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THE WALL STREET
JOURNAL. |
MARKETS
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Markets
Hedge Fund 'Appraisal Arbitrage'
Strategy Faces Court Challenge
Trial Under Way Between
Ancestry.com and Merion Capital Over Deal Price
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By
Liz Hoffman
June 19, 2014 4:06
p.m. ET
One
company is pushing back against hedge fund efforts to squeeze more
money from corporate buyouts, a move that threatens to upend an
increasingly popular investment strategy.
A
trial is under way this week between Ancestry.com Inc., the
family-tree website sold in 2012 to private-equity firm Permira, and
Merion Capital LP, a hedge fund seeking a bump to the deal price in
court.
Merion is exercising "appraisal rights," which allow stockholders to
ask a judge to determine a fair price for their shares after a deal.
Merion is seeking appraisal on 1.26 million shares, which it says are
worth far more than the $32-per-share paid by Permira.
But
to be eligible for appraisal, shareholders must abstain or vote no on
the deal. And Ancestry.com says Merion can't prove how its 1.26
million shares were voted because it bought them too late in the
process.
The
company's arguments touch on the difficulty of tracking individual
share ownership—and the votes attached to those shares as they change
hands. A ruling in Ancestry.com's favor could make such "appraisal
arbitrage" plays much harder and potentially less profitable.
In
appraisal cases, hedge funds buy shares of companies on the brink of a
buyout and ask a judge to award them a higher price. These lawsuits
have risen sharply
as a growing group of investors looks to extract more money from
corporate takeovers.
In
court filings, Merion said Ancestry.com's argument is "too cute by
half." The hedge fund said a ruling in the company's favor would
impose an "impossible" burden on shareholders seeking to ensure they
get a fair price for their stock.
"Shares of stock held in street name need not be, and cannot be,
traced to specific votes," Merion said in a court filing. "No such
requirement has ever existed." The trial is taking place in the
Delaware Court of Chancery.
Ancestry.com agreed in late 2012 to sell itself to Permira. The
company set a "record date" of Nov. 30 of that year, meaning that only
stockholders who owned their shares as of that date could vote on the
deal.
Merion bought all its shares after Nov. 30. In court filings, it said
the shares it purchased weren't voted in favor of the deal.
Ancestry says it can't know that, and indeed, when asked in a
deposition, a Merion executive said he wasn't sure. That is because
the vast majority of U.S. stock is held not in the name of individual
investors, but rather by Cede & Co., a centralized warehouse for stock
certificates. In a deal, Cede collects ballots from shareholders, then
votes all its shares in the aggregate. Cede held about 29 million
shares of Ancestry.com, of which 9.8 million either voted "no" or
didn't vote on the buyout, according to court filings.
Hedge funds like Merion often acquire shares late in the
game—typically after the record date—then say they weren't voted in
favor of the deal. Historically, as long as the total number of shares
seeking appraisal didn't exceed the number of shares that abstained or
voted no—as is the case here—nobody looked too closely.
Ancestry.com wants the court to require Merion to prove the specific
shares it bought didn't vote yes. If it succeeds, it could upend a
strategy that has been increasingly used by hedge funds, to the
frustration of companies and their advisers.
Appraisal claims were brought on 17% of takeovers of
Delaware-registered companies in 2013, the most since at least 2004,
according to a study from law professors Charles Korsmo and Minor
Myers. Those claims were valued at $1.5 billion, based on the deal
prices, an eightfold increase from 2012.
If
the court sides with Ancestry.com, these appraisal cases could become
much trickier to bring. Arbitrage funds would essentially be forced to
buy their shares months earlier, when deals are more vulnerable to
falling apart. Doing so also ties up the funds' money for a longer
period, which lowers their rates of return.
"It
would be a snaggle for people doing this kind of appraisal arbitrage,"
said Mr. Korsmo, who teaches at Case Western Reserve University's law
school. "The problems are fixable," he said, but the fixes could make
these plays less financially attractive.
Pennsylvania-based Merion is the largest "appraisal arbitrage" fund,
with more than $750 million tied up in cases challenging the buyout
prices of Zale Corp., Dole Foods Co., BMC Software Inc., Lender
Processing Services Inc. and Ancestry.com. The fund is run by Andrew
Barroway, a lawyer who used to represent shareholder plaintiffs in
lawsuits against companies.
Write to
Liz Hoffman at
liz.hoffman@wsj.com
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