Thursday, February 16, 2006

Henderson's Pandora Box
Stock lending, voting rights & minority interests

HK's Henderson Land Development's second attempt on January 20 to take its 73.5% owned Henderson Investment private was rejected despite it winning support from the unit's largest independent shareholder, Franklin Templeton Investments. Apparently, some shareholders controlling 10.94% of the firm's minority shareholding voted against the proposal, while those owning 85.74% voted in favor. Henderson Land needed to win the backing of shareholders controlling 90 percent of the minority stake for its share swap offer, worth about HK$10 billion, to succeed. Management insisted that the lack of a cash offer wasn't the reason the buyout bid failed. In December, Henderson Land was forced to sweeten the buyout offer after minority holders, including Templeton, objected that the offer was too low. The original offer of one Henderson Land share for every 2.6 Henderson Investment shares was increased to one for 2.5. Franklin Templeton managing director Mark Mobius said that the US-based fund group had voted in favor of the proposal the second time around. The fund now holds about 0.409 percent of Henderson Investment, followed by Baring Asset with about 0.2 percent. Henderson's management said the group has no plans to make another offer. Securities and Futures Commission rules bar Henderson Land from making another privatization bid for Henderson Investment for 12 months. Henderson Land successfully took its mainland property affiliate Henderson China and loss-making Henderson Cyber private last year.

The buyout attempt could have given Henderson Land more direct control over businesses held by Henderson Investment, the prize being its 37% stake in Hong Kong and China Gas, the sole supplier of piped gas to Hong Kong and an increasingly important supplier to mainland customers as well. Henderson Investment also owns 31% of Hong Kong Ferry, a transportation company that also has property interests, and 44% of Miramar Hotel and Investment, which runs a hotel in Tsim Sha Tsui. Under Hong Kong regulations, a parent company buyout plan for a subsidiary can be blocked if more than 10% of minority shareholders oppose it.

Henderson Investment Ltd. shares had their biggest one-day decline in more than eight years after shareholders vetoed the buyout offer from its parent. The day after, shares in Henderson Investment closed 16.6% lower at HK$12.80 in Hong Kong, the biggest one-day drop since October 28, 1997. They fell as much as 19.5% during the day. Henderson Land declined 1.2% to HK$38.65 after sliding as much as 2.1%. A hedge fund owning 72 million shares of Henderson Investment and with a short position on the stock voted against. The hedge fund's 72 million shares represent 95%of the 75.5 million shares that were in opposition to the offer.

Henderson Investment shares had surged more than 44% from Nov. 9, when Henderson Land announced its second attempt to privatize Henderson Investment, to Jan. 19, the day before trading in the company's shares was suspended pending the results of a shareholders' meeting. Hong Kong's Hang Seng Index rose 7.4% in the same period.

Naturally, some observers are questioning the abuse of "stock lending" and voting rights pertaining to it. When a company borrow stock, it naturally has the voting right attached to it Any proposals to reform stock lending should be done carefully as you do not want to rewrite the rule book every so often. Yes, in this case, the hedge fund took advantage of a double whammy loophole. By borrowing sufficient shares in Henderson Land, it has the potential to create a large short position. Knowing that if the proposal did not go through would send the shares plummeting worked in the hedge fund's favour. The problem lies not in the actions of the said fund manager but rather in the ruling that the company must get 90% in favour of the deal in order for it to pass. When the regulations are set like that, you are bound by the those rules.

Some corporate activists think that stock lending is a form of market abuse as it allows temporary shareholders to exercise voting rights. We have to be firm in allowing short selling and hence stock lending has been a sub-sector in many developed financial markets - short selling allows for a more transparent market place, and allow investors with differing point of views to place their investment bets accordingly. As for exercising voting rights, it makes no difference whether a shareholder is temporary or long term, that is ridiculous - if you hold the shares during the voting period, you vote. Whether you sell the shares quickly after that is not for anyone to question in a free market economy. No where does it say when you buy shares that you have to hold it for a certain period to become entitled and priviledged.

Looking at the sweetened offer, while it is a decent offer from the parent, it is not fair value no matter how you look at it. There is easily room for the parent to raise the offer value by another 10% at least, and it would still have been a good deal for all parties. This incident should not be linked to just hedge funds, in fact, the short seller could have been any fund or anyone for that matter. If the deal is so good, then the original shareholders of Henderson Land would NOT and should NOT have lent their shares out in the first place. No point arguing for rule changes, Henderson's management should just take their pill, learn their lesson and strategise better (anticipate potential calamities). This event can easily be anticipated and rectified - again, the over-confidence and exaggerated self-belief of management's egos got the better of them when considering minority interests.

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