Spring has arrived, and for investors that brings proxy season. Most companies hold their annual shareholder meetings in April and May, and the most important part of these meetings is the election to determine who sits on the board of directors. As shareholders own and control the company, they collectively make this decision through their votes. Almost no one casts votes in person at these meetings, so they vote by absentee ballot (usually online or by paper mail), called a proxy.
Most proxy votes are routine, with the outcome pre-determined. Directors are almost always re-elected or replaced by board-approved new candidates. But not always. Sometimes, proxy fights ensue.
If a company’s operating and share price performance is dismal, some shareholders may seek to replace some or all of the board members in an effort to turn around the company and its share price. These dissident shareholders may put forth one or more of their own board candidates, and then seek to persuade enough other shareholders to vote for them in hopes of gaining board seats.
While proxy fights are serious business, they can also be entertaining.
Jeff Gramm, a hedge fund manager and value investing professor at Columbia Business School, wrote a book, Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism, that recounts several of the more colorful shareholder efforts to change bad management practices. Each chapter is based on an actual letter written by an activist investor, starting with Benjamin Graham’s comparatively genteel pressure at Northern Pipeline to the highly entertaining letter written by Daniel Loeb to Star Gas wondering whether the CEO’s 78-year-old mom belongs on the board of directors.
Are proxy fight stocks worthwhile investments? Possibly. If the stock is out of favor, the company’s problems are fixable by new leadership and the dissidents win, then investors can be amply rewarded. The October 2014 proxy battle by Starboard Value led to the replacement of Darden Restaurants’ (DRI) entire board of directors. As the new leadership turned around the company, the shares went from lackluster to sharply outperforming the market.
More recently, in a closely watched proxy vote showdown last year, tiny activist investment firm Engine No. 1 gained three board seats at energy giant Exxon Mobil (XOM). While much of the subsequently impressive share price gains were driven by surging energy prices, the rebuke to CEO Darren Woods’ aggressive growth strategy clearly helped.
A controversial new rule from the Securities and Exchange Commission (SEC) may simplify proxy battles. Under the former rule, activists needed to distribute a separate proxy card to shareholders to solicit their votes – a cumbersome and murky process. The new system creates a Universal Proxy Card on which all candidates (from both the company and the dissidents) are on a single ballot sent by the company.
Like all turnaround investing, being selective is the key to success. Outcomes of most highly contested campaigns are unpredictable, so we generally avoid pre-vote situations. We may miss some winning stocks in the run-up to the vote, but we avoid the many cases where the shares slide following an unfavorable vote. However, if the dissident campaign succeeds, our experience shows that subsequent share price gains can still be strong yet with much lower risk.
Two current proxy battles worth a closer look include:
Proxy Fight Stock #1: Republic First Bancorp (FRBK)
This bank, not to be confused with the highly regarded First Republic Bank (FRC) based in San Francisco, is engaged in a vitriolic battle. Chairman/CEO Vernon W. Hill II, who founded Commerce Bancorp, joined Republic First in 2008. During his tenure so far, while the bank has grown from $700 million in assets to the current $5.4 billion, it has been a chronic underperformer. Its fundamental performance ranks among the worst of its peers, as does its share price.
Two investor groups are pressing for changes through proxy battles.
Driver Management Company, an investment firm specializing in banks, expressed their frustration in no uncertain terms in a November 21, 2021 press release, saying, “We are deeply troubled by the prospect of Republic pursuing a highly-dilutive capital raise – at the direct expense of existing shareholders – to support a flawed business model that has produced dismal returns for far too long. It is not lost on shareholders that a dollar invested in Republic five years ago is worth significantly less today. We question how any board of directors could even consider subjecting shareholders to punitive dilution on the heels of such significant underperformance. We urge the Board to prevent Vernon Hill from diluting shareholders and leading Republic down the path of Metro Bank, which saw massive destruction of shareholder value as a result of Mr. Hill’s obsession with an unworkable business model.”
The other investor group, with a 9.6% stake in the bank and supportive of Driver Management’s efforts, is led by George E. Norcross III. Norcross was a director at Commerce Bank, and quite familiar with self-dealing problems that led to Hill’s resignations from Commerce Bank and his subsequent board position at a different bank.
With the shares trading at a highly discounted 0.7x tangible book value, shares of Republic First Bancorp look well positioned to benefit from a proxy win by the dissidents, but may have limited downside if they lose.
Proxy Fight Stock #2: Kohl’s (KSS)
Shares of this department store remain unchanged from their price of 20 years ago. A recent change in leadership that brought in new CEO Michelle Gass hasn’t produced much in the way of fundamental progress or investor confidence. Activist investor Macellum Advisors, which holds a 5% position in the retailer, put forth two candidates in Kohl’s proxy vote last week, though neither candidate was voted in as the company’s shareholders instead reelected all 13 of the current board members.
Investors can quickly understand Macellum’s viewpoint simply by reading the opening header of their January 18, 2022 letter to the Kohl’s board that states, “Another Wasted Year.”
Despite the lost vote this time around, Macellum has vowed to keep trying to make changes at Kohl’s. “We aren’t going away,” Jonathan Duskin, the activist investor’s CEO, told CNBC after the failed vote.
Change is clearly needed at Kohl’s and an eventual win by Macellum could produce that change. As the shares trade at a discounted 3.4x EV/EBITDA, and pay an appealing 4.1% dividend yield, Macellum’s ongoing battle for control is a big potential catalyst for the shares going forward.
At the Cabot Turnaround Letter and Cabot Undervalued Stocks Advisor investment advisories, this is the type of analysis we do every day. Let us help you sort through the market to find the best catalyst-driven stocks.
Do you pay attention to proxy season? Have you invested in a company in the midst of a proxy battle? Tell us about your experiences in the comments below.