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The case against dual class shares (again)

Posted by admin on June 30, 2010 in Investment Products

Dual class shares refers to a company that has two different classes of shares: one sold to the public and another class which is tightly controlled by the founding families or insiders. Dual class shares are generally panned by the blogsphere since dual class shares tend to perform worse than their peers, controlling shareholders tend to run roughshod over the minority shareholders and, as we are seeing, the unwinding of dual class share structures can be a very painful and expensive process at the expense of the investing public.

Specifically, automotive parts company Magna International Inc. is attempting to unwind its dual class structure by converting the Class B shares held by the Stronach Family Trust into Class A voting shares; Class B shares represent approximately 0.6% of shares issued but control 66% of the votes. The terms are pretty generous to the Class B shareholders. The conversion is at a 1800% premium plus a $300 million cash payment. After the proposed conversion, the Stronach Family Trust would be the largest single shareholder of Class A shares after diluting the Class B shareholders by over 11%.

However, the regulators have halted the proposed vote, which was supposed to occur earlier this week, for lack of full disclosure to the shareholders on how the share premium was arrived at, the dilution effect and how the payout was determined.

What has come out of the regulator proceedings though is how expensive it is generally to unwind dual class structures. A report commissioned by Magna found in a sample size of 15 the shareholders are diluted anywhere from 0% to 3.04%. The premium paid for the shares being converted averaged 30%. When a director was asked about negotiating the terms of the conversion deal, the answer was basically he had no leverage to force something more reasonable. The alternative to negotiating conversion was the status quo which was more oppressive to the shareholders.

While the Magna story may represent the more extreme side of converting dual class shares, it does raise, yet again, why investing in dual class shares is not ideal. Some day, the controlling family/shareholders will want a liquidity event and it will generally occur on the backs of the other shareholders. The only question is how bad will the deal be. In some cases, the conversion came at nominal costs but the potential to craft a deal which affects the shareholders and company adversely always remains.

… yet, strangely, 57% of all shareholder voted in favor of the Magna conversion which has now been halted by the regulators. However, if one assumes your choices are bad deal or even worse status quo, you hold your nose and vote for the bad deal.

No posts until Monday. Enjoy the rest of the week.