KIRKLAND & ELLIS LLP “Hedge Fund Activism” April 7, 2006 Stephen Fraidin KIRKLAND & ELLIS LLP.

KIRKLAND & ELLIS LLP

“Hedge Fund Activism”April 7, 2006

Stephen Fraidin


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Increased Hostile Activity

Surge in Hostile Activity

Hostile / Unsolicited Activity as % of Total M&A Volume

4%

13%

5%

8%

14%

2000 2001 2002 2003 2004

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A. Selected Factors

• Hedge Funds - Over $1 Trillion• Increased Availability of Other Equity Capital

– Private equity

• Cheap Financing– Debt financing still relatively cheap based on historic

standards

• Deleveraging– Companies have accumulated cash and paid down debt -

Buyers can use target’s assets to finance deal

• Increased Disfavor of Takeover Defenses– Increased corporate governance initiatives have discouraged

adoption

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A. Selected Factors (cont.)

• Reluctance of Boards to Reject Deals– Boards less likely to reject publicly-made premium value bids

• Sarbanes-Oxley Twist– One effect is decreased risk of undisclosed accounting

irregularities of Target even without due diligence

• Outward Focus of Companies– After years of completing internal reviews, cleaning up

balance sheet and achieving internal efficiencies, companies are more acquisitive and are looking for outward growth

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B. Hedge Fund Activity

Funds Committed to Hedge Funds (billions, approx.)

$375$425

$475$525

$600

$800

$1,000

1998 1999 2000 2001 2002 2003 2004

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B. Hedge Fund Activity (cont.)

Number of Hedge Funds (approx.)

3,0003,500

3,9004,200

5,000

6,500

8,000

1998 1999 2000 2001 2002 2003 2004

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B. Hedge Fund Activity (cont.)

• Traders Mentality– Less focused on long-term value appreciation– More unspoken cross-firm communication (“conscious

parallellism”)

• Eye for Value and Arbitrage Opportunities• Increased Metrics-Based Analysis

– Mastery of Derivative/Hedging Strategies

• Flexing Muscles with M&A and Activism Opportunities– Willing to employ hostile bidding techniques (vs. many private

equity firms that are expressly prohibited from hostile activity and vs. mutual funds that typically do not engage in this activity)

– Competing for attention as define/distinguish themselves

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C. Common Form Hedge Fund Tactics

• Purchase “Toehold” Position in Target– Purchase quickly (usually following period of poor stock

performance)

– Use of derivatives to decrease actual exposure

– Make filings announcing position (potential influential role)

• Pressure Management for Near-Term Value Enhancing Changes– Force sales of Target or under-performing businesses

– Force monetization of assets

– Force distribution of excess cash to shareholders/stock buybacks

– Block pending transactions

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C. Common Form Hedge Fund Tactics (cont.)

• Other Hedge Funds Accumulate Shares - Conscious Parallel Activity

• Force Change of Un-Cooperative Management/Board– Request removal of takeover defenses to facilitate

– Shareholder proposals

– Threaten proxy fight to remove directors

• Use of Press to Sway Other Shareholders to Adopt Hedge Fund’s Strategy– Note: Additional press also helps attract publicity/distinguish fund

for raising of next fund

General Trend: Escalation of Tactics Until Achieve Goal

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D. Examples of Recent Activist Activity

Blockbuster/Carl Icahn• Icahn (largest shareholder) objects to management of

Blockbuster – Critical of failure to acquire rival Hollywood Video– Critical of CEO Antioco’s pay package and other uses of funds– Demands that greater dividends be paid to shareholders– Demands that offers for the company be duly considered

• Icahn commences proxy fight• Dissident slate of directors elected

– Classified board, but can take control of Board next year

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D. Examples of Recent Activist Activity (cont.)

Kerr-McGee/Carl Icahn and Jana Partners• Icahn and Jana (collectively 7.6% shareholders) want

changes at Kerr-McGee:– Divest its chemical business and monetize future production– Use the proceeds to buy back stock

• Icahn and Jana announce proposing slate of directors• Kerr-McGee agrees to divest chemical business and

commence $4 Billion share repurchase– In exchange for agreement of Icahn and Jana to withdraw

dissident slate of directors

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D. Examples of Recent Activist Activity (cont.)

Wendy’s/Pershing Square• Pershing Square (9.9% shareholder hedge fund) wants

value-enhancing changes at Wendy’s:– Spin-off Tim Hortons (Canadian brand)– Refranchise several Wendy’s-owned locations– Repurchase shares with proceeds of refranchising– Avoid acquisition of Quick Service

• Pershing Square Escalates Public Attention – Announces intention to make proposals– Announces retention of Blackstone to evaluate strategic transactions

for Wendy’s– Files letter with rationale for proposals and requests meeting

• Ongoing

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E. Observations - Preparedness

• Activism Can Come in Any Context; Most Frequently:– Following period of weak stock performance– When easily monetizable assets or large amounts of cash– In connection with transaction (either as buyer or Target)– Annual meetings or proposals to shareholders

• Swarming Effect of Activist Activity When Comes– Approach companies when at weakest

(undervalued/vulnerable)– Act quickly and together– Disputes are often made public

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E. Observations – Preparedness (cont.)

• Recent Transactions Have Shown Positioning is Helpful to Confront Activists:– Being prepared– Exposing activist vulnerabilities– Developing and communicating Board strategy– Legal challenges to tactics

• Companies Need to Continually Monitor Vulnerability– Evaluate Corporate Governance Posture– Identify Key Constituencies/Shareholder Base– Monitor Market Sentiment

• Examples: market reaction to news, press, chat rooms, etc.– Develop Communications Plan for Strategy

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E. Observations – Preparedness (cont.)

Example: Consider some Corporate vulnerabilities and develop strategy

• Corporate Governance Posture has vulnerabilities to proxy fight– Non-classified board elected by plurality– Ability of stockholders to call special meeting– Ability to remove directors and act by written consent– Poison pills generally prevent stock accumulation but not proxy fights

• Financial position– Recently depressed stock performance vs. market– Large pre-acquisition cash position– FY2003 and FY2004 restructurings– Large market capitalization companies and technology sector no

longer immune from shareholder activism/hostile activity/hedge fund activity

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F. Take-Aways

• Significant influence of hedge funds on today’s M&A environment

• Continued role of Board in determining Target’s long-term strategy

• Need to review vulnerabilities and have approaches/defenses ready (particularly in transaction context)

• Need to keep eye out for first signs of activity given common m.o. of escalating tactics

KIRKLAND & ELLIS LLP “Hedge Fund Activism” April 7, 2006 Stephen Fraidin KIRKLAND & ELLIS LLP.

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