Every now and then I like to highlight a transaction that to me looks unfair to minority shareholders. For example, two years ago, Waxman Industries tried to buy out shareholders at a ridiculous price that amounted to just 12% of book value. Apparently so many shareholders asserted their appraisal rights that the company ended up cancelling the whole deal about a year later.He did not post a copy of the letter to shareholders, but we are trying to track it down.
This week I received the financial statements of York Corrugating Company (OTC:YCRG). The company is a manufacturer of precision metal components and sheet metal products. [...]
In previous years I only received financials and the notes to the financial statements. There was no letter from the CEO describing how the business performed that year. This year there suddenly was a letter. It was even titled “Important Letter to Shareholders”, so that made me curious.
Unfortunately the letter announces an attempt from the company’s management to cash out the remaining minority shareholders. They plan to do this by way of a reverse split at a ratio of 2960-for-1. Every shareholder holding less than 2960 shares will see their fractional shares (post-split) cashed out at a price of $308 per share, determined on a pre-split basis.
The company has obtained a valuation from Baker Tilly Virchow Krause LLP to deterimine the “fair market value” of the minority shares. Their report is not included, nor is there any explanation offered why this price is deemed fair.
The company only had 20,841 shares outstanding as of December 31, 2019. At a price of $308, the Board of YCRG thinks that $6.4 million is a fair valuation for the company. Looking at the balance sheet and the company’s recent earnings, this valuation looks much too low.
York Corrugating Co. is a classic Oddball (it's in the Century Club) although we have not written about it on the blog before. It is based in West York, PA; a half hour or so from the headquarters of Hanover Foods, but pretty close to little York Airport where Hanover keeps its Cessna Citation jet!
Whatever is in the water in southeastern Pennsylvania does not seem to promote friendliness to minority shareholders. In fact, in looking for case law on squeeze-outs, we see some old friends: a 2012 Supreme Court of Pennsylvania opinion in Mitchell Partners, LP vs Irex Corporation:
Mitchell Partners, L.P., was a minority shareholder of Irex Corporation, a privately-held Pennsylvania business corporation. In 2006, Irex participated in a merger transaction structured so that some minority shareholders would be “cashed out” and would not receive an equity interest in the surviving corporation, a wholly owned subsidiary of North Lime Holdings Corporation. Mitchell objected to the acquisition, as it viewed the transaction as a “squeeze out” of minority interests at an unfair price. The merger proceeded nonetheless, and Irex commenced valuation proceedings in state court, per Section 1579 of the BCL, to address the dispute with Mitchell.Notice that the Irex merger closed in October 2006, Mitchell sued in federal court October 2008, and the case went to the federal court of appeals and the Supreme Court of Pennsylvania, because the federal court certified a question of state law for them to answer. The 2012 state supreme court opinion was a victory, establishing a legal precedent in Pennsylvania: "shareholders [can] bring a non-appraisal action, after the closing of a merger, asserting fraud or fundamental unfairness."
Meanwhile, Mitchell pursued common law remedies in a diversity action in federal court, naming as defendants Irex, its directors, most of its officers, and North Lime. The complaint asserted claims for breach of fiduciary duties, aiding and abetting breach of fiduciary duties, and unjust enrichment. The defendants sought dismissal on the ground that, under Section 1105 of the BCL, judicial valuation is the sole remedy available to dissenting shareholders in the post-merger timeframe.
Good for Mitchell for fighting so long and hard - Irex paid a big tax for not asking for minority shareholder blessing of what it wanted to do before doing it. But that 4+ year battle points to something important.
In his post, Value Investing Blog alludes to a problem that minority shareholders have in these situations: a high fixed cost of fighting what the management and/or controlling shareholders are trying to do. It can be a significant cost in terms of time and attention, and for someone to rationally pay that cost upfront he would have to anticipate a higher expected benefit. An appraisal action is likely going to require dissenting shareholders to have an expert report.
That suggests something important for corporate governance theory. The ownership structure of a company matters, and can be very important for the ultimate returns of shareholders. At the limit, if a company were to be owned by a large group of shareholders each holding a single share of de minimis value, it might be possible for the management to convert all of the company's equity to their benefit and rational for the shareholders to acquiesce. (In theory, the shareholders could resist as a class, but in practice those efforts have to be initiated and organized by a shareholder with an economic incentive to do so.)
Speaking of reverse splits, yesterday's post was about shareholder activism at Life Insurance Company of Alabama. On the Concerned Shareholder website, there is mention that LICOA was considering a reverse stock split in 2015 and met with state regulators about it. No word on what happened with it though (or why it didn't happen).