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Strategic Finance

Listening to shareholders

Monday, 27 November 2006

Norma Cohen examines the importance of investor relations in getting your message across. When Philip Green, the pugnacious billionaire entrepreneur, approached ailing Marks & Spencer in 2004 with a possible takeover offer, investors held their breath. He had, after all, succeeded in swallowing other UK retail groups such as Arcadia and Debenhams and had done a remarkably effective job in turning them around. The iconic Marks & Spencer appeared to have lost its way while its shares lagged and its management appeared to lack any clear strategy for turning it around.

Then, in a master stroke, the board replaced the chairman with a non-executive, Paul Myners. This City stalwart and paragon of the good corporate governance movement instantly went to the right place - his shareholders.

Within days, Myners understood what was needed and what was needed was new management. He appointed the well-respected Stuart Rose, a former M&S executive who knew the company inside and out and who, indeed, shareholders had asked for by name as a replacement for the hapless incumbent.

Despite an energetic campaign conducted through friendly journalists in the British financial press, Green was forced to abandon, at least for the time being, his hopes of acquiring the jewel in the UK's retail crown. At the company's annual meeting, even before Green threw in the towel, Myners conducted the event like a North Carolina revivalist meeting, receiving the cheers of hundreds of small retail shareholders.

So how was it that, despite years of underperformance and no clear turnaround in sight, M&S shareholders could see off a predator that had succeeded so many times before and that offered them a better potential price than many had seen for some time?

The answer, quite simply, is that the M&S board listened to its 'base'; its shareholders.

Other companies, finding themselves on the receiving end of a hostile bid, have been far less fortunate. In most cases, the key to survival has been the degree to which shareholders have been persuaded that management is acting in their best interests. And that persuasion requires careful management of investor relations.

Shareholder activism has long been a staple of the US market and is increasingly a hallmark of the UK as well. Not surprisingly, then, the US has spawned an entire industry of investor relations professionals who are highly paid to advise companies on how to get their message across. For too many executives, the failure to do so has had painful consequences.

For while shareholders may be prepared to tolerate periods of underperformance from a management that is able to articulate clearly its strategy for the long-term, they waste little time on those who fail to communicate clearly with investors. Moreover, when shareholders do send a clear message to management and find themselves ignored, the result can be brutal.

This lesson was demonstrated with painful effect at the Deutsche Borse in 2005 in what was probably the most spectacular shareholder coup ever witnessed in Germany and which, several months later, appeared to have been a catalyst for yet more dramatic corporate change. In the end, the coup led to the sacking of Chief Executive Werner Seifert, a stalwart of Germany's financial scene and the man probably most responsible for transforming that country's financial markets into some of the most sophisticated in Europe. It also led to the departure of Non-Executive Chairman Rolf Breuer who, as Chairman also of Deutsche Bank, has been a stalwart of Germany's economic establishment.

The stage for the debacle was set in December 2004 when the Borse approached the London Stock Exchange and indicated it would like to bid for the company at a price not less than 530p a share. The offer was rebuffed as undervaluing the company but the LSE agreed to talk further.

Not surprisingly, Paris-based Euronext, the Borse's continental rival, said it, too, would like to bid.

Behind the scenes, however, trouble was brewing. During 2004, the company's shares had significantly underperformed Germany's DAX index and, worse, were about the worst performing of any quoted stock exchange company anywhere in the world. Its shareholders were clamouring for a share buyback that they believed would help boost the price. The Borse's avuncular Chief Executive, Seifert, refused, saying the company had better things to do with its cash pile that totalled more than Î600m.

Large shareholders such as Fidelity, Capital International and Generali had privately been telling the company they wanted share buybacks for as long as 18 months. Nevertheless, Seifert pressed ahead but a little-known hedge fund, TCI, soon fired the first shot in what was to become his Waterloo. It publicly announced its opposition to the bid on the grounds that the price was too high and demanded that shareholders be given a chance to vote.

Other hedge funds added their voices to TCI's. Seifert dismissed the clamouring as that of a handful of malcontents but, behind the scenes, trouble was brewing. He insisted, in the face of demands for a vote, that a ballot could not be held for legal reasons. Shareholders stepped up their pressure, turning to Breuer for help but he backed his chief executive.

Soon a canvas of shareholders showed that a strong majority - more than 60 per cent - opposed the bid, but Seifert pressed on. Shortly afterward the Borse shelved its bid but said it would renew it if Euronext made a move.

Shareholders, worried that he would overpay in a bidding contest, sought changes on the board to ensure greater oversight by a body that appeared supine. A truce ensued for several weeks but was broken by Seifert who, without warning the shareholders, released an eight-page diatribe that attacked the personal integrity of some of the shareholders. At that point his fate was sealed but it was a further two months before he was sacked.

The damage caused by the battle reverberated throughout Germany, causing a political firestorm when a leading politician branded the hedge funds "locusts". Since then, corporate activism is running rife in Germany, a country that had seen very little of such practices.

That is in stark contrast to the UK where shareholder activism and investor relations professionals have long been working to bridge the gap between company managements and their shareholders. Indeed, several of the Borse's UK shareholders noted that, had a similar situation arisen involving a British company, the procedures for resolving the conflict are well known and frequently used.

A shareholder or a shareholder group would have approached the company's senior non-executive director and sought a meeting to make its views known. The non-executive, probably with the aid of the company's broker, would have arranged meetings with the largest shareholders to canvas their views. If a strong consensus emerged, it is likely that either the company would change its strategy or plans for a management change would be announced.

Neil Ryder, a Director of the International Investor Relations Federation and a Partner at Sage Partners, a specialist in cross-border investor relations, says that there are good reasons why different countries' investor relations practices vary widely.

"A lot of that is to do with the historic equity culture in Britain," says Ryder. The habit of buying shares is long ingrained in UK investors and, to a somewhat lesser degree, in Dutch investors, he says. Sweden, he notes, is developing a culture of listening to shareholders since foreigners were first allowed to buy shares there ten years ago.

Many companies based in continental Europe have long been protected against shareholder revolts because their largest investors are large banks with whom they have commercial relationships or other companies with whom there is some connection. "The free float of these companies has been fairly limited and managements have not needed to pay attention to these shareholders," says Ryder.

Austin Earl, Investment Analyst at advisory firm Newman Ragazzi and a speaker at the IIRF's 2004 conference in Rome, provides a handy checklist of the most common mistakes companies make in their dealings with shareholders. First on the list, he says, is a requirement to prepare even-handed reports.

"Don't just focus on positive aspects. Report negatives or problem areas and provide updates on these issues," he says. Reporting should be clear and consistent from one year to the next and make sure your annual reports are directed at shareholders. Too many companies treat these as mere regulatory reports.

Ryder says that, simple as these suggestions may be, it is not clear that many managements are prepared to hear them."The biggest challenge for investor relations professionals is to get management to take their shareholders seriously," he says.

Norma Cohen writes for the Financial Times on City subjects including stock exchanges. She is a New Yorker who joined the newspaper in 1988 reporting on capital markets, having worked previously for Reuters in New York and London. She has also covered property and education for the FT and been its investment correspondent and is a specialist on pensions.