Steven Davidoff Solomon writes for The New York Times, May 1, 2015
In the battle over DuPont’s future, it all comes down to point of view.
After months of fighting one of Wall Street’s most prominent activist investors, Nelson Peltz, DuPont was dealt a setback.
This week, Institutional Shareholder Services, the largest proxy advisory firm, recommended that DuPont shareholders vote for two of the four candidates that Mr. Peltz’s firm, Trian Fund Management, nominated for the board, including Mr. Peltz. Glass Lewis, the other big proxy advisory firm, followed by backing Mr. Peltz but not the other three directors that Trian nominated.
DuPont’s management was no doubt disappointed by the recommendations, but perhaps not surprised. According to a report provided by sources close to DuPont, when the target company is worth more than $5 billion in market value, I.S.S. has almost always sided with the dissident slate. (There were three exceptions, all involving proxy contests brought by Carl C. Icahn.)
Such a report may suggest that I.S.S. is biased in favor of the activist hedge funds, but this statistic may not be truly surprising because hedge funds tend to pick struggling targets. And every contest is unique.
What is unusual about the recommendation is something I.S.S. acknowledged in its report: that DuPont is “not a broken company.”
The significance of the I.S.S. decision was perhaps best put by Martin Lipton of the law firm Wachtell Lipton Rosen & Katz. In a memo to clients on the lessons in the DuPont fight, Mr. Lipton stated that I.S.S. and major shareholders would “be responsive to and support well-presented attacks on business strategy and operations” even if the company was run by “an outstanding C.E.O. and board of directors.”
In light of this, Mr. Lipton concluded that in some cases, fighting and winning a proxy contest may not be worth it; instead, a settlement was a better option.
Can we stop here for a second and note that this memo is coming from the Marty Lipton, who is legendary for anti-takeover tactics such as the poison pill? Even recently, Mr. Lipton was the cover story in the American Lawyer under the headline “Marty Lipton’s War on Hedge Fund Activists.”
He and his firm have vociferously fought against the hedge funds. Yet this memo seems to be an acknowledgment of defeat. Maybe this situation was his epiphany.
Wachtell Lipton is not representing either DuPont or Trian. Perhaps Mr. Lipton is piling on. Or perhaps he is conceding that corporate America is changing, and that fighting the shareholder activist tide is becoming increasingly difficult. After all, acceptance is the last of the five stages of loss.
Mr. Lipton’s capitulation aside (which he later walked back in a well-choreographed leak of an email exchange), shareholders may still wonder what to do in the DuPont vote.
DuPont has fought Trian. Its argument is based on what I.S.S. itself said, that DuPont is not a “broken company.” DuPont has taken this a step further, arguing that its performance is instead excellent. DuPont’s stock price has beaten the Standard & Poor’s 500-stock index and its peers over the last five years.
In addition, DuPont is restructuring itself to focus on core sciences businesses. The operating margin at these core units have grown by 7.4 percent to 2014 from 2008. Earnings per share at those businesses have also gone up by 19 percent in the same period. As John C. Coffee Jr. of Columbia Law School put it, “DuPont has regularly outperformed the S.&P. 500 index and virtually all other metrics of corporate profitability,” a sentiment I concurred with in a column a few months ago.
Trian, which has invested $1.7 billion in DuPont, disputes this and is putting forth an equally vigorous case that DuPont has underperformed. According to Trian, DuPont has repeatedly missed its long-term earnings targets.
The firm attributes the rise in DuPont’s stock price to market fluctuations and the influence of Trian’s presence. It also notes that the company’s 2015 earnings per share are expected to be below its 2011 numbers. Trian says that the company is also likely to miss its earnings forecast this year.
Trian also claims that DuPont has bloated costs in both administrative and research and development efforts, as well as bad corporate governance practices. DuPont’s acquisition of Danisco was a “disaster,” and DuPont left about $6 billion on the table in the sale of its performance coatings business, Trian said.
I.S.S. sided with Trian, finding a lack of growth in core businesses, inefficiencies in management and a lack of corporate governance.
The proxy advisory firm chose its stance primarily on the basis of the measurement periods it picked. Instead of using DuPont’s measurements, which went back to 2008, I.S.S. went back to 2007, subtracted the health and nutrition business (saying it is a new business) and excluded the effect of the commodity boom in ethylene.
Under this measurement, I.S.S. found that DuPont’s growth margin based on earnings before interest, taxes, depreciation and amortization was only 0.5 percent for each year over seven years. I.S.S. also seemed to base its recommendation on Trian’s assertions that DuPont had excessive costs and governance issues, but the low margin growth seemed to be I.S.S.’s chief concern.
This is where DuPont shareholders are left: Depending on the measurement period, DuPont is either a growth machine or a laggard.
This is a simplification, and the presentations of DuPont and Trian are for shareholders to decide.
It is certainly difficult for shareholders to objectively assess the situation. Proxy voters don’t want to deal with the issue of whether to use 2007 or 2008 as the starting point from which to decide whether the company looks good or bad.
Don’t get me wrong. Like any large corporation, or any person frankly, DuPont could use some cleaning up. As a result, the company is selling its hospitality businesses like Hotel du Pont, the DuPont Country Club and the DuPont Theatre (which was recently renamed). The chemical business is also being spun off into a new company called Chemours.
Both sides would have probably settled the proxy fight, if it were not for the fact that DuPont does not want to appoint a director from Trian. DuPont’s justification is that this would bring a new “back office” into the DuPont boardroom. The Trian directors would be working with Trian staff to second-guess management. This goes on almost any time a hedge fund takes a board seat. For DuPont, it is likely to be a problem because they suspect Mr. Peltz is a Trojan horse who will push to break up the company into three once he is inside the boardroom.
Who knows who is right? They both have good points.
But the battle highlights two things.
First, as even Mr. Lipton took note, Trian is like ValueAct Capital Management, a “white hat” activist that shook up Microsoft’s management. These are the funds known for working with management. They seldom run proxy contests and aim to build long-term value. These funds are not in it for quick profit-taking from a jump in stock price.
Although DuPont is not broken, this type of campaign is something only a few activists with reputations like Trian or ValueAct could sustain. The rule of settlement will be less rigid when companies like DuPont meet activists with lesser reputations.
The May 13 investor vote is fast approaching. Some 30 percent of DuPont’s shareholder base is made up of retail investors, many of whom may cast votes (but like much of the American electorate, probably won’t). This leaves DuPont’s fate to be decided by the mutual funds. Until the I.S.S. report, DuPont seemed to be on an upward track; now, it is hard to say whether the company will win.
In truth, a settlement is still the logical course – it’s a fact of life these days, as Mr. Lipton points out. Both sides know DuPont’s performance quite well and can work through all of these issues better than anyone.
But if there is no deal, shareholders are going to have to face those thorny questions: How do they measure DuPont’s performance — starting from 2007 or 2008? Include the new health and nutrition business or not? The fate of a $60 billion company may hinge on these answers.
Come to the table, kids, and save us from all of this.
Steven Davidoff Solomon, a professor of law at the University of California, Berkeley, is the author of “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion.” Email: dealprof@nytimes.com | Twitter: @StevenDavidoff