January 2017

Pity poor Hitachi.

In 2015 Hitachi, accustomed to the forgiving corporate governance culture of Japan, acquired control of Italian railway operator Ansaldo STS, a publicly listed company, without fully comprehending the traps for the unwary that lurk in corporate governance environments outside Japan.  The shareholder list of Ansaldo STS, it turns out, was loaded with sophisticated hedge funds that have cleverly exploited their “rights” as minority shareholder “victims” to try to shake down Hitachi for more cash.  The case for victimhood made by the hedge funds is superficially appealing, but on closer analysis unpersuasive.

In February 2015 Hitachi agreed to acquire 40% of Ansaldo STS from its largest shareholder, Finmeccanica, for €773 million, equivalent to €9.50 per share.  (STS shares were trading at around €9.00 at the time of the announcement.)

At the same time Hitachi agreed to buy Finmeccanica’s loss-making Ansaldo Breda train-making arm for €36 million.

Under Italy’s corporate law, acquisition of 30% or more of a listed company triggers an obligation on the part of the acquiror to make a mandatory tender offer for the remaining shares at a price no less than that paid in initial acquisition.  To comply with this rule in November 2015 Hitachi launched a mandatory tender offer for the remaining 60% of the STS shares at €9.50 per share, the same price it paid to Finmeccanica.  The offer was accepted by only 6.42% of the remaining shareholders, a not surprising result given that the tender offer price and current market price were the same.

By setting the mandatory tender offer at the same price it had paid to Finmeccanica, Hitachi fulfilled the purpose of the rule, namely to give the remaining shareholders the same opportunity to sell their shares at the same price received by a large shareholder like Finmeccanica.  None of the remaining shareholders can complain that they were discriminated against, or were not offered a deal at least as good as Finmeccanica’s.

Two hedge fund shareholders of Ansaldo STS, however, filed claims with the Italian securities market regulator CONSOB claiming the “real” price Hitachi paid Finmeccanica was not €9.50 per share, but a higher price.  Their argument was that Hitachi’s purchase of Finmeccanica’s railway assets (the STS shares and the Breda assets) were part of a “package deal” in which the parties colluded artificially to subsidize the price for the STS shares in exchange for an offsetting higher price (i.e. €36 million) for the Breda assets.

Given that the €9.50 per share price was higher than the pre-announcement market price (and twice the prevailing market price as recently as 2012) it would normally be hard to argue that the price was “too low.”  However, the two complaining hedge funds were able to get their hands on written materials prepared by Hitachi staff for the Hitachi board that described the Finmeccanica transaction as a “package deal”.  Even more unhelpfully to Hitachi, the staff-prepared materials stated that STS’s shares would fetch as much as €12 per share if Hitachi had to bid for them in an “open auction”.  This statement is puzzling in light of the fact that publicly traded shares are by their nature constantly up for public auction to the highest bidder, and the open auction price (i.e. market price) at the time was actually around €9.00 per share.  Perhaps the staff was trying to generate reasons to persuade the board that the €9.50 per share price tag was a bargain. (One hopes this experience will teach Hitachi and other Japanese companies always to conduct board meetings in the anticipation that the proceedings might eventually become public.)

With the damaging Hitachi board materials as evidence, the hedge funds were able to get CONSOB to re-allocate most of the €36 million paid for the Breda assets to the €773 million purchase price for Finmeccanica’s STS shares.  CONSOB shifted almost all of the €36 million Hitachi paid for the Breda assets to the STS purchase price, with the result that Hitachi was required to raise the price in the mandatory tender offer from €9.50 per share to €9.90, a 4% increase.

If things had ended with a 4% increase in the mandatory tender offer price, the damage to Hitachi would have been relatively light.  But the hedge funds, including Paul Singer’s Eliiott Associates, which holds 21% of the STS shares, have filed appeals to the CONSOB proceeding claiming that the “real” price Hitachi should have offered to the remaining shareholders was not €9.90, but €15.00—a 58% increase over the price paid to Finmeccanica.  Currently STS shares are trading at €11.50 per share.  Decisions in the hedge fund appeals are pending.  In the meantime the hedge funds have mounted a public relations campaign to make Hitachi look bad, paint themselves as victims and put pressure on Hitachi to buy their shares out at a big premium.

At the outset, in evaluating the merits of the hedge funds’ claims that they are victims of illegitimate “collusion” by Hitachi and Finmeccanica to lower the STS price, it is worth noting that in the hedge funds’ own home country, America, there is no legal requirement that the acquiror of a substantial block (e.g. 30% or more) of shares of a public company must offer the same or better terms to all shareholders.  Ironically, in America, Hitachi could have bought Finmeccanica’s STS shares for any price it liked and would not have been forced to offer the same or better terms to the remaining shareholders in a mandatory tender offer.  The lack of a mandatory tender offer requirement in America reflects the policy judgment that the free transfer of shares and corporate control in the market is a good thing, and that a mandatory tender offer requirement would often prevent an acquiror from attempting a partial acquisition in the first place.  In addition, “unequal treatment” of shareholders, unlike unequal treatment based on gender or race, is not something that offends our sense of justice.  In the world of commerce and business, different customers uncontroversially get charged different prices all the time.

Italy’s corporate law, following the EU Takeover Directive, does have mandatory tender offer rules to support the policy of “fair” and “non-discriminatory” treatment for all shareholders.  But even if you concede that inter-shareholder “fairness” is a legitimate goal, Elliott Associates’ gambit to use the courts to force Hitachi to buy its 21% share of STS for a price 58% higher than Hitachi paid Finmeccanica and at a 30% premium over the current market price takes a large dose of chutzpah.  Mandatory tender offer rules are supposed to shield the remaining shareholders, not be used as a sword to be used to gouge a premium by persuading a judge or regulator that the market price, or price agreed between the acquiror and initial selling shareholder, is somehow “too low”.

Elliott Associates is rolling the dice in the Italian courts hoping Hitachi will flinch and come to terms.  (The fact that STS shares are trading at €11.50 and not the €15.00 Elliott is demanding perhaps reflects doubt in the market about Elliott’s odds in court.)  At the same time Elliott has set up a website telling the world the story of seamy “collusion” between Hitachi and Finmeccanica, supposedly evidenced by the “smoking gun” board presentation describing the two parts of the transaction as a “package deal”.

One suspects that Hitachi was not fully aware of the dangers that attend control of a foreign company, especially where the remaining minority shareholders happen to be sharp and experienced hedge funds.  Hitachi for years has operated in Japan through “listed subsidiaries”—i.e. controlled affiliates of which public shareholders own a minority share—without major legal incident or minority shareholder litigation.  (It is no accident that listed subsidiaries are a favorite target of hedge funds in Japan itself, because they provide opportunities to pressure the controlling shareholder to buy out the other shareholders at a premium.)  Perhaps Hitachi casually assumed that it would be safe to operate in Italy in the same way it has done in Japan.  If so, Hitachi guessed wrong.

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