So oft of late has my interest by the hedge fund private equity conflict been piqued, I have created the Polonius category. You may recall my previous references to Polonius, that ill-timed and hapless soul eventually felled by Hamlet's blade as an accident of timing. Of course, in this case I mean activist hedge funds, and not hapless manslaughter victims. Often, however, Hamlet feels the cold sting of the blade from Polonius, not Laertes.
Paul, my sleeper agent in an activist hedge fund, points us to a dramatic demonstration.
Set the way back machine for the K-Mart bankruptcy, says Paul.
In short, some pretty myopic pricing spooked the hell out of K-Mart's vendors who tightened or refused to grant the chain credit. The vendor panic that ensued from the credit crunch spiral effectively sunk the company.
Eddie Lampert flies in to save the day, rescuing the flagging retailer and converting his debt into controlling equity. Lampert effectively makes a private equity play out of it.
Lampert closes some five to six hundred stores and sells a half-hundred leases on existing real estate before renegotiating a series of contracts with vendors (which included Sesame Street, amusingly). Things go mostly swimingly, and so Lampert's vehicle, ESL uses K-Mart after it exits bankruptcy to buy Sears.
This is fine, except that Sears happens to own 63% of Sears Canada. Lampert wants the rest and offers to buy out the minorities at C$17.94. The problem is that it is trading at upwards of C$32 at the time (though one astute reader points out that with the dividend Sears announced that amounted to a trading price of C$14 per share). The independent directors at Sears Canada throw a fit, but to no avail. And here's where things become more or less a matter of opinion:
Sears US harangues them so severely that they resign and are replaced with the finest quality wooden marionettes available in the northern hemisphere.
At this point, it shouldn't surprise anyone that Polonoius, in fact several Polonoiuses, have cows and refuses to tender. The tender offer fails and Sears US doesn't have the support within the minority to squeeze-out the dissenters. Then things allegedly get nasty.
Two of the banks advising Sears US are hedging against swap positions held by the dissenters with shares of Sears Canada. Enough shares, as it turns out, to sway the vote. A bit of accounting study suggests that a delayed closing will give the banks some tax benefits (not available to the other shareholders) and a timing for tender trade is in the works for the banks and Lampert.
Not so fast. The minorities discover this ruse and before long the Ontario Securities Commission is delivering a good caning to Lampert who, as a hedge fund guy himself, should have had some sort of sympathy for the plight of the minorities.
This week the vote came in, minorities (and Poloniuses) prevailed.
The Ontario Securities Commission factual summary is worth a read for anyone interested in the mechanics of the private equity vs. hedge fund conflict. I think these are my favorite passages:
Pershing approached SunTrust with a view to entering into cash-settled total return swaps approximately equivalent to 5.3 million Sears Canada shares (the “2005 Pershing Swaps”). The purpose of Pershing entering into the 2005 Pershing Swaps was to minimize its exposure to Canadian withholding taxes by disposing of its Sears Canada shares prior to receiving the dividend while maintaining an economic interest in the performance of Sears Canada shares.
On March 31, 2006, Pershing sold 1,600,000 shares of Sears Canada to SunTrust and entered into another cash-settled total return swap transaction with SunTrust (the “2006 Pershing Swaps”), on substantially the same terms as the 2005 Pershing Swaps. SunTrust offered Pershing the alternative of cash or physical settlement. At the time Pershing entered into the swap it elected cash settlement. Pershing did not maintain a legal or beneficial interest in, or the power to exercise control or direction over, the voting rights in respect of the Sears Canada shares that were sold by it at the end of March.
"To swap or not to swap," to bring The Bard into the fold again, is a delicate question. Swap and avoid withholding taxes and such in a foreign jurisdiction and hope that the custodian keeps your best interests in mind when it comes to voting, or "go naked" and deal with the taxes. Pershing almost got gelded here on this point and managed to pull the chestnuts out of the fire with a clever inequity argument. One wonders if Lampert couldn't have prevailed if he had been more circumspect. But, of course, that may well have run afoul of disclosure rules.
Suffice it to say that the dynamic between Polonius and Hamlet is quite complex.