Carl Icahn’s tender supply for Southwest Gasoline units the desk for a proxy struggle

Carl Icahn talking at Delivering Alpha in New York on Sept. 13, 2016.

David A. Grogan | CNBC

Firm: Southwest Gasoline Holdings (SWX)

Enterprise: Southwest Gasoline Holdings purchases, distributes, and transports pure gasoline in Arizona, Nevada and California. The corporate operates in two segments, Pure Gasoline Operations and Utility Infrastructure Providers. As of Dec. 31, 2020, it had 2,123,000 residential, business, industrial, and different pure gasoline clients. The corporate additionally offers trenching and set up, alternative, and upkeep providers for power distribution methods, and industrial development options.

Inventory Market Worth: $4.0B ($69.18 per share)

Activist: Carl Icahn

Proportion Possession:  4.91%

Common Price: $70.89

Activist Commentary: Carl Icahn is the grandfather of shareholder activism and a real pioneer of the technique. He’s very keen about shareholder rights and good company governance, and he’ll go to excessive lengths to struggle incompetent boards and overcompensated managers. On this state of affairs, he’s as soon as once more doing one thing that has by no means been completed earlier than in activism – a hostile takeover of a utility firm. In activism it’s a very highly effective weapon to have the ability to supply to accumulate the corporate if they don’t take your ideas to create shareholder worth, and Carl Icahn is likely one of the solely activists with that instrument.

What’s occurring?

On Oct. 14, 2021, Icahn introduced his intention to launch a proxy contest to switch Southwest Gasoline Holdings’ (SWX) whole board and to begin a young supply for all frequent shares at $75 per share in money.

Behind the Scenes:

Icahn’s preliminary overtures have been made in response to the announcement of the corporate’s proposed acquisition of Questar Pipeline Firm. Icahn got here out in opposition to this deal for a number of causes, together with as a result of he believes the corporate is massively overpaying and this transaction would lead to a dramatic fairness dilution for shareholders. Icahn particulars that the corporate must problem inventory at 1x price base to purchase property at 2x price base, and that there are admittedly minimal synergies right here, if any.

Proper off the bat, Icahn want to see the corporate drop this deal and concentrate on a number of worth creating alternatives. Icahn believes that the corporate’s service division is price $36 per share and the regulated utility enterprise because it stands at the moment is price $53 per share, however the firm’s inventory trades at $67.55. So, he want to see the true worth of those property mirrored within the inventory value. He doesn’t outwardly urge administration to monetize the service enterprise to realize its true worth, however it’s one thing that administration has thought-about and primarily based on Icahn’s historical past and investing philosophy, he wouldn’t be in opposition to it on the proper value.

The second alternative is for the corporate to enhance its margins within the regulated utility enterprise, which Icahn believes can add $15 per share. When a utility firm similar to SWX takes on a brand new undertaking, the regulators analyze the corporate’s proposed prices for the undertaking and permit them an ROE primarily based on these prices. SWX’s allowed ROE is 9.35% however their precise ROE is just 7.1% versus a mean of 9.2% for its friends. It’s because SWX administration reportedly pads the proposed prices to its utility initiatives with egregious private bills similar to golf memberships, massages, manicures and indulgent dinners, in accordance with the Las Vegas Overview-Journal. On a couple of event, the regulators didn’t settle for these as reliable undertaking bills, thus decreasing the corporate’s ROE to 7.1%. Fixing this margin problem may be completed with good old school activism that Icahn is aware of higher than anybody – reconstituting the board and changing the administration crew with people the brand new board will maintain accountable. It’s no coincidence that since 2015, when John Hester turned CEO, the corporate’s G&A has gone up by 42%.

The third alternative to create worth is to extend the speed base by including sure of the corporate’s initiatives to it that regulators haven’t allowed. This may be completed by bringing in a administration crew that will restore relationships with the regulators, which Icahn believes may add one other $8 per share to the worth of the corporate.

To perform his agenda, Icahn introduced his intention to launch a proxy struggle to switch the whole board and to begin a young supply for all frequent shares at $75 per share in money. That is old-fashioned, artistic activism that no person does higher than Icahn. His technique creates fairly the quandary for administration. As a part of their acquisition financing of Questar, they’re proposing elevating $1 billion by promoting frequent inventory at roughly $65 per share, the present market value. It could not be in step with their fiduciary obligation to promote inventory at $65 per share after they know there may be somebody who pays $75 per share for it. Nonetheless, they won’t promote it to Icahn as a result of it will give him an excessive amount of affect and make it a lot simpler for him to win his proxy struggle. Their implementation of a poison capsule (or as Icahn calls it – “the board and administration job safety plan”) in response to Icahn’s letters clearly tells you that. Moreover, the board will ultimately must suggest for or in opposition to Icahn’s tender supply and it’s arduous for them to say $75 shouldn’t be a good value when the corporate is a vendor at $65.

So how will this play out? Icahn will proceed along with his tender supply and proxy struggle however can be unable to consummate the tender supply as it’s conditioned on the corporate waiving the poison capsule, which they’ll by no means do. This leaves Icahn along with his proxy struggle. He could have an excellent thought of his probabilities of success relying on what number of shareholders tender shares to him. In protection of Icahn, the board is counting on two issues (i) Icahn’s slate is not going to get the required approval of the state regulators in California, Arizona and Nevada, and (ii) by the point the regulators act, Icahn could have walked away. Within the first case, there’s a very slim likelihood Icahn’s slate doesn’t get accredited. First, these are the identical regulators which have been coping with the corporate’s expense padding this whole time and would doubtless welcome a brand new board that can be extra sympathetic to the charges its clients are paying. Second, Icahn has owned a number of casinos up to now and has had no downside navigating the extra scrutinizing gaming regulatory course of. And third, Icahn will do no matter it takes to win, and we count on to see a really skilled and spectacular slate of administrators that can embrace two or three Icahn representatives at most together with skilled executives with the related skillsets to information administration. Within the second case, Icahn has proven in his historical past that he’s probably the most tenacious and dedicated activist on the market. After an unsuccessful proxy struggle at Forest Labs, he fought two extra proxy fights within the following two years earlier than he bought the extent of board illustration he needed and ended up making a 188.8% return on that funding versus a 55.2% return for the S&P500 over the identical interval. There is no such thing as a likelihood that he walks away right here. So, to place it one other manner, the corporate has two probabilities of avoiding a proxy struggle right here – slim and none. Nonetheless, it’s attainable that the proxy struggle doesn’t occur by the following annual assembly as a result of the regulatory approvals haven’t been obtained but. In that case, Icahn will ask stockholders on the annual assembly to approve a proposal to name a particular assembly of stockholders following the approval by regulators to vote on the election of the Icahn slate of administrators.

There’s one different potential consequence right here. When an activist will get concerned with an organization, it typically places the corporate in pseudo-play. When that activist makes a young supply for the corporate, the corporate is completely in play. So, there’s a likelihood that another person is available in and makes a better supply to purchase the whole firm. It is vitally doubtless that the corporate has been approached a number of instances up to now, possibly by a greater managed utility, however they’ve by no means let anybody within the door, which isn’t uncommon for entrenched boards – seven of the 9 “unbiased” administrators have served on the board for a mean of 13 years (occurring 14), and the chairman has served as a director for nearly 20 years. The potential for a third-party sale will increase as Icahn will get extra shares tendered and the board sees the writing on the wall. In the event that they assume they’re going to be out of a job by hook or by crook, they may as effectively exit promoting to the very best bidder.

Ken Squire is the founder and president of 13D Monitor, an institutional analysis service on shareholder activism, and the founder and portfolio supervisor of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.

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