Avoid the Dynegy Dilemma; Reach Out to Shareholders

Will the last shareholder leaving Dynegy please turn out the lights?

In what may be one of the more bizarre examples of a corporation's failure to convince its owners to follow management's recommendations, on Feb. 18 Dynegy shareholders rejected an all-cash offer from renowned activist Carl Icahn to buy the energy company for $665 million. Three days later, Dynegy's CEO, CFO, and all five of its independent directors resigned, leaving shareholders to decide the fate of the company themselves.

In what might be the understatement of the year, University of Chicago business professor Steven Kaplan was quoted in one media report saying, “I think this is very unusual, even wild.” So say we all, Mr. Kaplan.

How did things get to this point? Let's give some history first. Dynegy had two major shareholders: Icahn (doing business as Icahn Enterprises) owned 15 percent of shares; and Seneca Capital, an activist hedge fund, held another 12 percent in shares and options. On Feb. 18, shareholders rejected Icahn's buyout offer of $5.50 a share, at a time the stock was trading around $6. That came on top of another rejection last November, when shareholders turned down a buyout offer from the Blackstone Group of $4.50 per share when the stock was trading around $3. Seneca Capital urged that first rejection on the grounds that the company was worth more, an argument the fund used again to help defeat the Icahn offer in February.

So the Icahn offer was defeated. On Feb. 21 word came down that Chairman & CEO Bruce Williamson would resign as of March 11, and the board of directors would not stand for re-election at the annual meeting in June. Interim Chairman Patricia Hammick gave credit to Williamson for bringing Dynegy back from the brink of bankruptcy: “Bruce has guided Dynegy through numerous challenges over his eight-year tenure, including stabilizing the company at a time of great uncertainty, reducing the company's outstanding debt by more than $10 billion, implementing a comprehensive program to reduce environmental emissions from the Midwest coal fleet, and setting a new strategic direction by focusing on the electric generation business while exiting unrelated lines of business.”

Dynegy's board also had little love for Seneca Capital. In a Feb. 11 letter to shareholders, its special committee reviewing the buyout offer stated that Seneca “disseminated materials that contained factual errors, inaccuracies, and exceedingly wishful assumptions about power margins and environmental enforcement that make its purported equity valuation highly misleading to our investors.” The letter also said the board had hired Goldman Sachs and other advisers to review the company's value, and under a variety of scenarios, Icahn's offer still seemed like the best deal shareholders were going to get. The letter closed by noting that the company had spent more than 100 days shopping around for other suitors, found none, and urged shareholders to take Icahn's buyout while they could. The shareholders did not.

So … how did shareholders come to reject two buyout offers in three months, one that exceeded the value of the stock at the time (Blackstone), and another (Icahn) that roughly matched the value of the company in cash?

One primary factor appears to have been Dynegy's failure, through whatever shareholder communication efforts it made, to convince investors that the Icahn offer was in their best interests. On the other hand, Seneca Capital, through its opposition effort, also seems to have sown enough seeds of doubt about the adequacy of the Icahn offer that it convinced investors that a better offer may be around the corner.

Could it be that Dynegy's shareholder communications were aimed at the wrong investors? The company did hire D.F. King, one of the top proxy solicitors in the country, and one that should have known who the company's key investors were at the time. But you can't rule out the longstanding problem that quarterly Form 13F filings (which disclose who owns large stakes in companies) can provide outdated information, considering how frequently large investors turn over their holdings in today's market.

Once you've identified the current major investors, you have an opportunity in one-on-one meetings or calls to test your message. If enough of them aren't buying it, find out why and revise the message.

Another challenge for companies in Dynegy's situation are their Non-Objecting Beneficial Owners: individual investors who hold their shares in “Street name” accounts through brokerage firms. Previous studies indicate that about one quarter of all individual investors are NOBOs. A company can request a list of its NOBOs from an intermediary like Automatic Data Processing and communicate directly with them, yes, but it costs a fee. Even worse, the other three-quarters of individual investors are Objecting Beneficial Owners whose identify is shielded from the company entirely. The New York Stock Exchange commissioned a study in 2007 that found 54 percent of OBOs wanted communications directly from the company, not through their brokerage firm intermediaries. (Most didn't know their brokers had registered them as OBOs!)

All this is important because companies can generally count on their individual investors as longer-term shareholders who tend to vote their proxies with management. That can be an important factor in a proxy contest.

In all likelihood, multiple forces were at work as Dynegy's efforts went awry. But let's look at corporate communications and messaging with shareholders in particular, and consider a few best practices that can become important in a closely contested proxy fight.

1.    Work closely with your proxy solicitor to determine who your shareholders are, particularly the major investors.

2.    Reach out and meet individually and in person with as many of those investors as time allows, or at least call them directly. Make sure the investors you speak with actually hold the voting rights to the shares indicated in your company, and that no side agreement (a swap or loan or some other avant-garde relationship) is muddying the waters.

3.    Once you've identified the current major investors, you have an opportunity in one-on-one meetings or calls to test your message. If enough of them aren't buying it, find out why and revise the message. In the Dynegy case, for example, if you learned that investors were following Seneca Capital's argument that the current buyout offer was under-priced, you needed to counter that with facts and reasonable projections given the energy market and the company's financial prospects.

4.    Consider obtaining a list of NOBOs, and see if the numbers justify focusing direct communications explaining why a particular offer is in their best interests and why they should cast their proxy votes with management.

5.    Consistently monitor your major securities analysts, whose opinions you trust, to see what they are saying and hearing from investors about the company; that can help you to build your case to the institutional investors. Fourteen analysts follow Dynegy. Julian Dumoulin-Smith of UBS was among those who believed that Seneca's assessment of the company was overly optimistic. His words: “The current stock price already imbeds any recovery from a commodity-led rebound as well as a robust debt restructuring.” He added that he was “hard-pressed” to see how Dynegy was worth more than Icahn's offer of $5.50 a share.

6.    Try to ascertain whether any transactional history or bias exists among your major institutional investors and the offering firm that might pre-dispose the institution to vote a certain way regardless of financial valuation or communications prowess.

7.    Dynegy's special committee of the board letter to shareholders contained some strong arguments explaining why the directors were urging shareholders to accept the Icahn offer. Those needed to be integrated into meetings with shareholders and those who vote the proxies, as well as incorporated into other forms of communication with shareholders.

8.    Reach out to the proxy governance rating agencies to make sure they understand the board's perspective on the pending transaction.

9.    Engage outside publicity and investor relations counsel to counter aggressive financial media and shareholder communication campaigns by hedge funds who often fabricate facts to skew investor perceptions.

With a comprehensive integrated communication plan targeting all investors with the realities the company was facing, Dynegy should not have lost this battle to Seneca Capital and the remaining majority of shareholders who ditched the Icahn buyout offer believing the company was undervalued.