Friday, May 11, 2012

Telus Something We WANT To Hear

Dual-class share structures have been discussed on this site as something to be wary of as a shareholder. But in what appears to be a role reversal, one management team recently tried to eliminate its dual-class share structure only to be thwarted by shareholders! The media has portrayed this saga a certain way: Telus Fights For Equality And World Peace (okay, I added the "World Peace" myself).

So you've got the antagonistic, profit-hungry hedge fund from New York ("Why, this stuff's made in NEW YORK CITY???") trying to block a local company's altruistic attempt at improving its corporate governance. But a closer examination of Telus tells us what's really happening.

Usually, dual-class share structures are set up such that management controls the voting shares. This way, management can block attempts at an overthrow. Telus' history is a little bit different, with the dual-class share structure coming into be in order to circumvent government regulations on foreign ownership. As a result, management doesn't own that many voting shares. Instead, it has received a number of options (some 1 million options have been exercised over the last two years with a notional value of $58 million based on today's stock price) and a bunch more in restricted shares (some $22 million worth over the last two years).

But these are mostly in the form of cash or non-voting shares. As a result, management is strongly incentivized to see its non-voting shares receive voting rights! Non-voting shares have typically traded at a 5% discount to the voting shares, so any closing of that gap would reap a windfall for management and other non-voting shareholders.

So Telus proposed that non-voting stock be converted into voting stock on a one-for-one basis. That's it! No compensation for voting shareholders, who presumably paid a voting premium for their shares even though they receive the same dividends and other rights. In other recent cases of dual-class conversion to single-class, we have seen substantial compensation paid to the voting shareholders! In this case, however, voting shareholders were expected to receive nothing in return for sharing their voting rights.

So a hedge fund decided to buy up a block of voting shares (while simultaneously shorting non-voting shares to hedge out risk) and vote against the deal. Instead of offering better terms, however, Telus tried to get the government to help. When the government denied their claim, the company's CEO offered this beauty of a quote:

“I’m not saying, to be clear, that what Mason did was illegal. I find it morally objectionable,” said Mr. Entwistle. “And I find it a great example of what is wrong within the capital markets and I think it is area where securities regulators need to step in."

Of course, when it comes to his telecom business (i.e. not the hedge fund's capital market business), he's wary of regulations. Entwistle is quoted as telling regulators to rely more on market forces, and usher in a new era of minimal regulations.

Incentives play a powerful role in behaviour. When you take the time to figure out what a party's incentives are, you will go a long way towards understanding why they are behaving the way they are.

Also watch out for media portrayals. Writers want an angle, so they will pick out the facts that support a particular viewpoint and ignore those that don't. (I'm as guilty as anyone on this, as this one-sided piece illustrates, but it's important for you as the reader to recognize this when it happens and think for yourself.)

Entwistle remains intent on returning Telus to a single class of shares. Perhaps he should heed his own advice and let market forces determine a price that fairly compensates owners of the voting shares.

Disclosure: No position

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