NEW YORK (The Deal) -- In the world of modern-day activists no company is too big-or too well defended to elude investor displeasure. But a company with a dual class share structure has traditionally looked like a fortress on top of a mountain surrounded by a moat of fire. In other words, exceedingly difficult for an insurgent to conquer.
A dual class share structure -- sometimes called an A/B structure -- effectively keeps control in one voting class. It was a structure favored by the traditional family-owned publishing companies when they went public. Family owners of The New York Times (NYT - Get Report), Washington Post and Dow Jones believed the mechanism would ensure that business needs would not override journalism ethics.
Another group of dual class structure companies includes those where private equity backers retain control, often through a separate holding company. Recently, building construction materials company Summit Materials, which was formed by Blackstone Group, set the price range for its expected initial public offering, seeking to raise up to $400 million, partly as a way to pay off the debt its PE backer took out to do myriad rollups. Summit is offering public shareholders 24.1% voting power in the company, according to regulatory filings, with the rest of the votes controlled by its PE owners.
Some of the biggest companies in the world have adapted the controlled company feature, most notably the big Internet companies that have dominated the IPO scene in the last few years, including Facebook (FB - Get Report) and Alibaba Group Holding (BABA - Get Report).
According to statistics compiled by Institutional Shareholder Services the number of companies with two classes of stock in the S&P 500 have ticked up in the past two years, from 6% in 2013 to 8% by the beginning of this year. For the universe of stocks outside the S&P 500 the rise has been greater: 7% of companies had a dual-class share structure in 2013 -- it stands at 10% today.
To an activist investor, a dual class structures is like a super-majority voting requirement on steroids. What usually happens is that while the public -- usually the Class A shares -- might own more stock, insiders, generally founders or a private equity backer, have more voting rights. Sometimes for every one vote a Class A shareholder will have at the annual meeting, the Class B owners will control as much as 10 votes. When it comes to voting for board directors, it decidedly skews balloting in favor of controlling shareholders.
Take the example of noted activist Mario Gabelli (pictured). For years, he has been pushing for changes at Telephone and Data Systems (TDS - Get Report), a dual-class share company that is controlled by the Carson family. Though Gabelli got two seats on the board in a 2009 settlement, he has yet to get TDS to buy up the rest of the shares that it doesn't already own of its wireless, publicly traded subsidiary, US Cellular (USM - Get Report). The Carsons don't want to do it and Gabelli can't make them.
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All may not be lost for investors who want to shake up a controlled dual-class share company. Damien Park, managing partner of proxy advisory firm Hedge Fund Solutions, acknowledges that he doesn't know many activists who will run a proxy contest when they are guaranteed to lose. Still, it is possible to apply pressure even in dual class share companies.
For example, if the controlling shareholders don't have a complete stranglehold on the company -- investor advisers often cite 35% inside ownership as being the cut-off point for effective proxy campaigns -- constructive conversations with management may yield results.
And while Park says that a few years ago he would counsel investors not to waste their time on A/B share structure companies, now, he notes, it's "more difficult to find good, undervalued, small- and mid-cap situations." So some of the firms he advises may consider taking on such companies. Those mountaintop fortresses that were "previously untouchable, aren't untouchable anymore."
Indeed, the very the lure of dual class companies, one experienced investor says, is that there is often a valuation disparity. The share price of these companies trades at a severe discount because of the dual structure, thereby attracting activists.
It's not without historical precedent, either. At theme restaurant chain Benihana, though activists had managed to nab board seats, majority shareowner, Benihana of Tokyo, was still resisting calls to collapse its dual share structure. Eventually, the company went to one class of shares and, in 2012, Benihana was sold to Angelo Gordon for $296 million.
And not every dual class structure is created equal, says Steve Wolosky, head of Olshan Frome Wolosky's activism practice.
At title insurance company Stewart Information Services (STC - Get Report), which has an A/B structure, and where Wolosky was advising activists Foundation Asset Management and Engine Capital, the investors in 2014 got an agreement from the company to put two of their nominees on the board and to cut pretax costs.
"Public shareholders might be in the minority, but they can still put nonbinding public pressure on the board," Wolosky says. "It's part of the equation. They [the investors] take a look at a company to see what's the path to unlocking value."
Now, another dissident has shown up at Stewart Information -- longtime activist Phillip Goldstein of Bulldog Investors, with a 5.01% stake, who continued, in a regulatory filing last month, to question the dual share structure and the valuation discount the investor claims it confers on the company.
And, notwithstanding their ability to fend off a proxy fight, boards are increasingly sensitive to their fiduciary responsibilities these days, an investor says.
"Absolute control on paper is not absolute in practice," this person notes.
So even an executive who believes she is safely ensconced behind an A/B structure shouldn't be surprised to one day see a hedge fund manager leaping the moat and charging up the mountain.