Xerox CEO Showed Some Strategic Thinking

(Bloomberg Opinion) -- Xerox.

These are not the bullet points that you want to see in your annual performance review:

Jacobson was aware, too, that the rest of Xerox’s board was dissatisfied with him. In a call that spring, the board had discussed his shortcomings. Robert Keegan, a former CEO of Goodyear Tire & Rubber Co. who was soon to succeed Burns as chair, wrote some of them down in spidery, all-caps bullet points: “questionable priority setting,” “little strategic thinking,” “overconfident,” “poor listening skills,” and “whiner!”

Be more constructive with your feedback, please! But by this point, Xerox Corp.’s board of directors wasn’t really looking to give Chief Executive Officer Jeff Jacobson pointers on how to improve his performance. (“The Board exhausted every ounce of patience and coaching to make our current CEO a success,” one director wrote to another.) They were looking to fire him:

By midsummer, the board had concluded that Jacobson was incapable of leading Xerox. While he continued to talk with Fuji, they were interviewing replacement candidates. On Nov. 10, Keegan and Jacobson met in Westchester, N.Y. They talked amicably for a few minutes about the chairman’s recent foot surgery, then Keegan told Jacobson the board had given up on him. 

But there was one thing to finish up: Jacobson had been negotiating a potential acquisition of Xerox by Fujifilm Holdings Corp., with which Xerox already had an important joint venture, and he didn’t want to rudely cancel his meetings just because he had been fired:

Keegan told Jacobson to stop his talks with Fuji. But Fuji executives were scheduled to fly to New York a few days later. When Jacobson tried to cancel, Kawamura told him Komori “would be very disappointed” and might break off the talks. After reading the texts, forwarded to him by Jacobson, Keegan relented. Jacobson could go to the meeting, and they’d see where things went.

Where did things go? Oh, wild places. I have been remiss in not discussing the Xerox situation much here, because it is amazing, as you can tell from Drake Bennett’s Bloomberg Businessweek feature on the deal. Basically: Jacobson kept negotiating with Fuji; they signed a deal in which Fuji would acquire Xerox for no cash and in which Jacobson would run the Fuji-owned Xerox; the board approved it; a couple of activist shareholders—Carl Icahn and Darwin Deason—objected and sued to stop the deal; they found out about the board’s loss of faith in Jacobson and argued that he had cut a bad deal with Fuji just to preserve his own job; a New York judge sided with the activists; the deal was scuttled and Jacobson eventually resigned.

One obvious lesson is that, when you are negotiating a deal with a giant multinational company, you are actually negotiating a deal with a person (or a few people), and maximizing that person’s (or those people’s) utility can be more important to getting the deal done than maximizing shareholder value. Anyone who has ever sold anything to a big corporation knows this, but it is an uncomfortable fact. There is a spectrum; at one end, it is good to make small talk with the executives and ask about their kids and explain to them how doing the deal will be good for their own careers; at the other end, it is bad to just hand them sacks of cash to get them to agree to the deal. Helping a merger along by offering the target CEO a good job at the combined company is … a fairly standard move, really; it’s the sort of thing that people grouse about in merger lawsuits but that happens a lot. Helping it along by offering the target CEO a good job at the combined company after he’d already been fired is much weirder, though. It’s more or less okay for a CEO to try to preserve his job in a merger; it’s awkward for him to try to rescue his job that way.

We have talked a lot recently about the hierarchies of control at a corporation. In theory the shareholders can vote out the board, the board can fire the CEO, etc. In practice if the board wants to vote out a shareholder, or the CEO wants to fire the board, there are … means. If you are a public-company CEO and your board of directors has told you that it is going to fire you as soon as it can get the paperwork in order, you might as well try to find a new board of directors. Which probably means finding a new owner. Which might be hard if you have already been told that you’re out as the CEO and that you should shut down merger talks. But if you’re creative enough there might be a way. 

Founder friendliness.

“Money, like, there’s an unlimited amount of capital in the world, you know?” says Anna Delvey, aka Anna Sorokin, in this New York Magazine profile by Jessica Pressler. “But there’s limited amounts of people who are talented.” Delvey is currently at Rikers Island awaiting trial for charges of larceny and attempted larceny of the high-society con-artist variety: scamming fancy hotels, skipping out on lavish restaurant bills, trying to con rich people into financing her lifestyle, that sort of thing. But she objects to this narrative. In her telling, she was raising money to start a genuine arts foundation, and maybe moving a bit too fast and breaking a few things:

She was frustrated with the New York Post’s characterization of her as a “wannabe socialite” — “I was never trying to be a socialite,” she pointed out. “I had dinners, but they were work dinners. I wanted to be taken seriously” — and the District Attorney’s portrayal of her as, as Anna put it, “a greedy idiot” who had committed a kind of harebrained Ponzi scheme in order to go shopping. “If I really wanted the money, I would have better and faster ways to get some,” she groused. “Resilience is hard to come by, but not capital.”

She seemed most interested in expressing that her plans to create the Anna Delvey Foundation were real. She’d had all of those conversations and meetings and sent all of those emails and commissioned those materials because she thought it was actually going to happen. “I had what I thought was a great team around me, and I was having fun,” she said. Sure, she said, she might have done a few things wrong. “But that doesn’t diminish the hundred things I did right.”

It is an astute diagnosis. If there is not “an unlimited amount of capital in the world,” there sure is a lot of it, and it all seems to be very enthusiastically chasing after talent. Here is a Wall Street Journal article about how “founders of highflying startups are increasingly wresting control of their companies from venture-capital backers and extracting huge pay packages tied to going public”:

Venture capitalists had long called the shots in startup boardrooms and continue to be the primary backers of private companies. But in recent years, they have had to compete against new classes of investors including mutual funds, sovereign-wealth funds and now Japan’s SoftBank Group Corp. , which has a $92 billion fund investing in startups.

That has reduced their leverage, shifting power toward star entrepreneurs and adding pressure on VCs to cultivate “founder friendly” reputations that will help them get a piece of the next hot startup. The flood of capital also gives entrepreneurs the ability to pick not just their investors but also when and whether to go public. 

And: “Last year, 67% of U.S. venture-backed tech companies that staged IPOs had supervoting shares for insiders, according to Dealogic, up from 13% in 2010.” The basic trade-off used to be that if I had an idea and you had money, you would let me use your money, but in exchange you would have the right to monitor and control what I did with it, and to fire me if you thought I was doing a bad job. The new trade-off is, you let me use your money, and you are grateful that I deign to use your money instead of someone else’s. It is no doubt a good environment for innovation, but it’s a great one for hucksters.

Self-tender.

On Friday Herbalife Nutrition Ltd. announced the results of its tender offer to buy back $600 million of its stock:

Based on the preliminary count by Computershare Trust Company, N.A., the Depositary for the tender offer, a total of approximately 49.7 million common shares of the Company were properly tendered and not properly withdrawn at or below the price of $52.50 per share.

In accordance with the terms and conditions of the tender offer and based on a preliminary count by the Depositary, the Company expects to accept for payment a total of approximately 11.4 million common shares of the Company at a cash purchase price of $52.50 per share, for a total cash cost of approximately $600 million, excluding fees and expenses relating to the tender offer. …

Because the tender offer is oversubscribed, the Company expects to purchase only a prorated portion of the common shares properly tendered by each tendering shareholder …. The preliminary proration factor for the tender offer is expected to be approximately 23% of the shares properly tendered at or below the cash purchase price of $52.50 per share ….

Meanwhile Herbalife’s largest shareholder, Carl Icahn’s Icahn Enterprises LP, made its own announcement:

Yesterday IEP tendered its Herbalife shares into the Company's self-tender offer. Of the shares we tendered, at most only 11.4 million could possibly be purchased in the tender, which would still leave us as the Company's largest shareholder with at least 34.3 million shares.

Some quick math: 11.4 plus 34.3 is 45.7; Icahn owned 45.7 million shares—almost 26 percent of the company—before the tender offer. And 45.7 divided by 49.7 is 92 percent, suggesting that, if Icahn Enterprises tendered “its Herbalife shares”—not “some of its Herbalife shares”—into the tender offer, then it was 92 percent of the takers and effectively set the price. (The tender offer was a Dutch auction with a price range of $49 to $54; if Icahn was 92 percent of it then presumably he set the market-clearing price.) And 23 percent times 45.7 is 10.5, suggesting that Icahn will only get to sell 10.5 million, not 11.4 million, of his shares, if he’s prorated like everyone else; the other 0.9 million will come from the shareholders who made up the other 8 percent of the tender offer.

Still the overall impression here is that Herbalife is going to buy back $600 million of stock from Carl Icahn at a price he picked, with a few other public shareholders coming along for the ride. I suppose the company could have just bought the stock from him directly, saving some paperwork and avoiding leakage to the other 8 percent. But doing it as a public tender offer—and letting those other shareholders participate—is generally a better look; if it’s open to everyone then it doesn’t look like Icahn is getting any special favors.

People are constantly getting mad about stock buybacks for reasons that puzzle me. In my simple model of the world, investors invest money in companies, and the companies do stuff with the money, and if the stuff is successful then the companies have more money than they started with, and they use some of it to pay back the investors. That is, for instance, very uncontroversially how lending works: A bank gives you money, and you spend it on doing stuff, and you hopefully end up with more money than you borrowed, and you give the bank back the money that you borrowed and have some left over.

The arithmetic of stock investing is a little different—there is no fixed dollar amount or maturity to the investment—but the principle is, surely, the same. How could it not be? If the way that stock investing worked was:

  1. Investors give money to a company, and
  2. The company keeps it forever, 

then why would anyone ever buy stock? Why would the stock have value? If you donate money to Harvard University, it will invest that money and turn it into more money and grow rich in perpetuity. But your donation receipt won’t grow in value, or even have any value; you’ll never be able to sell it to speculators in the secondary market. Because Harvard has promised never to give you the money back. Investing in the stock market is different. Because—by merger or liquidation or dividend or, yes, absolutely, stock buyback—the company, in the very long run, is expected to give you your money back.

Herbalife is a weird case because it’s not like Carl Icahn bought a lot of stock directly from Herbalife so that it could use the money to make diet powders or whatever. Carl Icahn bought stock in the open market; Herbalife never got any money from his investment. But his investment was very directly and obviously useful to Herbalife. He gave the company a vote of confidence when Bill Ackman waged his noisy short-selling campaign, and he also did a lot—both in the stock market and on television—to annoy Ackman and hound him out of the position. Icahn’s large position, coupled with other Herbalife share buybacks in which Icahn “never sold a share, even after our investment doubled,” made it difficult for Ackman to remain short: With so much of the company’s float effectively out of public hands, the stock price was buoyed and stock borrow for short sellers was hard to come by. Ackman eventually threw in the towel in February, and Herbalife launched the tender offer a few weeks later. Icahn’s massive investment has served its purpose, and there is no longer a need for it to be as big as it is, so why shouldn’t Herbalife give him back some of his money?

Fund research.

Last week the Securities and Exchange Commission announced that it was proposing new rules “that would promote research on mutual funds, exchange‑traded funds, registered closed-end funds, business development companies, and similar covered investment funds.” The basic, somewhat archaic, situation is that there are rules restricting offers of securities, and there is an exception from those rules allowing banks to write research reports on stocks without being deemed to be “offering” those securities (and having to deliver a prospectus, take on underwriter liability, etc.). There is no such exception for similar research on mutual funds and ETFs, but now there will be. Congress called for this rule last year, which I guess means that there is some demand for it—that people are really looking to publish, and maybe even read, ETF research.

Which makes sense. In one way it is a very zeitgeist-y proposa. There are, famously, more stock indexes than there are stocks, and if you are trying to help investors make sense of their investment options this does seem to be where the opportunities are. And if you are going to tell retail investors what to invest in, you should probably tell them what mutual funds and ETFs to invest in, not what stocks to invest in. Who invests in stocks?

In another way it is a bit strange, though, to see new rules intended to make research easier. Elsewhere the story of investment-bank research is mostly gloomy: The U.S. Global Analyst Research Settlement after the dot-com bubble made it harder for analysts to earn their keep by drumming up investment-banking business, while Europe’s MiFID II rules made it harder for them to earn their keep by drumming up trading business. And we have talked before about the suspicion in which research is held, because of the awkwardness of serving two different markets: Retail investors want research analysts to tell them which stocks to buy, while institutional investors want analysts to help them understand companies and industries and get access to corporate executives. When those goals conflict—when analysts with Sell ratings can’t get their institutional investors meetings with corporate executives—and the analysts prioritize the institutional clients who actually pay their bills, people worry that the analysts’ recommendations will mislead retail investors.

You could imagine a synthesis in which Wall Street research would consist of two parts. Institutional research would be marketed to hedge funds and other institutional investors, and would help those investors make decisions about what stocks and bonds to buy through analysis and access rather than Buy/Sell ratings. Retail research, meanwhile, would tell retail investors what ETFs to buy, presumably with basic statistical screens for like returns and expenses and Sharpe ratios. You don’t need access, or deep industry knowledge, to recommend an ETF, and you don’t really need to be recommending any individual stocks to retail investors. 

The crypto.

“Castle Craig Hospital in Peeblesshire, the Scottish Borders, has created a course of residential treatment for ‘crypto addicts’ to deal with the underlying issues and learn to live without it,” it says here. I hope the treatment is like equine therapy, except that instead of riding horses to cure your addiction, you ride around in Lamborghinis. I am still waiting for a program to treat secondhand exposure to crypto addiction: I have never owned any cryptocurrency, but having written about it every week for years now, I could definitely use a few quiet weeks in a Scottish sanitarium.

Elsewhere: 187 Things the Blockchain Is Supposed to Fix.

Things happen.

Fidelity, Bruised From Crises, Searches for Life After Mutual Funds. Graduate applications flood Deutsche and other banks. Bank of Italy warns Rome is close to losing ‘asset of trust.’ National team’ sells $28bn of vast China stock holdings in Q1. Chinese Energy Company’s Missed Bond Payment Fans Fears of More Defaults. Companies Look to Libor for Debt Savings as Rates Rise. Mick Mulvaney Is Having a Blast Running the Agency He Detests. Jeff Bezos: ‘We Must Go Back to the Moon, and This Time to Stay.’ The Irrepressible Myth That SEC Overregulation Has Chilled IPOs. Vix-mageddon revisited: it's the buyers who disappeared. Do middle name initials enhance evaluations of intellectual performance? Drink at lunch.

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