October 28, 2005
Hedge Funds: Successes and Failures
Jenny Anderson's Insider column in today's NYT chronicles a hedge fund raid on BKF, a publicly-traded asset management company. Several hedge funds, led by Steel Partners and Cannell Capital, bought shares in BKF, waged a successful proxy fight and elected three new board members (forcing out, among others, Burton G. Malkiel a noted Princeton professor of economics), eliminated the firm's poison-pill plan, and pushed out the firm's CEO. The funds sought to increase share value by increasing BKF operating margins, which were below industry averages. For their efforts the funds lost big; stock has fallen 39 percent since last December and BKF continues to hemorrhage clients.
The raid illustrates how and why hedge funds are so active. Because hedge funds hunt in wolf packs (one announces a position and others follow), they do not trigger anti-takeover defenses. Most poison-pill plans and other defenses are triggered by an unwanted stock acquisition of 10 percent or higher. No one fund has ten percent and the funds are not collectively a single group because they act alone, not in organized explicit concert. The five percent trigger of 13(d) is not a problem, indeed it can be an advantage, as one hedge fund goes over five percent and announces in a 13(d) filing what its plans are so as to encourage other hedge funds to join in.
Once the funds take over 30 percent of the public float in the stock they have (or threaten) effective control over board elections. Most managers capitulate and do what their new largest group of shareholders wants; those that do not lose in BKF style proxy contests. The key is the hedge funds' ability to circumvent a firm's anti-takeover defenses by flying under the stock accumulation triggers.
Why do firm's not declare that the hedge funds have triggered the defenses by acting as a group? Because once triggered a poison-pill defense wrecks the financial structure of the firm for everyone, not just the unwanted bidder, by creating, among other things, situations of severe, uneven stock dilution or a severe captial drain. The poison-pill plan trigger stops firms from using other defenses that do not wreck the firm (business combination freeze-out triggers, for example) because a declaration that they are triggered will also trigger a poison-pill plan. The poison-pill plan becomes a firm liabiltiy!
It really is a game of chicken and the hedge funds have called firms' bluffs and forced them to swerve. If the funds' prescriptions for corrections are correct, the funds profit on a stock price increase. If incorrect, they lose big.
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