The New Neutral

The New Neutral is the name for our near-term economic future according to William Gross, founder and Chief Investment Officer of PIMCO, one of the largest of investment funds.

He and his investment team pride themselves on discerning the big trends and avoiding herd mentality when plotting the course of PIMCO fund investments.

After prematurely calling the end of the era of interest rate declines and predicting a more rapid rebound in interest rates, Gross is now predicting a new trend, “The New Neutral”.  In this environment, he suggests the US economy is in for a period of market stability with moderate to low returns (broadly, bonds returning 3-4% and stocks 4-5%) with relatively lower volatility.

Of course, he points out that the US economy is subject to impacts from our major trading partners and specifically calls out the risk of Japan’s current economic policy.

While his reputation as an economic wizard has been tarnished, his predictions, in my view, still merit consideration.

Excerpt

In 2014, the tide may be turning again as demographics, fear of another Lehman, or just income-starved insurance companies and similarly structured liability-influenced institutions, reach for anything they can get. The era of income may be, at the margin, replacing the era of capital gains, despite artificially low current yields.

Click here to read the PIMCO article.

I admit, my posts predicting a slow growth environment were also premature. Click here.

Three Steps to Prepare for Shareholder Activism

Latham & Watkins, the law firm, provides this easy to read series of recommendations for dealing with increasing shareholder activism.  Other valuable articles for corporate executives and board members may be viewed at www.lw.com.

Three Practical Steps to Stay Ahead of Shareholder Activism

by Steven B. Stokdyk, Joel H. Trotter & Patricia Judge

Activist investors continue to shape corporate governance. Last year saw more than 300 activist proxy campaigns, proposals and contests. Activism-focused funds manage over $100 billion in assets.

In this climate, no company is too large to avoid activists’ influence. There is no guaranteed safety — not corporate governance, share price appreciation or outperforming peers. All companies should remain prepared for engagement.

Experience shows that preparation can make a decisive difference. Companies that establish and maintain a good reputation with institutional investors will have an advantage when interacting with activists.

To prepare effectively, we recommend three broad ongoing practices:

  • monitoring exposure to activists;
  • communicating with shareholders and analysts; and
  • planning for activist campaigns.

Monitoring exposure to activists

Companies should continually monitor available information to assess their exposure to activists:

  • Monitor outside groups, including the company’s peer group, sell-side analysts, proxy advisors, pension funds, activist investors, print media and online sources.
  • Understand institutional holdings and the relationships among the holders, especially those who may team up with others, by monitoring Schedule 13G, 13D, 13F and Hart-Scott-Rodino filings, parallel (wolf pack) trading and debt trading patterns.
  • Watch the proxy advisory firms and institutional investor groups, such as Institutional Shareholder Services (ISS), Glass, Lewis & Co., the Council of Institutional Investors  and TIAA-CREF. Although ISS can influence up to 30% of the vote, some investors use ISS’s position only as a starting point. For example, institutional investors such as Fidelity and BlackRock have their own internal proxy departments.
  • Review corporate governance ratings, correct any inaccuracies and identify potential changes that could improve the company’s governance rating.
  • Maintain a feedback loop by monitoring earnings call participants, conference attendees, follow-up requests and other investor contacts, always seeking candid feedback and facilitating open communication.

Communicating with shareholders and analysts

Use inbound and outbound communication to build key relationships:

  • Use relationship building to keep your friends close and your major institutional investors closer. Engage regularly with both portfolio managers and proxy departments. Know institutional investors’ guidelines, key decision makers and how to reach them. Establish credibility with shareholders and analysts in advance.
  • Seek out inbound communication and candid feedback. Use ongoing dialogue to ensure that management and the board of directors understand investor sentiment.
  • Use outbound communication as part of a concerted communications strategy. Ensure that communications consistently describe the basic strategic message. Focus especially on relative performance, proactively addressing any shortfalls as compared to peers.

Planning for activist campaigns

Formulate a plan to prepare for an activism crisis:

  • Evaluate protections in the company’s charter, bylaws and applicable laws for potential measures that could be used in response to an activist campaign.
  • Develop and maintain a public communications plan, which should include steps for strategic outreach to the media, regulators, political groups and others. Keep these relationships current to facilitate public messaging.
  • Identify team members and have key players ready in advance to assist quickly in response to emergencies. Identify your lineup of counsel, investment bankers, proxy solicitors and public relations specialists.

Taken together, these three steps — monitoring, communicating and planning — offer concrete actions that companies can use to ensure their preparedness for an activist campaign.

Steven B. Stokdyk
steven.stokdyk@lw.com
+1.213.891.7421

Joel H. Trotter
joel.trotter@lw.com
+1.202.637.2165

Patricia Judge
patricia.judge@lw.com
+1.202.637.3352

Smaller Company Reg A Offering Rules Get Update

Lance Kimmel, a well-regarded attorney and head of SEC Law Firm, provides us with this helpful summary of key developments that should make Reg A offerings more useful again.

To refresh your memory, the current Reg A rules are available by clicking here.

LanceImageFollowing the mandate of the Jumpstart Our Business Start-Up (JOBS) Act, on December 18, 2013 the Securities and Exchange Commission proposed rules to amend largely forgotten and little-used Regulation A.

Having received far less attention than either of the other two major equity raising initiatives under the JOBS Act, general solicitation of accredited investors and equity crowdfunding, the revisions to Regulation A may well be the most far-reaching of the JOBS Act reforms. Informally known as “Regulation A+”.

The new proposal – expected to be adopted by the SEC in the first half of 2014 following a 60-day public comment period – has the potential to become a dramatically less expensive path to going public for many smaller companies whose investors seek an exit strategy or liquidity for their investment.

The SEC’s proposal builds upon existing Regulation A, which is an existing exemption from registration for small offerings of securities up to $5 million within a 12-month period.

The two major drawbacks to Regulation A are the small dollar limit (thereby resulting in high transaction costs as a percentage of the offering) and the fact that Regulation A offerings are not exempt from state blue sky laws, adding additional levels of complexity and cost to completing a Regulation A transaction.

For these reasons, Regulation A receded into relative obscurity over the last few decades. Regulation A, in its current form, will continue as so-called Tier 1 of Regulation A, and we expect reliance on Tier 1 to continue to remain in obscurity.

As proposed, “Regulation A+” will enable companies to publicly offer and sell up to $50 million of securities within a 12-month period under a so-called Tier 2 within Regulation A.

In addition, and crucially, Tier II-registered securities will be exempt from state blue sky laws, something that the state securities administrators strongly oppose. Finally, ongoing reporting obligations will be less burdensome than those for traditional reporting companies.

Proposal
As proposed, both Tier 1 and Tier 2 offerings under Regulation A will:

  • permit companies to submit draft offering statements for non-public SEC review prior to filing;
  • permit the use of “testing the waters” solicitation materials both before and after filing of the offering statement;
  • modernize the qualification, communications and offering process in Regulation A to reflect analogous provisions of the Securities Act registration process; and
  • require electronic filing of offering materials.

In addition, in Tier 2 offerings:

  • investors would be limited to purchasing no more than 10 percent of the greater of the investor’s annual income or net worth.
  • the financial statements (two years in most cases) included in the offering circular would be required to be audited; and
  • the company would be required to file annual and semi-annual periodic reports and current event updates that are similar to the current requirements for public company reporting under the Exchange Act.

The main eligibility requirements to use Regulation A (both Tier 1 or Tier 2) include that the company:

  • must be organized in the United States or Canada;
  • cannot have no specific business plan or purpose or have indicated that its business plan is to engage in a merger or acquisition with an unidentified company;
  • is not or has not been subject to an SEC order revoking the company’s registration under the Exchange Act during the preceding five years; and
  • is not disqualified under the recently adopted “bad actor” disqualification rules.

If you have questions regarding the new SEC proposal, other capital raising initiatives under the JOBS Act, strategic planning to take advantage of the new initiatives or specific fact patterns, please contact:

Lance Jon Kimmel
SEC Law Firm
11693 San Vicente Boulevard
Suite 357
Los Angeles, California 90049
tel. 310/557-3059
lkimmel@seclawfirm.com

Handling an Activist Attack

My friend and colleague Moira Conlon, President of Financial Profiles, was keynote speaker at a recent National Association of Corporate Directors event addressing steps that public companies should take to be prepared for activist shareholder attacks.

Click here to take you to the article or copy and paste the link below into your browser”

http://finprofiles.wordpress.com/2013/03/19/are-you-prepared-for-an-activist-attack/

 

Crowdfunding Update from Rick Citron

My friend and colleague, Rick Citron of Citron and Deutsch, provides an update on the type of crowdfunding currently available and the expectation for equity crowdfunding.

Rick has a Youtube channel on which he offers a series of educational videos on raising capital for early stage companies (link).

Doing Business in China

PNC Bank has produced another informative video, this one about doing business in China, with Daniel Joseph, Global Advisor, China.

Daniel’s contact info is:

Daniel R. Joseph
Global Advisor, China
(412) 762-0354
Daniel.joseph@pnc.com

Link to the website: http://www.ideas.pnc.com/mitigate_risk.html?asset=Taking_the_Plunge_Doing_Business_in_China.html%3Ftype=Video

Interest Rate Risk – “Preaching to the Choir”

Dennis McCarthy – (213) 222-8260 – dennismccarthy@ariesmgmt.com

“Preaching to the choir”.  In this case, the choir is me.  It seems that every commercial banker I meet, tells me to advise my clients, or anyone who’ll listen, to lock in today’s low interest rates.

When I ask, “what’s the risk?”, I get a lecture that we’re in an interest rate bubble and that despite the Fed’s announcement about the Fed Funds rate, business loan rates will likely rise, especially after the election.

When I confess that I not only believe them but share their concern, I ask “what should a company do to lock in these low rates?” 

Since most companies have floating rate business loans, the bankers’ most common recommendation is to enter into a swap arrangement to fix the rate.

The cost of the swap, especially after tax, is considered very low cost insurance relative to the risk of a rise in interest rates.

A swap is not the only way, however.  Some bankers recommended fixed rate term loans or even public bond issues if the financing is large enough. 

One of my clients raised its first high yield bond last week so I’m doing my best to help companies to reduce interest rate risk.  My banker friends would be pleased that their preaching paid off.

I can help your company to lock in low current interest rates.  Please contact me.  Thank you.

M&A Defense – “Devil’s in the Details”

Dennis McCarthy – dennis@mbsecurities.com – (213) 222-8260

Roche’s hostile offer for Illumina is a great case study to follow up my post “M&A Defense Checklist” and to prove that old adage that “the devil’s in the details”.

The Roche hostile offer for Illumina highlights two of my points,

  1. Now there is higher risk of hostile activity for all companies.  Illumina, before the offer, was trading at 4x revenue and 14x EBITDA: not what you’d consider a low valuation target although its stock at $37.69 was below its 52 week high of $79.40.
  2. Companies should carefully review their M&A defenses to uncover and potentially fix any weaknesses before an aggressor uses them against the company.

As background on this case, after what appears to be a short courtship period, Roche launched a hostile tender offer to shareholders to buy Illumina at $44.50/share an 18% premium to Illumina’s closing price the day before the offer.  Roche also announced that it intends to wage a proxy battle which would result in its slate of nominees comprising a majority of the Illumina board.

In this post, I highlight key points from an impressive article entitled “The Chink in Illumina’s Defense” by Steven M. Davidoff, writing as The Deal Professor, a commentator for the New York Times’ “DealBook”.  The article speculates that Roche’s proxy battle strategy will likely include proposals to:

  1. Nominate board candidates for the 4 seats up for election this year;
  2. Propose a by-law amendment to expand the size of the board by two members to 11 and nominate those two board candidates; and
  3. Propose a shareholder vote to remove all of Illumina’s board without cause.

Illumina’s defenses include:

  1. Staggered board of nine members with only 4 up for election this year;
  2. Supermajority vote of 67% of all shares outstanding required to amend a by-law;
  3. Shareholders can’t call a special meeting;
  4. Shareholders can’t act by written consent; and
  5. Poison pill which had expired in 2011 but could be reinstated by board action alone.

Proving that time-tested maxim, “the devil’s in the details”, here’s what we might learn from issues with Illumina’s defenses that Roche may be exploiting according to “The Chink in Illumina’s Defense”.

  1. Certain key elements of Illumina’s defenses are contained in its by-laws, not as charter provisions.  A corporate provision contained in a company’s by-laws may be amended by shareholder action without board action.  In contrast, a provision in a company’s charter requires approval by both the board and shareholders.
  2. Illumina’s by-laws specify the size of the board which Roche is proposing to expand by two to eleven members of which Roche’s slate of 6 would constitute a majority. Shareholders can approve, albeit by 67%, this by-law amendments to expand the board without board approval.
  3. Illumina’s by-laws also permit removal of board members without cause upon approval by a simple majority of the votes cast at the meeting, a relatively low threshold.  Delaware law requires the provision for removal of board members without cause to be in a company’s charter so this provision will, no doubt, trigger litigation as to its validity and usefulness in Roche’s attack.
  4. Illumina’s advance notice provision for submission of proxy proposals to be included for consideration at its annual meeting requires only 90 days vs longer periods which are common.  As a result, Illumina has less time to respond before its annual shareholder meeting.

Subsequent to Roche’s offer, Illumina’s share price rose well above Roche’s offer price signaling that Wall Street thinks Illumina is worth more than Roche’s offer.  Also, Illumina reinstated its poison pill at a 15% threshold with updated definitions of beneficial ownership to include ownership through derivatives.

To read Roche’s offer letter to Illumina, click here or go to www.sec.gov for the recent documents filed under Illumina including its poison pill and various filings by both sides.

This is a valuable lesson for all of us, at Illumina’s expense.

Behind The Headlines On Interest Rates

 

The Federal Reserve announced that economic factors “are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

This will, no doubt, influence interest rates through this period, but this is not the sole determinant of a company’s interest rate as noted in my post “Seems Smart Now“.

For example, the debt market for corporations, both large and small, is influenced by supply and demand factors in addition to the benchmark federal funds rate.  The predicted reduction in demand for corporate debt by collateralized loan obligation (CLO) funds suggests that companies may see higher new issue interest rates.  In contrast, any increase in demand by other lenders such as high yield bond and “relative value” investors may ease rates.

The recent post, “No Loan Left Behind“, by Randy Schwimmer of Churchill Middle Market Finance, now a unit of The Carlyle Group, describes these supply and demand forces at work on the larger size loan market (size above $100 million).

To support Randy’s view that high yield investors are supplying critical demand, this week one of my clients successfully priced its first high yield bond replacing other financing sources.

My message is that while Fed action gets the headlines, there are several other factors at work, behind the headlines, which influence a company’s debt rate.

Dennis McCarthy

(213) 222-8260

dennismccarthy@ariesmgmt.com

No Growth? Not Us!

A frequent response to my post “Living with No Growth” focused on the argument that the US will benefit from continued growth in Asia, particularly China, to escape a slow to no growth world.

While the optimist in me hopes this is true, the message I’m getting from reputable sources in China is that its economy is experiencing stresses which may result in a “harder landing” than had been hoped.  The benefit to the US, therefore, may be less than expected.

One of my sources on developments in China is Patrick Chovanec whose Bio and bloglink is below:

Patrick Chovanec (程致宇) is an associate professor at Tsinghua University’s School of Economics and Management in Beijing, China, where he teaches in the school’s International MBA Program.  His insights into Chinese business, economics, politics, and culture have been featured by international media including CNN, BBC, Time, Newsweek, Wall Street Journal, Financial Times, Bloomberg, New York Times, Washington Post, Forbes, Foreign Policy, The Atlantic, PBS, NPR, and Al Jazeera.  He is a regular guest commentator on Chinese Central Television (CCTV-9) and China Radio International (CRI), and serves as Chairman of the Public Policy Development Committee for the American Chamber of Commerce in China.

Blog: An American Perspective From China

Thank you.

Dennis McCarthy

dennismccarthy@ariesmgmt.com

213-222-8260