The Lost Wisdom of Polonius
O, fear me not.
I stay too long:--
but here my father comes.
A double blessing is a double grace;
Occasion smiles upon a second leave.
Yet here, Laertes! aboard, aboard, for shame!
The wind sits in the shoulder of your sail,
And you are stay'd for. There,--my blessing with thee!
[Laying his hand on Laertes's head.]
And these few precepts in thy memory
Look thou character. Give thy thoughts no tongue,
Nor any unproportion'd thought his act.
Be thou familiar, but by no means vulgar.
Those friends thou hast, and their adoption tried,
Grapple them unto thy soul with hoops of steel;
But do not dull thy palm with entertainment
Of each new-hatch'd, unfledg'd comrade. Beware
Of entrance to a quarrel; but, being in,
Bear't that the opposed may beware of thee.
Give every man thine ear, but few thy voice:
Take each man's censure, but reserve thy judgment.
Costly thy habit as thy purse can buy,
But not express'd in fancy; rich, not gaudy:
For the apparel oft proclaims the man;
And they in France of the best rank and station
Are most select and generous chief in that.
Neither a borrower nor a lender be:
For loan oft loses both itself and friend;
And borrowing dulls the edge of husbandry.
This above all,--to thine own self be true;
And it must follow, as the night the day,
Thou canst not then be false to any man.
Farewell: my blessing season this in thee!
Most humbly do I take my leave, my lord.
The time invites you; go, your servants tend.
I was once told that the brilliance in Hamlet is, Hamlet. I think this view trite and shallow. I've always understood the brilliance in Shakespeare, as a whole, to be the many layers in which he writes. Every tier of the audience can draw something from his best work. Hamlet, while a tragedy, is sprinkled nicely with humor. Some dark, some light, some subtle, some slapstick, some all four. And Hamlet, while perhaps one of the deepest and certainly the most existential of the Bard's works, (The Life and Death of Richard the Third is it's only rival for complexity and depth of exploration in my opinion) still holds enough lighter fare for the young to pleasantly sit through a good production thereof.
One of the down sides of such flexibility is that people see what they want in Shakespeare, and they tend to do so by missing subtleties. Dick the Butcher's famous "...kill all the lawyers," quip in Henry VI is perhaps the most notorious example. It pays, therefore, to pay attention to the details and the deeper meanings in his works.
The humor in Polonius, I have always found, is his begging insistence to be a part of the play in a role much larger than he warrants. His contradicting advice (rambling wisdom to those willing to ignore those details I speak of) amuses both because it sounds contradictory and mostly useless (though deeper reflection shows it actually to be quite wise) and seemingly endless (at least to the characters unfortunate enough to be on stage with the ill-fated advisor).
His interests work entirely against the world that the audience associates itself with, and to which Shakespeare deftly distracts their attention. The trials and travails of Hamlet. Hamlet's plight is so terrible to contemplate that without some relief the play would doubtless would lack the potency it enjoys.
Consider, however, if the play were titled "The Tragedy of Polonius," (his demise is awfully tragic after all). Hamlet's existential whining and endless moping might well grate our nerves in this new play as we anxiously await the next development in Polonius' struggles to preserve his place in the King's court, to prevent his daughter's flirtations from Hamlet from marring his reputation with the King, to see his son off to University well, and so forth. There is a whole nuance there, a play within a play, (at least the second in Hamlet) keenly ignored- or at least overlooked.
Polonius plays against the audience expectation that a minor character, would prattle on so, and outlive his welcome in every instance of his appearance, so much so, in fact, that it eventually kills him when he finally wanders for the last time into a scene that should have much earlier carried the stage instruction "[exit Polonius]" or perhaps even "[exeunt all but Polonius]."
Indeed, at least for Polonius, timing was everything. I want to explore this conflict- but let's use something more "Going Private" for the theme today. Let's use finance.
My Polonical fascination with timing stems from an ongoing conversation
with the head of activism for a hedge-fund on the neglected topic (as if it were Shakespearean detail) of what has in
recent years, and against the backdrop of private equity and hedge fund
convergence, become an increasingly common occurrence, namely,
cooperation and, occasionally, conflict between private equity and
hedge funds as common shareholders. I believe that the fluid transformation of these dynamics has changed the landscape of shareholder activism and, in turn, unveiled a new interplay in corporate governance. This, I believe, is worth no small amount of attention.
Sub Rosa has had occasion to work with some of the more active and prominent hedge funds (including, by the way, the likes of the luckless Amaranth, with which I have, in particular, done quite a bit of work). While it had been mostly rare for us to encounter activist shareholders given the smaller size of deals we tend to pursue, we have begun to find ourselves in cahoots with such shareholders more often in the last several months as the fluidity of the market place causes them to reach for smaller deals and for us (and smaller private equity firms like us) to reach higher.
I have been lumping hedge fund activists into two categories. First movers and follow-on activists. First movers tend to seek out, target and attack publicly held firms as a primary strategy. Follow-on activists jump on the bandwagon after someone else has started the fight. I am less responsible for this categorization than Morgan Jospeh, the mid-market investment bank, and they have probably lifted it from common usage themselves. (Their white paper on the subject is highly recommended).
The dynamics of the cooperation between these two classes of hedge funds are themselves very complex and driven (or restrained, as the case may be) by disclosure requirements. 13Gs are filed before the intent to exert an active role through the shares. However, within 10 days of acquiring 5% or more of the voting interests (or having options to do so) of a listed firm Schedule 13D must be filed disclosing, among other things, the intent of the investor (acquisition, management replacement, etc.). Complicating matters, if any group acting in concert together owns 5% or more of the voting interests, or has options to acquire them, they must together file Schedule 13D within 10 days of the acquisition of the shares or options.
This lower bound is complicated by the upper bound of 10%, after which the firm or group must file a Form 3 within 10 days. A Form 4 must be filed within 2 days of any purchase or sale of shares thereafter. The 10% number is sticky not for the reporting requirement, but because the 10% ceiling imposes an "insider" status to the investor and this triggers some ugly matching and profit disgorging rules that most activists will badly want to avoid. For this reason firms with under 10% are wary of appearing to act in concert with other shareholders as they may be branded as a "group" holding in excess of 10% and, therefore, subject to disgorgement, etc.
Even more burdensome, the Hart-Scott-Rodino threshold, surprisingly named for the "Hart-Scott-Rodino Antitrust Improvements Act." This obscure restriction requires notices and prior governmental clearance after a 30 day waiting period as the government looks for anti-trust issues if more than $56.7 million in shares are owned by an entity. That's a time consuming and expensive process. Says the Head of Activism: only the likes of Carl Icahn, who expect to be in for a long haul, bother.
All this is a long way of pointing out that the dynamics between activists are complex and often require a lot of tip-toeing.
According to my Head of Activism friend, the former class of activism seems to take very heavy lifting. There are few first mover activist funds and fewer "pure" activist funds (who concentrate primarily on activism as a strategy). First movers require quite a bit of work and high adept legal teams, as the threat of litigation, and eventually proxy fights, is the primary "stick" activists wield. They are expensive to run, have long-term horizons and, accordingly, are the rarer variety.
Targeting firms is probably the "highest art" in the tasks undertaken by first mover activists. Morgan Joseph outlines a set of criteria for "activism vulnerable" firms that Going Private readers will likely have anticipated:
...high cash balances, M&A activity with questionable rationale, under-exploited asset values, depressed valuation multiples, earnings underperformance or the presence of disparate businesses with limited strategic underpinning wrapped within a single entity.
Follow-on activists tend to join first movers once a firm is in "play" and join, either formally or informally, in the agitation. This strategy is often less lucrative (as the news of a well known activist's attack often itself drives stock price up in anticipation of positive change) but also doesn't hold the up-front and ongoing costs that first movers might.
This effect can look "wolf-packish" or, in an analogy brought to my attention by the yummy Abnormal Returns citing Jeff Matthews, "…when the market smells blood in the water, it goes after whatever is bleeding and doesn’t let go."
Clearly, publicly held firms present the cleanest targets for activism as the liquidity in shares makes it easier to both gain a significant stake in the firm, and also exit quickly once return targets or other goals have been achieved. (Despite this, some jurisdictions with significant- even misplaced- concern for the oppression of minority shareholders in closely held firms make good hunting grounds for activism in closely held firms. Often these efforts tend more to the sinister and sleazy).
Quick reflection will cause the Going Private reader to realize that activist firms would do well to target public firms with highly concentrated blocks of major institutional shareholders likely to have similar goals to the activist, rather than fragmented equity structures that will make it difficult to generate a credible threat of a victory for the activist(s) in a proxy fight. Depressed share prices in combination with a number a large (and theoretically cranky) institutional shareholders are, therefore, likely a beacon for activist interest. Retail shareholders are generally considered a "minus" and high insider or employee ownership (where it tends to vote with management) is equally annoying.
Interestingly, this dovetails nicely with recently IPOd (and I now wonder after LIPOd, *ahem, Burger King*) firms with significant "leave behind" investments by private equity firms. Almost by definition, if a public firm has a private equity fund as a significant investor, that investment is near the end of its term for a private equity investor. Even assuming a 1-2 year time frame between initial investment by a private equity investor and an IPO (and this would be wonderfully quick) it is doubtful that the private equity fund has more than a 2 year lockup, and perhaps not even that. More likely, the IPO was after 3-4 or even 5-6 years and the private equity fund is itching to get out. Perhaps the life of the fund is drawing to a close. Certainly, distributions to the fund's investors are a strong pressure for a quick private equity exit. Not only that, but given the importance of IRR to the fund, and that the fund is already probably sitting on 35%+ of it, the private equity fund has sharply different motivations with respect to timing than an activist. A quick example might be illustrative. I draw this from a highly sanitized real-world Sub Rosa example:
Let's assume for a moment that Sub Rosa invested $10,000,000 in Loser Management, Inc. back in 1/1/02 for a leveraged buyout. Sub Rosa acquired 100% of Loser Management in the transaction, did all the things private equity firms do for the next four years and then, with great fanfare, IPOd Loser Management, Inc. on New Year's Day 2005. (Since Sub Rosa is so influential, and the IPO so hot, the market was opened specially for the IPO). Let's give Sub Rosa paper gains of 300% on the investment and assume, for argument's sake, that it held its entire position in Loser Management, Inc. pursuant to a 1 year lock-up agreement that forbid the selling of any shares by Sub Rosa (even in the IPO) until 1/1/2006. This isn't particularly realistic, as Sub Rosa would certainly have insisted on exiting a good portion of the investment and probably given itself a fat dividend in the meantime before the IPO, but the Debt Bitch was asleep at the wheel after a hard night of martinis with the folks at Pershing Square and bungled the pre-IPO loans. (This simplifies things and the outcome isn't particularly different for the purpose of the analysis- don't tell Laura about this hypothetical, thanks).
Unfortunately, on 12/31/06 (right before the corks pop) Activism, L.P., calls up Sub Rosa and introduces itself as the next largest shareholder of Loser Management and indicates that it intends to agitate for change and anticipates a sharp increase in share price as a result. Would Sub Rosa like to participate?
Sub Rosa is torn. Big boost in the stock price sounds good, but Sub Rosa has ties to the management of Loser Management (we probably actually installed them, actually, but the private equity firm could well have slipped out of the power circles intentionally as the IPO approached) and really isn't sure it wants to alienate them. So the senior people at Sub Rosa ask some poor, young, Vice President to do a quick analysis. What kind of returns can Sub Rosa expect from an activism campaign?
In this particular case I used Bally Total Fitness, a long and protracted campaign involving litigation, but generally considered a success. (The campaign yielded a 58.1% ROI to Liberation Investment Group after almost 2 years). Should Sub Rosa jump on board? The math looks about like this:
As you can see, the impact to the IRR of Sub Rosa is not good. This late in the game Sub Rosa, like most private equity firms, is highly time sensitive when it comes to exit. In this case a 25.74% IRR (tasty for the hedge-fund) is just not enough to keep Sub Rosa in the game. This is in addition to the additional risk of a failure of the campaign, and it becomes easy to see why private equity firms might choose to pass on the opportunity to participate and, in fact, might find themselves on the other side of activists angling for a better price on a sale when it looks likely to be a 6-12 month fight. At this point, Sub Rosa would just love to hook Polonius right off the stage.
Later this week: Ophilia was a private equity Vice President.
(Special thanks to a certain Head of Activism for some local color and a certain SVP in a private equity firm for war stories, three hours of discussion and as many hours of martinis).