Hedge Funds and the Satellite Industry (Part I)
In 2003 and 2004, the satellite industry was abuzz with speculation about the entry of private equity firms into the fixed satellite service sector, and we analyzed many potential positive and negative impacts of the new players.
In July, Harbinger Capital Partners, a hedge fund that has invested broadly in the mobile satellite service (MSS) sector and has a 28.8 percent stake in Inmarsat, made a preliminary takeover overture to the U.K.-based company. The two companies entered into an agreement by which Harbinger’s portfolio company, SkyTerra Communications, the parent of MSS operator Mobile Satellite Ventures (MSV), would acquire the shares of Inmarsat not already owned by Harbinger. The transaction would enable Harbinger to merge Inmarsat and SkyTerra. Harbinger’s MSS investments and interest in an Inmarsat acquisition provide the occasion for examining the likely effects, for better and worse, of hedge fund entry into the satellite industry.
The conventional wisdom for private equity entry said the positives would include professional financial management and discipline. Among the feared negatives were resistance to research and development, curtailing capital investment and lack of industry expertise. Happily, the feared negatives turned out to be almost entirely unfounded. Given that experience, should the industry be at ease concerning the entry of activist shareholder hedge funds?
There are sharp limits to the private equity-hedge fund comparison. Private equity funds want the value of the companies they acquire to appreciate. The concern industry had was the firms’ exit horizon and whether long-term health might be sacrificed for maximizing returns. Hedge funds, by contrast, see their holdings as part of a larger strategy that may not depend on, or even be contrarian to, a targeted company’s health. That strategy may be a traditional long-short strategy or any of a myriad of others driven by mathematical formulae, events or other considerations.
Activist hedge fund shareholders have become a preoccupation of companies across all industrial sectors. The Wall Street Journal reported July 14 that Pfizer, Monsanto and Sara Lee were among corporations that have amended their by-laws to require that investors that propose resolutions or nominate directors at annual meetings disclose their transactions in the companies’ stock. Because hedge fund transactions often are complex, multi-stage and rapid, it can be difficult to discern the shareholder’s motive in purchasing stock. For example, a rapid accumulation of stock that would be straightforward in motive by most other shareholders may be, in the case of a hedge fund, intended as a pan-industry play in which multiple holdings in a sector are intended to assure choosing the winner; as a hedge against other holdings’ decline; or as a hedge against other holdings’ appreciation. Harbinger’s approach to Inmarsat included a review of the fund’s MSS holdings generally. MSV is heavily invested in ancillary terrestrial component (ATC) service. Inmarsat is a non-ATC MSS play, and its acquisition would hedge Harbinger within the MSS sector against ATC not living up to expectations.
An activist fund seeking a board seat may have different motives than the other directors, and it is reasonable for any company to be concerned about a directorship going to an institution betting on the company’s decline. Of course, once a directorship is obtained, the director has a fiduciary duty towards the company’s other shareholders and the company itself, barring actions directly contrary to the company’s interests. Moreover, the fund will need the support of other directors and shareholders, and therefore is incentivized not to propose actions inimical to the company’s interests. However, the fund may be betting on more nuanced strategies not shared by other directors or shareholders, such as the company’s break-up value if divestitures were voted.
Another concern is the use of complex transactions to decouple voting rights and economic interests. The use of derivative instruments either to borrow shares to vote without owning the shares on which the voting right is based, or accumulate economic stakes in the company that do not have to be disclosed under U.S. Securities and Exchange Commission rules, provide opportunities for deploying strategies under the usual regulatory radar screen. The proposed by-law amendments are an attempt to address such transactions by requiring their disclosure by shareholders nominating directors or proposing resolutions.
In October, we will examine Harbinger’s strategy, how real hedge fund concerns are and whether the legal and regulatory tools at hand are sufficient to deal with them.