Notes From Proxy 2017 – Cont’d.

There are a number of highly successful companies that have corporate governance structures with several classes of stock. In many cases one of classes has essential voting control over all matters under the sun but not belonging to the heavens. It can be argued that one great business person focused on wealth creation is all you need, and names like Malone, Buffett, et al. come to mind. We wake up Monday, Wednesday, and Friday thinking that.

But, alas, the original movies are almost always better than the 20th sequel and we have seen a lot of bad corporate movies. So on Tuesday, Thursday, and Saturday, we rant and rave against the machine of voting restrictions that enslave shareholders to empire building and mediocrity. We rest on Sunday.

IAC Interactive (Ticker: IAC) has a structure that gives Barry Diller voting control. He has built enormous wealth for those who have stuck with him. He has a B stock that DOESN’T lose its voting rights when he dies (he is 75 and in good health, as far as I can tell) or leaves his job. After a long-winded battle between a “special” committee and Mr. Diller, IAC just issued a non-voting C class stock to make sure that—unusually—this situation stays the same. Throw in a son-in-law, Chelsea Clinton, and Michael Eisner on the Board. I am reading the following Proxy and writing this on a Thursday. It still irks me.

Since its inception, IAC has had two classes of common equity securities: IAC common stock and Class B common stock. The IAC common stock and the Class B common stock have identical economic rights. The IAC common stock has one vote per share and the Class B common stock has ten votes per share. The two classes vote together on all matters, except as required by law and except that the IAC common stock has the separate right to elect 25% of the Board. The voting and other rights of the Class B common stock continue in effect so long as the Class B common stock is outstanding and, unlike the high vote common stock of most companies that have a dual class common stock structure, do not lose their characteristics upon transfer to an unaffiliated third party, if Mr. Diller is no longer affiliated with IAC or if the equity ownership represented by the Class B common stock falls below a specified percentage of the combined common equity.

But Shareholders got the following in return for the C. It’s something.

The New Governance Agreement will specify that upon any sale of IAC or other change of control transaction, including a merger, third- party tender offer or other business combination involving or open to all Company stockholders, and any private transaction by the Diller Parties that would result in the third party or group holding 25% or more of the total voting power of all IAC’s outstanding capital stock, shares of IAC common stock and Class C common stock would be entitled to receive the same amount and type of consideration, on a per share basis, as the shares of Class B common stock, except: (a) in the case of certain stock-for-stock transactions where the three-class structure is substantially replicated; (b) in the event of any private sale by the Diller Parties of shares of Class B common stock to a third party or group at a price per share no higher than the market price of the common stock as of the date such sale is agreed or closed (whichever is higher); (c) where receipt by the holders of IAC common stock or Class C common stock of different consideration from that received by any other class of common stock has been approved by the holders of shares of such class; or (d) as may be approved by a special committee of IAC’s directors.

The Special Committee and the Board believe that these equal treatment provisions could confer important benefits on the stockholders of IAC (other than the Diller Parties). These provisions substantially restrict the ability of the Diller Parties to receive a premium for their shares in IAC in a private transaction and should encourage the Diller Parties, should they seek to dispose of their equity interest in IAC, to do so in a transaction that is open to all stockholders. In the case of any transaction (other than certain stock-for-stock transactions replicating the three-class common stock structure) in which holders of shares of IAC common stock or Class C common stock would receive different per share consideration than that received by the Diller Parties, a special committee of independent and disinterested directors would have advance notice of, the opportunity to participate in discussions regarding, and the right to approve, the transaction. These provisions would be specifically enforceable by IAC and the Diller Parties would not be permitted to seek a waiver of these provisions. At the same time, the Diller Parties, if they chose not to support a transaction, could likely block that transaction if they were to maintain a level of voting power similar to that the Diller Parties hold at the present time.

Select Comfort (Ticker: SCSS) is a relatively new holding. We like this business for its growth potential, its margins, its returns on capital, its free cash flow, its shift to off-mall locations, and its corporate prowess as an online and omni-retailer. We should have no business buying this business at its current low valuation, but for the obvious thing we haven’t mentioned—management. The current crew and board have bungled growth and margin opportunities, thrown away close to $100mm on enterprise software to get it right, and then alienated potential customers through a bungled installation, missed nearly every long-term goal they have articulated, diluted the stock under $5 per share, and… that’s plenty. Even with all of that they beat off a poorly timed activist attempt in 2015.

This week, the CEO Shelly Ibach was awarded stock grants that will vest if she hits her $2.75 EPS goal in 2019. If Mrs. Ibach hits that target, we are going to make a lot of money and in general we are more than happy to have our CEOs retire filthy rich on performance based stock grants. But, if you miss every target for 4.8 years and the stock goes nowhere, isn’t it somewhat perverse to simply get another shot at the gold every year with zero downside? If such a structure is OK for company executives, can long-term shareholders reset their cost basis every year too?


The opinions expressed herein are those of Cove Street Capital and are subject to change without notice. Past performance is not a guarantee or indicator of future results. Consider the investment objectives, risks, and expenses before investing. You should not consider the information in this blog a recommendation to buy or sell any particular security and this should not be considered as investment advice of any kind. You should not assume that any of the securities discussed in this report are or will be profitable, or that recommendations we make in the future will be profitable or equal the performance of the securities listed in this report. Recommendations made for the past year are available upon request. These securities may not be in an account’s portfolio by the time this report has been received, or may have been repurchased for an account’s portfolio. These securities do not represent an entire account’s portfolio and may represent only a small percentage of the account’s portfolio. Partners, employees or their family members may have a position in securities mentioned herein. CSC was established in 2011 and is registered under the Investment Advisors Act of 1940. Additional information about CSC can be found in our From ADV Part 2a.

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