No love lost for hedge funds

Its difficult to reconcile to the way the Kraft Cadbury deal finally ended (the deal got done today). Not the outcome – M&A transactions like this happen all the time. But the way it happened makes me reflect if unbridled capitalism is really a good thing.

My ire is on the hedge funds – they are no different to a herd of vultures which circle over an animal that’s about to die. When there’s a whiff of a M&A transaction, the hedge funds pile in to buy the shares of the target, hoping to make a killing . This is what happened in the Alcon transaction about which I posted here. Somebody tell me how what happened in the Cadbury case is reasonable by any yardstick.

Here’s what happened. When the first whiff of a possible takeover of Cadbury was in the air, the hedge funds bought heavily into Cadbury shares. They then drummed up noise that Kraft’s bid was inadequate and it had to raise the price. They kept making this noise and were prepared to play brinksmanship. Till virtually yesterday, they kept repeating the mantra – Kraft had to bid more.

Kraft caved in. They raised their offer to an effective 850p per share, from the original 745p where they started. Once this happened, the herd turned on Cadbury’s board to accept the offer. Never mind that one of Cadbury’s largest shareholders Standard Life said that they wouldn’t support a bid lower than 900p. Never mind that many independent valuations supported a price above this figure. Never mind that Cadbury released excellent results even with this protracted takeover process was on. The noise making ability of the hedge funds is pretty large . The Board was right to be worried about lawsuits – the scoundrel’s last refuge. Cadbury’s investment bankers advised the Board to accept – they would; wouldn’t they – they don’t make any fees if the deal doesn’t happen. So ultimately the Board of Cadbury caved in.

So the hedge funds win. They are only concerned about a windfall now. Who wants to wait for the long term for value creation. Who cares about the 180 year history of a company. Who cares for the management which has created all this value. So 850 is a great price because they bought it at 750. Forget about long term potential.

I simply cannot accept that a short term raider has the same equal shareholder rights as a long term investor. As managers, we are supposed to be working for our shareholders. But I certainly don’t want to work for vultures. Governments have to intervene – if you haven’t held the shares for more than a year, you have no right to influence a M&A transaction – you have no voting rights, you have no right to sue. The fate of companies built over 180 years cannot be decided by the shark who wants to make a killing now. Its just not on.

The financial services industry has learnt nothing from the past year. Their behaviour is exactly the same. Forget about bonuses and pay which have hogged the headlines. Hedge funds have got back to behaving exactly as before. No wonder the public mood is so much against this lot. They stand next only to Osama bin Laden in public contempt. They deserve this contempt, and more.

When shareholders’ and company’s interests don’t coincide

What happens when the interests of the shareholders do not coincide with what’s good for the company ? Ordinarily there should not be any conflict – the company should have no interests of its own other than the interests of its shareholders. In the capitalist model, the interests of management or the employees – doesn’t matter; they operate solely to safeguard and promote the interest of the shareholders. But once in a while a situation crops up where its not so clear cut. That’s the position with Carrefour today.

Carrefour is the second largest retailer in the world after Walmart. It is the most international of the retail chains – Walmart for all its successes in the US has not really shone outside. Tesco, another giant retailer is a relative newcomer to the international arena. Carrefour has been the truly successful international retailer – it came to Brazil in 1975 and to China in 1995.

In the peak of the boom, a little while ago, a couple of investors, including some famous names, bought a 13% stake in Carrefour at around Є 50 a share. With the recession, Carrefour’s shares are now at Є 30 a share. They don’t like this , of course, but there’s nothing to suggest that any of this is due to Carrefours’ performance. On the contrary the company is doing OK. Its share price has just been a victim of the global circumstances.

So what do these shareholders want to do ? They want Carrefour to sell off its Latin American and Asian businesses and then pay them a special dividend. They then want Carrefour to withdraw into becoming a European (mainly French) retailer.

Here’s the conflict with the company’s interests. Clearly the strength of Carrefour is its international leadership. In its home markets in Europe, it is plagued by low growth (in France) and poor profitability (most other countries). If it withdraws from Asia and Latin America, then it doesn’t have a real future. In any case, who would want to withdraw from China, if you already have a strong presence there.

There’s an argument to say that however rosy the future may be, if you get a full price for the business, you should sell. In this case, its far from clear how Carrefour would get its full value. The more obvious buyer is Walmart, but its highly unlikely that the Chinese are going to allow this on anti trust grounds. Who’s going to pay the full price ? And is it OK for a bunch of shareholders with an extremely short term motive to cut losses and run, and perhaps harm the company’s future ?

So, is the shareholder always right ? I am not so sure. Perhaps the question should be posed differently. Is it OK for the shareholder to have a sub optimal short term motive, when an alternate long term view is demonstrably superior ? And who should be the judge of this ?