BlackRock Won't Save You From Blackstone

It’s time for big, passive investors like FMR LLC (Fidelity), Vanguard Group and BlackRock Inc., sitting on trillions of dollars of assets, to use their heft as shareholders and protect corporate governance standards. It’s no longer enough to simply shovel money into index funds and ETFs. 

As the global economy stages an uneven recovery from the pandemic, mergers and acquisitions are surging, and valuations are all over the place. Everyone’s looking to pounce on a good deal. But investors beware: Those deals may not always be in their best interests. Money managers with substantial stakes must do their part to protect minority shareholders.

Just consider what’s transpiring at Extended Stay America Inc.

In March, the U.S. lodging chain announced it was being acquired by Blackstone Group Inc. and Starwood Capital Group for $6 billion. A group of smaller investors, which collectively own just over 14%, were up in arms. They opposed the timing, valuation and low premium on the deal’s share price.

Meanwhile, the board, which consists of individuals that were either appointed by or have continuing relationships with Blackstone, rushed the sale, small investors have said. One of them, Tarsadia Capital, suggested Extended Stay's board add directors that had lodging experience. The board put off interviews with the fund’s privately nominated candidates and then announced the merger agreement in March. The board  has said that it “negotiated vigorously” and the sale is the best way forward.

Two directors on the company’s board also disapproved  – a highly unusual outcome, according to proxy advisory firm Institutional Shareholder Services, or ISS. It recommended shareholders vote against the deal. So did its peer Glass Lewis & Co., noting that sale processes like Extended Stay’s should be open, enabling others to participate. But the hotel owner and operator didn’t “solicit interest from alternative parties” before entering into the agreement with Blackstone et al., Glass Lewis said. The process has been fraught with other concerns, too, investors and proxy firms have noted.

After all the noise, Blackstone and Starwood pushed the price up by $1 per share this month (hardly a sweetener). Glass Lewis didn’t change its recommendation, while small shareholders said this was still too low. One investor, SouthernSun Asset Management LLC, noted that “the transaction and the process undertaken by the board represents one of the more egregious examples of poor corporate governance." 

The new terms, however, were enough to flip the two directors and ISS. The advisory firm said that while most of its previous concerns can’t be remedied without running a new sale process, the dissenters changing their mind was “meaningful.” 

As this unfolded, Extended Stay America’s largest investors were effectively silent — at least publicly. BlackRock, Fidelity and Vanguard own over 18% of the company. That should be enough to wield power when it comes to good governance and company boards, and big money managers have a fiduciary duty to their investors. But they aren’t pulling their weight. Because smaller, less vocal shareholders would likely follow their lead, the costs of inaction are even greater. 

Critics of passive fund managers say they tend to be deferential to executive teams, which sometimes turn out to be clients. If their compensation is based on increasing assets under management versus performance, they may not be incentivized to boost gains.

So while many money managers have built small corporate governance teams and started taking their stewardship responsibilities more seriously in recent years, their efforts haven’t gone far enough. They often rely on proxy advisers, who in this case are saying different things. What transpired between Exxon Mobil Corp. and Engine No. 1, where a tiny, climate-focused hedge fund forced change atop the oil major, was perhaps the closest example of success. 

The reluctance among asset managers to get their hands dirty is understandable: Pushing change along is expensive. Other large mutual funds will benefit from the upside without spending a dime. That’s a disincentive for whoever bears the financial burden, and few will be willing to raise fees amid the cutthroat competition for customers. The cost of engagement is high.

Yet it’s in situations like these that big shareholders need to ensure they vote in favor of the best corporate governance standards. In this case, that means ensuring long-term value for the company and that transactions are undertaken properly. This is where stewardship matters. If managers want to be passive, they should be kept out of the voting process, as some scholars have suggested

All the players in this small-scale David and Goliath-esque drama are driven by their own motives. Proxy firms are advising their clients to act (especially the merger arbitrage-focused hedge fund variety, driven by short-term goals and stock gains). Goldman Sachs Group Inc., Extended Stay’s financial advisor, is moving the process along to get the deal done. Small investors want to make sure they get their money’s worth. 

Blackstone, meanwhile, is a buyer and seller. It’s likely just looking for the best price. The alternative asset manager wants to make money, and its business model relies on offering more to investors than traditional options. Blackstone knows its way around real estate, and especially this company: After all, it has owned Extended Stay twice before, having bought the hotel chain in 2004 for $3.1 billion and then selling it three years later for $8 billion. In 2009, the company filed for bankruptcy. The following year, the private equity giant took on Starwood to buy Extended Stay again for around $3.9 billion, taking it public in 2013.

None of these goals seem to be leading to a collective gain, especially for Extended Stay, where the board should be acting to protect the interests of all shareholders.

Responsibility now falls to the likes of BlackRock, Fidelity and Vanguard to advocate for what’s right, not what’s easy. Shareholders will vote later this week. It may be a moment to let their money do the talking.

An existing shareholder.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. She previously worked for the Wall Street Journal.

©2021 Bloomberg L.P.

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