Emmis Corp (EMMS)

[hmmauto]

A strategy to vote dead shares.....good luck, michael
Times:NY March 29, 2012
There was an old joke in which a man said that when he died he hoped to be buried in Chicago, so that he could continue to vote.

Emmis Communications, an owner of radio stations around the United States, not to mention in Slovakia and Bulgaria, is based in Indianapolis, which may be on its way to becoming the Chicago of capitalism.

Put briefly, Emmis and its controlling shareholder have hatched an ingenious plan to make the company’s preferred shares all but worthless and strip them of their rights.

To do that requires getting two-thirds of the preferred shares to agree, which would normally be impossible.

But not if Emmis can persuade a state judge in Indiana to bless its strategy to allow dead shares to be voted.

If it succeeds, that strategy could have serious ramifications for investors in other companies. “It is not a good thing,” said Charles Elson, a law professor and director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “Ultimately, the court has to protect the minority investors or the minority shares will be worthless and no one will invest.”

Here’s the situation. Back in 1999, when radio properties were hot, Emmis sold convertible preferred stock at $50 a share. The shares were to pay 6.5 percent a year in dividends. The dividends were cumulative, meaning that if they were not paid the company would still owe them and would have to pay them before any money could be paid to common shareholders. If dividends were not paid for a year and a half, the preferred shares would be entitled to elect two directors.

Like all preferred shares, those shares offered investors greater security and higher income than an investment in common stock, but less chance of a big upside if the company did well.

If the company went private, it would have to redeem the shares at $50 plus accrued dividends. Emmis has not paid dividends on the preferred since 2008, and a little over $11 in unpaid dividends has accumulated. The market price of the shares collapsed after dividend payments were halted.

The provision in the preferred stock contract that allows the terms to be changed with the consent of the owners of two-thirds of the shares is fairly standard. It assumes that investors in a company in trouble might want to cut a deal that gave them something rather than the nothing that they might receive if the company went bankrupt.

Emmis is not doing very well, but it has sold some radio stations and is bringing down debt. A big part of its reported profits in the most recently reported quarter — $56.8 million — stemmed from its effective repurchase of most of the preferred shares at a large discount to face value. It stated in its quarterly report that those shares had been “extinguished.”

But as far as Emmis is concerned, extinguished is not the same as gone. It figures that they can still be voted as the company’s board wishes. And the board wishes to extinguish nearly all the rights of the preferred stock. It wants to cancel the unpaid dividends and never pay another dividend again. The only right remaining would be to convert each $50 preferred share into 2.44 common shares. At current prices, the conversion value is about $2.

How does Emmis think it can vote the dead shares? It says it did not really buy them, even though they are no longer alive under tax and accounting rules. Instead, the company says, it entered into a “total return swap.” The previous owners of the shares got a price — often about $15 or $16 — and no longer have any economic interest in the shares. But Emmis says those owners still have the voting rights and, as part of the swap, have agreed to vote them as Emmis orders.

Last week Emmis, which is incorporated in Indiana, asked a state court in Indianapolis to issue a declaratory judgment that its actions were proper. It names as defendants in the suit several institutional investors who own preferred shares and are resisting the company’s move.

The company is represented by James A. Strain, a partner at Taft Stettinius & Hollister. Company officials have told investors he wrote the Indiana law and was confident that the Emmis strategy was legal. Taft’s Web site states Mr. Strain, who declined to be interviewed, was “one of the architects of the Indiana Business Corporation Law.”

There does not appear to be any direct precedent in Indiana, or anywhere else, for this particular strategy.

In Delaware, where most major corporations are incorporated, courts have held that a company need only comply with the contract with preferred investors, loopholes included. That is what Emmis claims it is doing.

“We’ve got a contract,” Patrick M. Walsh, the company’s chief financial officer, told me. “The rights are spelled out in that contract. We feel like we are acting in the corporation’s and the shareholders’ best interests.”

But there are also cases in Delaware that could point the other way. “For many years, Delaware decisions have expressed consistent concerns about transactions that create a misalignment between the voting interest and the economic interest of shares,” the state’s Supreme Court said in a 2010 decision that quoted articles by Henry Hu, a law professor at the University of Texas.

I asked Professor Hu, who was also the first director of the division of risk, strategy and financial innovation at the Securities and Exchange Commission, to look at the Emmis plan.

“I would think that a Delaware court would strain hard to say that not only is there a misalignment, but this is a negative economic interest,” he said, and added that the shares would be voted in the interests of the common shareholders, who were seeking to profit by taking away the rights of the preferred shares.

The battle is even more complicated than the above would indicate. Unable to get two-thirds of the shares that had been issued, Emmis decided to issue some more to a newly created employee benefit plan. The right to vote them will go to Jeffrey H. Smulyan, the Emmis founder and chief executive. Add those votes to the ones it already has, and the company would have the two-thirds majority even if every actual investor in the stock voted against the plan.

A shareholder meeting on Monday will approve creation of the employee benefit trust and issuance of the preferred shares. Since Mr. Smulyan controls a majority of the votes, through super voting shares, the outcome is not in doubt.

After that vote, the company plans to hold another shareholder meeting as soon as possible, perhaps within weeks. At that meeting, the preferred shares are to be stripped of their rights, and the directors elected by the preferred shares are to be kicked off the board.

Financing the purchases and “total return swaps” was not easy for Emmis. Its bank lenders demanded and got $1.1 million in fees to allow the purchases, but did not provide the cash. That came from a $35 million loan from a fund run by Sam Zell, the real estate investor whose previous venture into the media world, taking over the Tribune Company, ended in bankruptcy. Emmis is paying an interest rate of 22.95 percent.

Emmis management is not happy with the criticism it has been receiving. Mr. Smulyan told me he did not want to see the minority preferred shareholders left out in the cold, and that such an outcome would not happen if the institutional investors blocking the deal would stop being so “greedy and unrealistic” and agreed to sell out on terms the company deemed to be fair.

Mr. Smulyan tried to take Emmis private in 2006 and again in 2010, with the last effort blocked by a failure to get support from enough preferred shareholders. He told me he had no intention of making a third try. Instead, he said, he had acted only after some preferred investors asked for a way to sell their stock.

He argues that his strategy is not very different from a tactic companies sometimes use, of soliciting consents from bondholders or preferred shareholders at the same time as they tender for the securities. That tactic can be very coercive, but at least the votes are cast by people who have a stake in the company when they cast them.

I learned of this case from James Grant, the editor of Grant’s Interest Rate Observer, who wrote in the current issue of that publication that a victory for Emmis “would shake the presumption that contract law applies even when, from the point of view of the insiders, it would be more convenient if it didn’t.”

There are 126,221 preferred shares of Emmis now held by investors who have neither sold out to Emmis nor joined the blocking group. Most of those shares appear to be owned by individual investors, some of whom probably paid $50 a share for them in 1999.

If there is no settlement, and if the Indiana court rules as Emmis expects, those shares will be worth about $2, thanks to a voting arrangement that the old Chicago Democratic machine would have found all too familiar.


Floyd Norris comments on finance and the economy at nytimes.com/economix.



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