Dynegy Shakeup a Case Study in Shareholder Communications

Usually when a board does a poor job of reaching out to shareholders, the consequences are some additional shareholder resolutions on the proxy or a few prickly questions at the annual shareholder meeting. On rare occasions, the stakes are much higher.

Such was the case at Dynegy Corp., which stunned the corporate governance world last month with the mass resignations of its CEO, CFO, and four independent board directors after shareholders rejected two management-recommended takeover bids in the space of seven months. A few days later the company announced that a bankruptcy filing was on the table in coming months.

Tension between Dynegy's board of directors and its shareholders started during initial attempts to sell the company last August to the Blackstone Group, a New York private equity firm, at $4.50 per share. Dynegy's share price had been steadily declining for several quarters, hitting a low of $2.76 that month, and management reasoned that the Blackstone deal was the only viable option to save the company from financial turmoil. To back that argument, Dynegy CEO Bruce Williamson cited the decline in natural gas prices and the company's $4 billion debt load. Additionally, no alternative bids emerged during the 40-day go-shop period included as part of the Blackstone deal.

But Dynegy couldn't convince shareholders to take the offer. They voted down Blackstone's final bid of $5.00 a share. Investor activist Carl Icahn and hedge fund Seneca Capital, Dynegy's largest shareholders, argued that the bid undermined the true value of Dynegy's assets. That's when Icahn injected his own bid of $5.50 a share—10 percent higher than Blackstone's final offer. In a Dec. 17 statement, Williams called Icahn's offer “a very positive outcome for all Dynegy stockholders.”

Once again, though, Dynegy couldn't get shareholders to coalesce, including Seneca Capital, which launched it's own shareholder campaign. “Seneca Capital urges shareholders to NOT TENDER their stock for $5.50 per share,” the company said in a letter to stockholders (and yes, the capital letters are its own doing). “It is the WRONG PRICE at the WRONG TIME for the WRONG REASONS.”

Failure of both the Blackstone and Icahn deals “essentially reflected what we believe are the views of a new group of shareholders that have come into the company,” Byford says. “For that reason, the board and management made the tough but responsible decision of aligning our corporate governance structure with our new shareholders”—that is, walking away from the company and letting those shareholders set up their own governance structure.

Part of the conflict Dynegy's directors encountered is one faced by all public company boards: They simply can't afford to take the same amount of risk as hedge funds like Seneca. If boards make the wrong financial decision, the consequences include bankruptcy, investigations, lawsuits, and more. In contrast, for hedge funds and proxy advisers that can afford to absorb the losses, the possible rewards make such gambles much more palatable. Those competing interests can leave management and the board stuck in the middle.

What the Dynegy shakeup reveals is “evidence of a failure by management to establish control of the communication process.”

—Gary Lutin,

Chairman,

Shareholder Forum

Investor activism is louder and more influential than ever before, but senior management and board members aren't yet accustomed to responding to that higher level of investor activism, says Gary Lutin, a lead investor and chairman of the Shareholder Forum. “Aside from that high-visibility activism, there is also a significantly increased need for corporate managers to focus on winning the support of investors, generally,” he says.

With Dynegy, failure to gain that support eventually resulted in a divorce over irreconcilable differences. Williamson, who as served as Dynegy's CEO since 2002, immediately resigned as chairman and stepped down as CEO effective March 11. David Biegler, who has served on Dynegy's board since 2003, will be interim CEO. Patricia Hammick, previously lead director, will serve as chairman.

“Through these actions, the board is positioning Dynegy for a new management and board structure as soon as prudent,'' Hammick said in a prepared statement. “We are open to stockholder suggestions to additional independent directors.''

Hammick added: “While all current directors intend to remain fully engaged in their duties through the 2011 Dynegy annual meeting, we expect the new members of the board to take the lead in defining the future composition of the board and in selecting a new chief executive officer.”

DYNEGY BOARD RESTRUCTURING

Following its rejection of Carl Icahn's bid, Dynegy made the following announcement in regard to its management team:

Dynegy Inc. today announced that Bruce A. Williamson, pursuant to a mutual agreement with the board of directors, will resign as president and chief executive officer, effective March 11, 2011. Mr. Williamson has also resigned as a director and chairman of the board, effective immediately. David Biegler, currently an independent Dynegy director, has been appointed interim president and chief executive officer following the departure of Mr. Williamson, and Patricia A. Hammick, previously lead director of Dynegy, now serves as chairman of the board.

Dynegy also announced that effective March 11, 2011, Holli Nichols will resign as executive vice president and chief financial officer, to accept an opportunity at another company. Charles C. Cook, Dynegy's executive vice president, commercial operations and market analytics, will serve as interim CFO following the departure of Ms. Nichols.

"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," said Patricia A. Hammick, Dynegy's new chairman. "Holli has been a valuable member of the executive team and has also made several important contributions to the company. Throughout the leadership transition, we will continue to take appropriate actions to position the company for the future."

Dynegy Announces Termination of IEP Merger Agreement

An insufficient number of shares were tendered in response to the Icahn Enterprises L.P. tender offer, and as a result the merger agreement with an affiliate of IEP automatically terminated as of 5:00 p.m. (Eastern time) on Feb. 18, 2011.

Board Changes

Recognizing the desire of the stockholders to pursue a different path, Dynegy's five remaining directors do not intend to stand for reelection at the company's upcoming annual meeting, anticipated to be held in June 2011.

Dynegy's board has met with and offered a Seneca Capital nominee a position as a director of Dynegy. Dynegy has also contacted Icahn Associates to discuss appointing an Icahn designee to the board. The board's nominating committee is expected to consist of new directors and will begin identifying qualified director nominees to be appointed as soon as possible and to stand for election at the company's annual meeting.

Ms. Hammick said, "Through these actions, the board is positioning Dynegy for a new management and board structure as soon as prudent. We are open to stockholder suggestions as to additional independent directors. Dynegy will not expend any further resources in responding to the Seneca Capital consent solicitation, if Seneca chooses to pursue it. While all current directors intend to remain fully engaged in their duties through the 2011 Dynegy annual meeting, we expect the new members of the board to take the lead in defining the future composition of the board and in selecting a new chief executive officer."

Source: Dynegy Announcement of Board Restructuring, Feb. 21, 2011.

The only comparable situation to Dynegy's is that of Hewlett-Packard in 2002, when several of its board members and top executives threatened to quit if shareholders rejected a merger with Compaq Computer Corp. The message was clear, and shareholders approved the deal, averting a crisis.

Message Control

The Dynegy shakeup reveals “evidence of a failure by management to establish control of the communication process,” Lutin says. “They were not the ones who were defining the issues and controlling the messages.”

The same rules that apply to winning the support of customers also apply to winning the support of investors, Lutin says. “You need to control the definition of the issues, and you need to do that in the context of understanding the criteria of the decision makers,” he says. “Any company that has achieved sufficient marketplace success to be publicly traded already has learned how to do that with their customers.” Dynegy understood the basic principles but didn't apply them, Lutin adds.

“The reality is you're always going to have some people thinking one way and some another way,” says Lutin. If Dynegy couldn't get Seneca's support, it at least needed to know how to get the support of the majority of its other shareholders, “and that's where they failed.”

There's one more lesson to be had: knowing who your investors are. “The same tools and skills that managers use to follow shifts in their market for products can be applied to shifts in their investor constituencies,” Lutin says.

In business, he explains, you conduct qualitative research—interviews with representative examples—to determine what may be relevant to decision making. Then follow up with quantitative research—things like independent surveys—to define the issues that will influence the undecided segments.

“Politicians do this, too,” says Lutin. “In a contest for corporate control, it's just plain common sense to do the same thing.”

Earlier this month, Icahn revealed that he was upping his stake in Dynegy to 19.99 percent, indicating that he may take another run at the company. Time will tell if the current configuration of board members and officers will put together a takeover deal or rack up a third shareholder rejection.