One of the most frustrating courses in my MBA program was a required one on corporate governance.
Not because of the subject matter, mind you – but because of the teacher.
It was taught in the evenings by a nearly retired adjunct who preferred lecture to debate, and did nothing to connect our textbook review to current real-world case studies.
This could have been a fascinating seminar on ethics and shareholder value in the post-Enron, post Sarbanes-Oxley world, and occurred at the dawn of a new era of activist investors and hostile takeovers.
Instead it remains burned in my memory as a colossal missed opportunity.
Public vs. Private
Let’s start at the beginning.
For those of you who may be ignorant of corporate finance, most companies would prefer to remain privately held.
By keeping a company private, you
- Get to retain all ownership;
- Can experiment and invest for the long term, as you aren’t under pressure to show a profit every quarter;
- Don’t have to present GAAP-audited financials every quarter, let alone publicly disclosure all manner of documents to the SEC;
- Most of all, you get to retain governance rights – not having to share in governance with your thousands of stakeholders, who typically vote on issues ahead of the annual meeting;
- Similarly, you are a less likely target for hostile takeovers, as there’s no easy way to acquire a controlling share.
But – I hear you saying – big companies _need_ to go public.
Not so – here a few big companies that are still private.
- Chick Fila
- Dairy Queen
- Fruit of the Loom
So given all of this, why would any company go public?
Access to capital.
That’s basically it.
If you want to aggressively expand into new markets, an initial public offering of stock (IPO) gives you instant access to hundreds of millions of dollars.
An IPO can also make owners (as well as the early investors/venture capitalists) instant millionaires.
In this second golden age of tech start-ups, the Millennial dream is to accept VC money and eventually go public.
Which brings us to Snap Inc., the parent company of social media darling Snapchat.
Since going public for $3.4 billion in March (the third-largest ever IPO for a U.S. tech company), its bubble has burst.
First, sales of its “Spectacles” have done about as well as the Apple Watch – that is to say, not well at all.
Second – and most troubling – new downloads of Snapchat and time spent on the platform among teens – its primary demographic – has slowed in recent months.
This has led the stock to slip in recent weeks – to even (gasp!) below its IPO price of $17 a share.
It fell further this past week in anticipation of July 30, when the “lock-up” period expired, thus allowing major inside shareholders to finally sell their shares and cash out.
But then, today shares slid further to $13.10 per share.
S&P 500 Rule Change
The S&P 500 announced a rule-change whereby it will no longer list companies in its index that issue new multiple classes of shares.
This will have an immediate detrimental effect on Snap Inc., as huge institutional investors will no longer carry the stock.
This includes many pension funds and index funds that – as their name implies – invest passively in only companies listed in the major indices.
Why did the S&P 500 do this?
Corporate governance concerns.
See, what “multiple classes of shares” implies is that a select few – normally the executive team and/or a few VC principals, have a class of preferred stock that gives them voting rights in governance issues.
The vast majority of the stock, however, is “common,” and the shares offer you a piece of the company, but zero say in governance.
You become, in effect, a silent partner – willing to lend your money (via buying shares) for a fair rate of return, but without the usual say in how the company is run.
Corporate Takeovers for Dummies
This also makes you essentially immune to hostile takeovers and activist investors.
The “activist investor” phenomenon is one that fascinates me. It usually works like this:
A hedge fund manager decides they could run the company better.
So they quietly amass a percentage of the outstanding stock – usually 1-3% or more – stealthily, through various companies and subsidiaries.
Now, as a major shareholder, they announce themselves and demand a seat on the Board of Directors.
With that power, they have direct influence on the CEO and sometimes can even force a CEO change.
Carl Icahn has made his name (and fortune) as an activist investor.
In fact, this Huffington Post piece details how Icahn “notoriously” killed Blockbuster Video’s plans to expand their online service offerings in favor of sticking to its brick-and-mortar model.
That mistake ultimately led to Blockbuster’s demise in the face of competition from Netflix.
The piece also notes how Icahn killed airline TWA back in 1985 by forcing it to take on excessive debt (which can save millions in the short term by lowering taxes).
Recent examples of investor activism include:
Dell – After a bitter fight with Icahn, Michael Dell ultimately took his namesake computer company private again in 2013 – both to alleviate the pressure of quarterly earnings and to fend off activist investors such as Icahn.
Olive Garden – In 2014, private equity fund Starboard Value presented its classic (nearly 300 slide) PowerPoint deck detailing every way parent company Darden Restaurants was mismanaging the fast casual Italian restaurant chain. Business Insider published a hilarious (and spot-on) piece on the deck called We’ve Just Witnessed The First True Masterpiece Of The Modern Hedge Fund Era.
Whole Foods – This April, hedge fund Jana Partners announced it owned more than 8 percent of the grocery store chain and demanded immediate changes to enhance profitability. That move ultimately led to Amazon buying Whole Foods last month.
The S&P 500 rule change is a huge one, but it goes to the core of the issue:
Corporate governance is extraordinarily important, and moves by companies to limit shareholder input via different classes of shares that effectively silence shareholder voices should be heartily discouraged.
Now, they have been.
Snap Inc. may be the sacrificial lamb, but this one rule change should have far-reaching (and positive) corporate governance implications – in Silicon Valley and beyond.