Carl Icahn’s tender offer for Southwest Gas sets the table for a proxy fight

Business: Southwest Gas Holdings purchases, distributes, and transports pure gasoline in Arizona, Nevada and California. The firm operates in two segments, Natural Gas Operations and Utility Infrastructure Services. As of Dec. 31, 2020, it had 2,123,000 residential, business, industrial, and different pure gasoline prospects. The firm additionally gives trenching and set up, substitute, and upkeep companies for power distribution programs, and industrial development options.

Stock Market Value: $4.0B ($69.18 per share)

Activist: Carl Icahn

Percentage Ownership:  4.91%

Average Cost: $70.89

Activist Commentary: Carl Icahn is the grandfather of shareholder activism and a true pioneer of the technique. He may be very enthusiastic about shareholder rights and good company governance, and he’ll go to excessive lengths to fight incompetent boards and overcompensated managers. In this example, he’s as soon as once more doing one thing that has by no means been performed 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 offer to amass the firm if they don’t take your recommendations to create shareholder worth, and Carl Icahn is certainly 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 Gas Holdings' (SWX) whole board and to start a tender offer for all widespread shares at $75 per share in money.

Behind the Scenes:

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

Right off the bat, Icahn wish to see the firm drop this deal and give attention to a number of worth creating alternatives. Icahn believes that the firm's service division is price $36 per share and the regulated utility enterprise because it stands in the present day is price $53 per share, however the firm's inventory trades at $67.55. So, he wish to see the true worth of those property mirrored in the inventory worth. He doesn’t outwardly urge administration to monetize the service enterprise to achieve its true worth, however it’s one thing that administration has thought-about and based mostly on Icahn's historical past and investing philosophy, he wouldn’t be towards it at the proper worth.

The second alternative is for the firm to enhance its margins in the regulated utility enterprise, which Icahn believes can add $15 per share. When a utility firm similar to SWX takes on a new challenge, the regulators analyze the firm's proposed prices for the challenge and permit them an ROE based mostly on these prices. SWX's allowed ROE is 9.35% however their precise ROE is simply 7.1% versus a mean of 9.2% for its friends. This is as a result of SWX administration reportedly pads the proposed prices to its utility initiatives with egregious private bills similar to golf memberships, massages, manicures and indulgent dinners, based on the Las Vegas Review-Journal. On a couple of event, the regulators didn’t settle for these as reputable challenge bills, thus decreasing the firm's ROE to 7.1%. Fixing this margin subject may be performed with good old style activism that Icahn is aware of higher than anybody – reconstituting the board and changing the administration staff with people the new board will maintain accountable. It isn’t any coincidence that since 2015, when John Hester turned CEO, the firm's G&A has gone up by 42%.

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

To accomplish his agenda, Icahn introduced his intention to launch a proxy fight to switch the whole board and to start a tender offer for all widespread shares at $75 per share in money. This is old style, inventive 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 widespread inventory at roughly $65 per share, the present market worth. It can now not be in line with their fiduciary obligation to promote inventory at $65 per share once they know there’s somebody who pays $75 per share for it. However, they won’t promote it to Icahn as a result of it could give him an excessive amount of affect and make it a lot simpler for him to win his proxy fight. Their implementation of a poison tablet (or as Icahn calls it – "the board and management job protection plan") in response to Icahn's letters clearly tells you that. Furthermore, the board will ultimately must advocate for or towards Icahn's tender offer and it’s onerous for them to say $75 just isn’t a truthful worth when the firm is a vendor at $65.

So how will this play out? Icahn will proceed together with his tender offer and proxy fight however will probably be unable to consummate the tender offer as it’s conditioned on the firm waiving the poison tablet, which they’ll by no means do. This leaves Icahn together with his proxy fight. He can have a superb thought of his possibilities 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 won’t get the required approval of the state regulators in California, Arizona and Nevada, and (ii) by the time the regulators act, Icahn can have walked away. In the first case, there’s a very slim probability Icahn's slate doesn’t get permitted. First, these are the similar regulators which were coping with the firm's expense padding this complete time and would seemingly welcome a new board that will probably be extra sympathetic to the charges its prospects are paying. Second, Icahn has owned a number of casinos in the previous and has had no drawback navigating the extra scrutinizing gaming regulatory course of. And third, Icahn will do no matter it takes to win, and we anticipate to see a very skilled and spectacular slate of administrators that can embody two or three Icahn representatives at most together with skilled executives with the related skillsets to information administration. In the second case, Icahn has proven in his historical past that he’s the most tenacious and dedicated activist on the market. After an unsuccessful proxy fight at Forest Labs, he fought two extra proxy fights in the following two years earlier than he obtained the degree of board illustration he wished and ended up making a 188.8% return on that funding versus a 55.2% return for the S&P500 over the similar interval. There isn’t any probability that he walks away right here. So, to place it one other means, the firm has two possibilities of avoiding a proxy fight right here – slim and none. However, it’s doable that the proxy fight doesn’t occur by the subsequent annual assembly as a result of the regulatory approvals haven’t been obtained but. In that case, Icahn will ask stockholders at 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 is one different potential end result right here. When an activist will get concerned with a firm, it typically places the firm in pseudo-play. When that activist makes a tender offer for the firm, the firm is completely in play. So, there’s a probability that another person is available in and makes a increased offer to purchase the whole firm. It may be very seemingly that the firm has been approached a number of occasions in the previous, perhaps by a higher managed utility, however they’ve by no means let anybody in the door, which isn’t uncommon for entrenched boards – seven of the 9 "independent" administrators have served on the board for a mean of 13 years (happening 14), and the chairman has served as a director for nearly 20 years. The risk of a third-party sale will increase as Icahn will get extra shares tendered and the board sees the writing on the wall. If they assume they’re going to be out of a job a method or the different, they may as effectively exit promoting to the highest 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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