Deal Professor
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Harry Campbell
Hedge funds are supposed to be the smart money, but sometimes even they can be outsmarted.
Take the case of Mason Capital Management and the Telus Corporation, a large Canadian telecommunications company. Mason Capital, a New York and London hedge fund with about $8 billion in assets under management, has made a complex bet in Telus stock that looked shrewd at first, but that may now lose tens of millions of dollars.
Telus has two classes of shares, one that is voting and trades only in Canada and another that is nonvoting and trades in Canada and the United States. The nonvoting shares traditionally trade at a discount to the voting shares, but Telus is proposing to convert the shares on a one-for-one basis, giving a windfall to the holders of nonvoting shares.
Mason has taken a complex trading position in opposition to the proposal. In April, the hedge fund announced that it had acquired 19 percent of Telus’s voting stock, worth 1.9 billion Canadian dollars, or $1.8 billion.
Mason was able to finance this position by setting up a roughly equivalent short position in Telus’s nonvoting common stock, betting that those shares would fall. Basically, for every dollar that Mason earned on the voting shares, it would lose a dollar on the nonvoting shares. Since Mason is almost perfectly hedged, this was a bet that Telus’s proposal would fail, causing the nonvoting stock to lose value and the voting stock to gain.
Pretty clever, right?
Mason has no real economic interest in the future of the company because of its offsetting positions, but it can still vote its 19 percent against the share conversion proposal. This anomaly has led Telus to claim that Mason is an “empty voter” — voting shares in which it has no economic interest “at the expense of other shareholders.”
The hedge fund has argued that Telus is seeking to hand the nonvoting shareholders free money by collapsing the shares at a 1-to-1 ratio instead of at the traditional discount.
According to Mason, “over the past 13 years, Telus voting shares have traded at an average premium of 4.83 percent relative to the nonvoting shares; the premium has been as high as 15.23 percent.” The hedge fund also argues that the Telus directors who approved this transaction are conflicted because 89 percent of their total holdings are in the nonvoting shares.
In response, Telus claims that the lack of a discount is justified because the voting shares would get additional liquidity.
Mason won Round 1 of this argument in May, when Telus withdrew its proposal.
At the same time, Telus also planted the seeds to thwart Mason’s trade. The company announced that it would try again to collapse the shares at some future time. This gave price support to the nonvoting shares and prevented Mason from cashing out its position.
Mason reportedly hired the Blackstone Group to look at strategic alternatives for its Telus stake, but was unable to sell it.
In August, the fund sought to press the issue by calling a shareholder meeting to amend Telus’s charter to prevent the nonvoting shares from being converted into voting shares without a discount.
This started Round 2.
Telus again proposed that the shares be collapsed. But in a twist, the company has structured the transaction so that only a majority of the voting shares are needed to approve it, instead of the 66 2/3 vote initially required. The reduction in the number of necessary votes gives the proposal a much better chance of passing despite Mason’s 19 percent holding.
Telus also refused to hold a special meeting. The battle came before the Supreme Court of British Columbia, and on Sept. 11, the court rejected on technical grounds Mason’s effort to force Telus to hold the meeting. But in an aside, the court heavily criticized the hedge fund for its voting strategy, calling it “empty voting.” The court stated that “the practice of empty voting presents a challenge to shareholder democracy … when a party has a vote in a company but no economic interest in that company, that party’s interests may not lie in the well-being of the company itself.” Mason has appealed the ruling.
Unless a higher court intervenes, the share collapse is heading to a shareholder vote on Oct. 17. Given that only a majority vote is needed, Telus may have the votes necessary to push the measure through.
And with the decision of the Canadian court, other hedge funds appear to have closed out their positions in Telus, further narrowing the spread between the share classes.
On paper, Mason’s trade was a deliciously clever scheme that made perfect sense. But once the trade went public, its position in Telus raised eyebrows. Mason has argued that it is not an empty voter because its interests are aligned with the voting shareholders; the conversion will be at their expense. That message may make sense, but the messenger has been viewed with suspicion. As a result, Mason has had a hard time persuading Canadian shareholders to support it.
And with the nonvoting shares still holding on to their earlier gains, Mason finds itself boxed in. Telus’s total market value has increased by $2 billion since February. Mason would have made much more money — hundreds of millions, in fact — had it simply taken a long position.
Lost in all of this maneuvering are the economic merits of Telus’s share collapse and the fact that nonvoting shares do appear to be getting a significant benefit that may be inappropriate.
According to sources close to Mason, the trade is currently profitable. But Mason is finding that its ingenious trade may lose it millions, thanks to the equally adroit maneuvering of Telus. Who said Canadians were too nice?
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.
Article source: http://dealbook.nytimes.com/2012/09/25/hedge-funds-complex-scheme-may-backfire-costing-it-millions/?partner=rss&emc=rss
