganization plan.

Fairpoint, which is headquartered in Charlotte, North Carolina, was long a rural local telecomm business -- the most old-fashioned sort of telecomm -- something from the days of "Watson, come quick, I need you!" The company leaders got ambitious in 2007 and bought Verizon’s land line service area in rural New Hampshire, Vermont, and Maine for $2.7 billion dollars, acquiring 1.48 million acces lines in the process.

That may have been over-reaching at a bad time. Fairpoint filed for bankruptcy court protection on October 26, 2009.

Even after that filing it was getting back news from those "down east" assets, as when regulators in Maine said it couldn't use its chapter 11 filing to shield itself from a mandatory rate drop.

Since then it has had to restate its numbers for the first three quarters of 2009, the pre-bankruptcy quarters, significantly.

But that's all background. Here is what I wanted to foreground. Some heavy hitters, including John Paulson and Angelo Gordon, bought large positions in Fairpoint's bank debt before its filing for chapter 11 protection.

Judge Burton Lifland, in Manhattan, Lifland recent approved the troubled service provider's reorganization plan and a $75 million loan to pay for its exit out of Chapter 11 protection. Under the plan, FairPoint will give holders of secured debt 92 percent of the shares when the company emerges from Chapter 11 protection, while unsecured creditors would get eight percent of the shares.

Lifland applied what sounds like a minimal standard for approval. "I cannot find this plan patently unconfirmable," Lifland said adding that objections could be addressed during the confirmation hearing in May.

I'll try to come to a fuller understanding of the issues involved until then. This is sound and fury, yet I think it signifies something.

Lehman's Problems, Continued

I'm still mining the Examiner's Report that I discussed yesterday, looking for the good nuggets.

I found this: On page 480 of the second pdf in the series, the Examiner is discussing Lehman's efforts to sell itself to Warren Buffett. Fuld and Buffett spoke on Friday, March 28, 2008.

"They discussed Buffett investing at least $2 billion in Lehman. Two items immediately concerned Buffett during his conversation with Fuld. First, Buffett wanted Lehman executives to buy under the same terms as Buffett. Fuld explained to the Examiner that he was reluctant to require a significant buy-in from Lehman executives, because they already received much of their compensation in stock. However, Buffett took it as a negative that Lehman executives were not willing to participate in a significant way. Second, Buffett did not like that Fuld complained about short sellers. Buffett thought that blaming short sellers was indicative of a failure to admit one's own problems."

Buffett was of course wise in this. And the short sellers were right to believe that Lehman was over-valued as Einhorn explained in May 2008.

The vulture doesn't kill. The vulture feeds on the flesh of the dead. And, in so doing, said vulture performs a service. Though he is led to perform that service by his regard for his own self-interest, it is a genuine service. Bring out your old Adam Smith neckties!

Lehman's Problem was ... Lehman???

You mean it wasn't a conspiracy of short sellers?

I see from Sorkin's book that back on April 2, 2008, Dick Fuld had a breakfast meeting with Jim Cramer and sold him on the theory that Lehman's real problem was "a cabal of shorts," and the abolition of the uptick rule in 2007, which had presumably empowered said cabal.

Many have echoed Fuld's views. Indeed, in September 2008 the SEC halted the short selling of stocks in the financial sector altogether. That didn't last long, and it didn't seem to have any impact while it lasted, but the geniuses in Washington thought they had to show that they could collectively be a tough sheriff coming into Dodge.

Now there is a bounty of new evidence for what those of us who were skeptical of the anti-shorting cause have suspected all along. The problem with Lehman according to a report by the bankruptcy court's examiner just released was Lehman's own management, compounded by overly creative accounting and its enablers at Ernst & Young.

The report is available in full here. It's more than 2,000 pages long, and accordingly each of the links on the Jenner & Block page to which I've just linked you represents a separate volume. (The examiner is J&B's chairman, Anton Valukas.) But let's just stick to the Executive Summary, which appears at pp. 58-70 of the first volume/PDF.

Lehman failed because it was unable to retain the confidence of its lenders and counterparties. Why was it unable to retain their confidence? Because "a series of business decisions had left it with heavy concentrations of illiquid assets with deteriorating value...." Those decisions, misguided though they were, were within the business judgment rule -- i.e. they were legal. What may not have been legal, though, was the use of accounting trickier to obscure them.

The short sellers, then, were right. They accurately perceived the rottenness that Lehman's accounting trickier was designed to hide. Short sellers are the heroes of this examination, not the villains. Of course, they are well-compensated heroes, so there is no need to cry over their underappreciated character., Still, the short sellers were doing a valuable job, doing it well, and were made the scapegoats by the real malfeasors.

Who'd a thought?

Bill Ackman

Eric Jackson, of thestreet.com, has written this profile of Bill Ackman, the CEO of Pershing Square, and has thereby inspired me to put together a few Ackman-related links for you folks this morning.

Pershing Square has a very high exposure these days to the General Growth bankruptcy proceedings as discussed in Market Folly, and as discussed by Ackman himself here.

Here's the latest on Pershing Square and General Growth, from Reuters.

And here's Ackman on CNBC's Fast Money, talking about Kraft.

The Wall Street Journal gave Ackman a positive write-up in regard to his firm's February performance here.

But we began with one blog and we'll end with another, even if we have to got back behind the latest New Years' celebrations to find one we like, The Investment Linebacker.

Selectica's poison pill upheld

The Delaware Court of Chancery recently dismissed a challenge to Selectica's shareholder rights plan, i.e. its "poison pill."

The facts of this case take us back to November 11, 2008, when Versata Enterprises, Inc. and related parties filed a Schedule 13D disclosing a 5.1% ownership position in Selectica common stock. Selectica had a poison pill plan in place at that time, but it had (as is/was the custom) a 15% triggering threshold, so Versata had no reason to believe that this was an epochal moment.

Six days later, though, apparently because of concern that futher share accumulation would have an impact on its own net operating loss carry forwards (NOLs), Selectica amended its pison pill to reduce the triggering threshold to 4.99%. Holders who had more than that before the adoption of the new plan were exempted, providing they didn't thereafter acquire another half percent.

On November 19, Versata updated its 13D filing to disclose a 6.1% ownership interest. It is unclear whether Versata was aware of the reduction in the triggering threshold two days earlier. From there we got to this, the board pulled the trigger (swallowed the pill, whatever the pertinent metaphor might be) on January 2, 2009.

Key takeaways fgrom the Chancery Court decision upholding Selectica:

1. Loss of NOLs is a legally cognizable threat under Unocal Corp. v. Mesa Petroleum Co.
2. There is nothing de jure about a 15% threshold, it has been simply a custom.
3. A decision to lower the trigger in the face of a legally cognizable threat is not per se invalid under Delaware law.

Random Quote

This concerns an incident from 1869. I find it in the book "The Money Men," by H. W. Brands. Consult amazon dot com if you wish further information.

"Fisk and the bulls plotted how to squeeze the bears most painfully. The pool held commitments for delivery of more than $100 million, at a time when barely $15 million in gold and gold certificates circulated in New York outside the vaults of the subtreasury there. Someone suggested publishing the names of the shorts -- a group that included more than two hundred of the city's most prominent bankers, brokers, and merchants -- and the amounts they owed. The bad publicity alone would bring many to their knees and they would beg to settle at whatever terms the bulls required. But someone else suggested that such a course might constitute, or indicate, crimninal conspiracy. And there was no telling what the desperate bears might do by way of personal injury to particular bulls. The extortion scheme was shelved."

WaMu agreement near

Just a quick note, because this has been a very busy weekend for me.

On Thursday, the judge presiding over the bankruptcy of WMI (the former holding company of Washinton Mutual) postponed a hearing on WMI's dispute with JPMorgan, because lawyers told the court that settlement talks were well advanced.

Casual observers of such matters may not be aware that there was a WMI filing. The operating company itself, WaMu, didn't go bankrupt during those hectic days of the fall of 2008. Rather, the Federal Deposit Insurance Company, acting as receiver, simply seized it and sold “substantially all” WaMu’s assets to JPMorgan Chase, Inc. (JPMC). At the same time, the holding company, WMI, remained in existence, and did file for bankruptcy.

This was all done hectically without a lot of attention to specifics, such as which assets remain with which of those entities. The resulting litigation has generated a lot of paperwork, and some intriguing disputes on contested points of bankruptcy procedure.

Indian Takeover Legislation

There have been a lot of acquisitions of late that have involved one party in the nation of India, another somewhere else. For example, India's Reliance Industries in November offered to buy LyondellBasell Industries. Last month it sweetened that bid. Separately, Bharti Airtell has lately made a USD$9 billion offer for Zain Africa. This is its third attempt in two years to get an African presence.

Those are two instances in which Indian companies are the would-be buyer. But it stands to reason that Indian assets will come into the sights of outside corporations, as well. Accordingly, Sandeep Parekh, of the Indian Institute of Management, has offered us all a primer on Indian Takeover Regulation, which he calls "Under Reformed and Over Modified".

One paragraph from his abstract: "This paper argues that the complexity in the trigger points for disclosure and tender offer introduced over the years lacks a philosophy, and most of the amendments can not only be deleted but a very simple structure can be introduced making compliance of the regulations straight forward and easy to understand by management of listed companies. Certain other areas which need amendments have also been discussed. Chief amongst these are the provisions relating to consolidation of holdings, conditional tender offers, hostility to hostile acquisitions, definitional oddities, payment of control premium in the guise of non compete fees, treatment of differential voting rights, treatment of Global Depository Receipts and disclosure enhancements.

Skilling's arguments

The Supreme Court of the United States yesterday heard arguments on an appeal by Jeffrey Skilling, of Enron infamy.

You'll remember, although in the world of business/financial scandals this already seems a long time ago, that in October 2006, Skilling was sentenced to 24 years and 4 months in prison, and fined $45 million, and he began serving that sentence that December.

There are two questions before the court on appeal. First, was it constitutional that this case was tried in Houston, Texas, where the rest of that city's economy had been closely intertwined with Enron's fate, and where the bitterness over its failure was strong? Skilling's lawyers contend that "given the widespread community hostility toward Skilling, the [trial] court should have presumed the jurors to be prejudiced, and therefore changed venue to obtain jurors from a community that was not itself a direct victim of Enron's devastating collapse."

Second, the defense contends that section 1346, which defines "honest services" fraud, is unconstitutionally vague. That is the section of Title 18 of the US Code that criminalizes "a scheme or artifice to deprive another of the intangible right of honest services."

As it applies to old-fashioned bribery this seems easy enough to understand. If I accept payment from my employer (i.e. a corporation and its shareholders) to do my job in a careful and lawful way, then accept a payment from a third party to do the job in a careless or illegal way, then follow through on my promises to that third party, one can see how I have cheated my employer.

But there exists a much more specific anti-bribery statute, against both offering and receiving. And that doesn't appear to apply to Skilling. So what does the honest-services language accomplish? Anything specific? This is what the lawyers and Justices were thrashing out yesterday.

Warren Buffett

Buffett is buying up Burlington Northern (BNSF), an historic railroad.

Check out their website. BNSF describes itself as the product of 390 different railroad lines that have come together under the same corporate roof over a period of 150 years. Among them: the Northern Pacific, the Great Northern, and the Santa Fe. It has 32,000 route miles through 28 states, and two Canadian provinces. That's impressive infrastructure, especialy if one happens to be a grandson of Henry Comstock.

Anyway, Buffett's holding company, Berkshire Hathaway, is paying $100 a share for those shares of BNSF it doesn't already own, and (this is the surprise, given Buffett's known predispositions) it is doing so with a combination of cash and stock.

Why is there a stock-swap component to this deal? In his annual letter to shareholders, issued Friday, Feb. 26, Buffett said: "The reason for our distaste is simple: If we wouldn't dream of selling Berkshire in its entirety at the current market price, why in the world would we 'sell' a sigificant part of the company at that same inadequate price by issuing our stock in a merger?"

Good question. After some heming and hawing, WB gets around to the answer. Sort of.

"In the end, Charlie and I decided that the disadvantage of paying 30% of the price through stock was offset by the opportunity the acquisition gave us to deploy $22 billion of cash in a business we understood and liked for the long term. It has the additional virtue of being run by Matt Rose, whom we trust and admire. We
also like the prospect of investing additional billions over the years at reasonable rates of return. But the final decision was a close one."

Aaaah. Well, if Matt Rose is running the railroad, then swapping BRK for BNSF makes perfect sense!

In the words of Felix Salmon, "The letter does make it seem that it's a lot easier to argue against the BNSF acquisition than it is to argue for it."