Tuesday, March 4, 2014

Differences In The Types Of "BAD" Governance.

Often times, people paint corporate governance with very broad strokes. In the animal like nature of The Increadible Hulk, investors can scream "Poison pills bad! Staggard boards bad! Share repurchases good! Voting structure bad!!!!" When often, these, and so many other points should be investigated on an individual, and case by case basis.

Obviously, share repurchases are not always a good thing- as Warren Buffett points out in his most recent annual letter to Berkshire shareholders, buying back stock below intrinsic value (note, not neccessarily market price, book value, or some stated multiple) is wealth creating for shareholders, whereas purchasing stock above intrinsic value is value destructive. Dividends can be similar- if the company can reasonably expect to grow investment at a greater rate than its shareholders, generally, a dividend would be a bad thing to pay.

In the instance of Winland Electronics, a poison pill was adopted, which the company claims was to protect the Net Operating Losses (NOLS) of the company. While many think that these are only negated when a change in control occurs, by someone buying 50% of the stock, that isn't the case. It's a much more complicated rule that has to do with 5% shareholders and the amount of stock that they purchase (here is an easily Googleable article, which doesn't go nearly in depth enough). This is the exact same sort of poison pill that ModusLink, formerly known as CMGI adopted. You can also look at insider transactions to see how they go about creeping up their stakes so as to not lose the NOLs. Clearly, this poison pill is a good thing for the small company, especially when the board is plumb full of value investors. Even just a few million dollars of NOLs means the world, when your whole market cap is just a few million!

Other instances, such as that of ITEX, the poison pill seems to be more about the CEO controlling the company, based on a historic disregard for shareholders and lengthy legal battles by management. They even had an interesting share buyback that while value creating (since it was implemented below the intrinsic value of the company) seems to also have been done to get rid of shareholders that wouldn't have voted with management in the coming proxy battle. And this is after certain items (such as a dividend) had been pushed for by shareholders, which has clearly helped the share price rise in a responsible way, over time.

In other types of governance related issues, last year, Solitron Devices was forced by various shareholders to have an annual meeting. At the meeting 2 of the former directors of the company were ousted, simply because they didn't get enough votes to stay on the board. Now, one of them is back. The company also initiated a staggered board, which would seem to only serve to entrench management... in light of previous struggles with shareholders, this doesn't seem to be very shareholder friendly, which is unfortunate- at the Solitron Annual meeting, there were numerous shareholders that attended, both large and small, united by their desire to see the company do well. Thus far, few suggestions have been taken by the company other than holding an annual meeting and a small buyback of shares in a private transaction.

Paranoia seemed rife when the company responded to questions at the meeting (here is the transcript.) As a side note, a lot of the quotes were misattributed to specific shareholders, and a lot of stuff was missed in the back and forth. (On a personal level, I am not a quack when it comes to drones, there was a load of sarcasm in my voice!) Interestingly, one of the old directors came up to a few of us who were talking after the meeting (Nate at Oddball Stocks and Valueprax can back me up on this one) and told us that the company would have lost x number of dollars (I think a few million, which was absurd) if they would have held an annual meeting every single year that they hadn't. This stuck with me, as the resentment of holding the meeting in the first place was clearly still there, despite righting the wrong of the company not operating in a legal manner for nearly 2 decades...

Often times, the will of shareholders is totally ignored. Even when the right thing is done, there is often still work to do- just look at the whole of the situation with Solitron. Despite the progress that the company has made, a ton of shareholders are still not happy with how things have been going, and likely think that progress is longer than originally expected. Several shareholders were outright angry at the annual meeting! However, activism is often a slow process in the small cap world, due to capital, legal, and time restrictions. With Solitron, any change seemed to be met with great resistance, after all, the company is the CEO's baby, and "outsiders" can't go about changing things in weeks or months...

In light of this, it is important to remember that if a company doesn't act in the interest of all shareholders, it falls on the shareholders themselves to do what is right and make the needed changes. This is true whether it is a big company such as Motorola, small company such as Syms, or even smaller, which is what this and a lot of other value blogs are known for. The companies are yours- make your voice known!

Disclosure/Disclaimer:  I own and represent shares of TPHS (formerly Syms) and Solitron Devices, but none of the other companies mentioned, though, reserve the right to change the positions at any time. This post is my nothing more than my thoughts/opinion. Always do a ton of your own research before so much as contemplating anything that I say, do, write, or even so much as think about.