Download - The TELUS Share Conversion Proposal- Part I

8/10/2019 The TELUS Share Conversion Proposal- Part I

1/9

The TELUS Share Conversion Proposal

Darren Entwistle, President and CEO of TELUS CorporationCanadas second-largestelecommunications companywas concerned as he and Monique Mercier, the firms chief legal

officer, entered the board meeting on May 8, 2012. The next day, at the firms annual general meeting,shareholders were scheduled to vote on a proposal to eliminate the firms dual class structure byconverting its non-voting shares into voting shares on a one-to-one basis.

TELUS Corporation

Despite strong support from Entwistle, many large shareholders, the board of directors, and twoindependent proxy advisory firms, the conversion was opposed by Mason Capital Management, aU.S.-based hedge fund. Mason, which controlled almost 20% of the firms voting shares and had largeshort positions in both the firms voting and non-voting shares, had filed a dissident proxy circularrecommending that shareholders vote against the proposal, primarily because of the one-to-oneexchange ratio. With the success of the vote increasingly in doubt, the board meeting would allow thedirectors, a special committee of independent directors, and the financial advisors John Tuer andFiras Kitmitto from Scotia Capital to discuss their options. More importantly, the board had to decidewhether to proceed with the vote, postpone it, or cancel it for good. If the board decided to postponeor cancel the vote, they would then have to decide whether and how to address the dual-class sharestructure in the future, and how to explain their decision to shareholders.

TELUS was incorporated in British Columbia, Canada in 1999, following a merger between BCTelecom and Alberta-based TELUS Corporation. The company provided landline, wireless, internet,and television services to both consumers and businesses. Entwistle became president and CEO in2000 and that same year, he spearheaded the largest telecommunications (telecom) acquisition inCanadian history when TELUS acquired Clearnet Communications of Toronto for almost C$7.0billion. With Clearnet and several subsequent acquisitions, TELUS provided wireless telecom servicesacross the country.

By 2011, after a decade of growth, TELUS served 12.7 million customers: 7.3 million wirelesscustomers, 3.6 million wireline customers, 1.3 million internet subscribers, and approximately 500,000TELUS TV subscribers. TELUS finished 2011 with revenues of C$10.4 billion and net income of C$1.2billion (see Exhibits 1 and 2). This growth and financial performance continued into the first quarter

________________________________________________________________________________________________________________


2/9

of 2012: revenues were up 4%, and net income and earnings per share (EPS) were both up 6%.Reflecting its financial performance, TELUS shares had earned total returns of more than 90% in theprevious two years. As one analyst noted, We believe TELUS is currently one of the best positionedcompetitors in the Canadian telecom industry. We estimate management will be able to continue

delivering solid financial growth over the next twelve months[As a result,] TELUS represents anattractive investment.1 In addition to driving financial performance, management was focused onimproving corporate governance. In 2011, the company had received two awards and two honorablementions from the Canadian Institute of Chartered Accountants for excellence in disclosure andreporting.

Origins of the Dual-Class Structure

With the creation of the new share class, TELUS amended its articles of incorporation to include

coattail rights. These rights required that the two share classes be treated equally in future mergersor acquisitions, and gave non-voting shareholders the option to convert their shares to voting shareson a one-to-one basis if the Canadian government ever fully lifted the restrictions on foreignownership.5 In 2004, Verizon sold its interest in TELUS, causing total foreign ownership of TELUS tofall below 20%.6

In early 2012, TELUS had 325 million shares outstanding: 175 million (54%) voting shares and 150million (46%) non-voting shares. Both share classes were listed on the Toronto Stock Exchange(TSX)the non-voting shares were also listed on the New York Stock Exchange (NYSE)and bothwere trading above C$50. Exhibits 3, 4, and 5 show historical stock prices, historical spreads betweenhe two share classes, and other trading information (volumes and bid-ask spreads), respectively.

Exhibits 6 and 7 show share ownership by TELUS directors and by institutions, respectively. Theownership positions of the firms officers and directors had been disclosed on a regular basis.

2

a TELUS reservation system required non-Canadian voting share buyers to contact a transfer agent to request a reservation

number. Within two hours, the buyer was then notified if voting shares were available. (Source: TELUS 1999 Annual Report.)Where depository shares were concerned, TELUS was entitled to rely upon a declaration by CDS Clearing and DepositoryServices Inc. as proof that the beneficial owner of the shares was Canadian.b TELUS shareholder rights plan was triggered if an investor obtained over 20% of TELUS voting shares. The plan authorizedthe board to issue a set of rights to each share class to purchase newly issued shares at a 50% discount. These rights were notextended to the investor who had acquired over 20% of the company, thereby diluting his or her ownership interest.

While company founders often created dual-class share structures to facilitate the concentration ofownership and control, TELUS had formed its dual-class structure to comply with Canadianregulations on foreign ownership of telecom firms. In 1993, the Canadian government limited foreignownership of telecom companies to 20% of common shares in operating companies and 33.3% inholding companies.2 The 1999 merger between TELUS and BC Telecom initially violated this

restriction as U.S.-based Verizon (through GTEs previous ownership position in BC Telecom) andother foreign investors owned approximately 34% of the new company.3 To comply with ownershiprestrictions, TELUS created a dual-class structure of common (voting) and non-voting shares andimplemented a declaration and reservation systema for tracking purchases of common shares by non-Canadians. Aside from enfranchisement (i.e., the ability to vote on corporate matters such as the righto elect directors, appoint auditors, amend articles of incorporation, approve aspects of executive

compensation, and approve certain mergers and acquisitions), the two classes had equal economicrights: they had the same dividends and other cash flow rights. Despite their non-voting status,non-voting shareholders had been able to vote on a shareholder rights plan in 2000b and on adoptingamendments in 2005 relating to compliance with radiocommunications and broadcasting acts.4


3/9

In March, the Canadian government announced that it would lift foreign investment restrictionson telecom companies with less than 10% market share by revenue.7 Although this change did notapply to TELUS and its major competitors, Bell Canada Enterprises (BCE) and RogersCommunications, Inc. (RCI), which had a combined market share of 90%,8 some industry observers

saw the announcement as a signal that further liberalization was likely.9

TELUS Share Conversion Proposal10

Entwistle and his team first began to contemplate the idea of collapsing the dual-class structure inlate 2011 based on shareholder requests. Because both management and the board believed thatenfranchisement of all shareholders was a principle of good corporate governance, the idea gainedraction. Furthermore, foreign ownership levels had dropped to between 10% and 15%, which put

into question the need for a dual-class structure from a compliance perspective. c Over the next twomonths, Entwistle and his team began to analyze the idea in greater detail, speaking with legaladvisors and reviewing comparable transactions in order to prepare for a discussion with the board.

After receiving an initial presentation, the board decided it needed to learn more about theconversion process. The full board appointed a special committee of six independent directors onanuary 25, 2012, and asked them to assess whether collapsing the share structure was appropriate,

how such a transaction might be implemented, and what effects it might have. The committeeevaluated the following factors:

The historical trading price and volumes of the two share classes;

The effect of the conversion (or exchange) ratio on the stock price, dividends, trading volume,and EPS; and

The impact of the conversion on both shareholder groups.

On February 6, the special committee hired Scotia Capital (Scotia) to provide an independent

fairness opinion on a possible conversion from the perspective of both voting and non-votingshareholders. Scotias primary responsibilities were to recommend an appropriate conversion ratioand to assess the likely impact a conversion would have on trading liquidity and share prices. Scotiamade three presentations to the special committee in which they discussed three possible conversionratios: converting non-voting shares into voting shares at a ratio based on the historical tradingprices of the two classes of shares (approximately 1.045-to-1.0); converting at a ratio of one-to-one; orconverting at a ratio somewhere between these two endpoints. In the end, Scotia concluded that aone-to-one conversion ratio was fair to all parties and the most likely to be supported by bothshareholder classes based on the following factors:11

The non-voting shares came into existence solely as a result of a large foreign shareholder.

Both share classes were entitled to the same dividends, and according to the articles ofincorporation, in the case of dissolution, both classes would receive the same benefit.

According to TELUS articles of incorporation, non-voting shares would be converted tovoting shares at a one-to-one ratio if foreign ownership restrictions were lifted.

The companys coattail provisions dictated that non-voting shares could convert to votingshares at a one-to-one ratio in an acquisition.

c The company also had other ways of addressing foreign ownership levels, such as certification through i ts reservationsystem, vote suspension, and ultimately disposition.

3


4/9

After conversion, the EPS and dividends paid on each share would not change.

A unified shareholder class would improve corporate governance and trading liquidity.

Scotia also reviewed 22 share unification transactions of Canadian companies (see Exhibit 8). Outof the 17 transactions that had occurred since 2000, 15 of them had used a one-to-one conversionratio. Moreover, all 13 transactions involving firms with coattail provisions used a one-to-one ratio.

After reviewing Scotias proposal and analysis, the special committee voted unanimously torecommend the proposal to the full board with a one-to-one conversion ratio. The board approvedhe proposal and announced it on February 21. TELUS set the record dated for March 27 and

scheduled the vote for the annual meeting on May 9. Because the proposal amended the firmsarticles of incorporation, each shareholder class had to approve the proposal by a two-thirds majority(i.e., 66.6% of the shares in each class). Commenting at the time, Entwistle stated:

This proposed share conversion is responsive to shareholder feedback, resulting inenhanced trading liquidity and the extension of voting rights to all TELUS shareholders.Notwithstanding the fact that both classes of shares are entitled to the same dividend, arewidely held and have similar liquidity, our Non-Voting Shares have historically traded at adiscount to our Common Shares. The approval of this proposal will eliminate this pricediscount. TELUS believes the proposed simplification of our share structure to a single class isbeneficial and fair to all shareholders, and consistent with good corporate governance.12

4

Four weeks later, on March 21, a research analyst from Mason Capital Management (Mason), aNew York-based hedge fund, called TELUS to say that it owned a large number of shares and wouldnot support the conversion proposal unless the conversion occurred at a premium for the votingshares.15 TELUS management had become aware that a large number of voting shares had moved tonon-Canadian shareholders through the reservation system. The following day, TELUS issued a pressrelease moving the record date back to April 3 and noting that the level of foreign ownership had

increased significantly. In an interview, CFO Robert McFarlane stated, TELUS could go above the [33.3%] foreign-ownership limit and there may be a number of foreign trades that theelecommunications company cant approve as a result . . . there has been a massive attempt, or a

significant attempt, by hedge funds to purchase voting shares in a short-term trading tactic to goagainst the proposal.16

d The record date was the date on which one had to own shares in order to be eligible to vote in the upcoming plebiscite.

In addition to announcing the share conversion proposal, TELUS announced it was increasing itsdividend by 5% (the fifth increase in less than two years). Analysts reacted positively to theconversion proposal. For example, analysts at Desjardins Capital Markets said, We believe this simpler share structure goes a long way toward raising the companys corporate governancestanding, and should improve overall liquidity in the shares. Hence, we expect that shareholders ofboth classes will vote to approve this proposal. 13 Other analysts from Canaccord Genuity said, Webelieve that the proposed collapse would, if approved, create value for all shareholders throughincreased trading liquidity and the elimination of unnecessary arbitrage between the two classes

some voting shareholders may want a more favorable exchange ratio. However, we believe that both classes of shareholders could benefit from improved trading liquidity 14 On the day of theannouncement, the voting shares closed up 2.4% while the non-voting shares were up 5.5%. Incomparison, the two major competitors, BCE and RCI, were up 1.2% and 1.0%, respectively, while theTSX was up 0.6% that day. Exhibits 9 and 10 show TELUS stock price performance in 2012.


5/9

Mason Capital Management

Michael Martino and Kenneth Garschina co-founded Mason in 2000. Martino, formerly a riskarbitrage researcher at Oppenheimer & Company, got his MBA from New York Universitys Stern

School of Business.17 The founders created an event-driven hedge fund, meaning they sought toinvest in companies on the verge of strategic or structural change. For example, Mason had investedin Kaman Corporation, a U.S. aviation company, when it tried to unify its dual-class structure andredistribute voting rights.18,19 After buying 8.3% of the voting shares, Mason started a bidding warwith Kamans board of directors and tried to buy all of the voting shares, most of which were ownedby the Kaman family. In the end, the board bought back all of the voting shares for approximatelyhree times its original offer, giving Mason a handsome return on its investment.20

On April 10, Mason announced that it owned 33 million voting shares (18.7% of the totaloutstanding) and more than 600,000 non-voting shares (0.4% of the total outstanding) as of March 31.At the same time, Mason revealed that it had obligations to return (i.e., it was short) nearly 11million voting shares and 21.7 million non-voting shares to lenders (see Table A).e At the time,Mason had approximately $8 billion in assets under management.21

Table A

Position

LongShortNet

Masons Holdings as of March 31, 2012

Voting Shares

32,722,329-10,963,52921,758,800

Non-VotingShares

602,300-21,672,700-21,070,400

Source: Alternative Monthly Reporting System Report, Submitted by MasonCapital Management, Canadas security regulatory authorities database:SEDAR, April 10, 2012, accessed via SEDAR in August 2013.

Essentially, Mason was long the voting shares and short the non-voting shares, a position thatsurprised many people.22 Mercier explained,

Even before the announcement, we knew hedge funds would be trading in our stockmostlikely a classic pair trade of being long the non-voting shares and short the voting shares tocapture the likely price increase in the non-voting shares at a successful conversion. But withhedge funds, you have to scratch your head and think carefully; you have to think that theunlikely or the impossible might happen. We and the other hedge funds didnt expect therade that Mason put onbeing long the voting shares and short the non-voting. But as soon

as we got wind of it, we immediately recognized the danger of having an empty voterfcasting votes at the annual meeting.

e In Canada, a shareholder had to publicly disclose its ownership if it owned 10% or more of a public company. The thresholdin the U.S. was 5%. Source: http://www.canadianmergersacquisitions.com/ 2012/06/01/5-things-us-activist-investors-need-to-know-about-canada/, accessed July 2013.f (A)cademics have defined empty voting as a situation where the voting rights of investors e xceed their economic stake inthe company. This can happen in several situations, such as when an investor might sell shares after the record date for a

ote but before the actual vote. As a result, the investor would be able to vote on corporate matters despite having little or

Total Shares

33,324,629-32,636,229

688,400

5


6/9

Proxy Fight

On April 20, Mason filed a dissident proxy circular recommending that common shareholdersvote against the conversion proposal for both substantive and procedural reasons. Regarding the

substance of the transaction, Mason contended that the right to vote and, therefore, to control thedirection of the company, had been valued by the market at a 4% to 5% premium over the years. As aresult, converting on a one-to-one basis would confer a windfall benefit on holders of Non-votingShares.23 Mason also argued that collapsing the share structure would limit the extent to whichforeign investors could hold stock, which would actually decrease the liquidity of TELUS shares. Thehedge fund explained that with two classes of stock, foreign investors could buy an unlimitednumber of non-voting shares plus up to 33% of the voting shares equal to 64% of total shares.g With aunified class structure, foreign investment would be limited to only 33.3% of total outstanding shares.Not only would the conversion cause liquidity to fall, according to Mason, it would also requireforeign investors to divest approximately 2.8 million shares.

On procedural grounds, Mason questioned the decision-making process because the specialcommittee had hired financial advisors (Scotia) which had prior working relationships with TELUSinstead of completely independent advisors. 24 Mason also argued that the special committeeshould have requested two fairness opinions from two independent sources, one for the votingshareholders and one for the non-voting shareholders.25 Finally, Mason questioned the boardsindependence, noting that the directors had greater economic interest in the non-voting shares.

Mason concluded by stating they would consider a revised proposal if it offered an appropriatepremium for voting shares, but did not state how large a premium would be acceptable. Mercierreacted to this suggestion:

Independent Proxy Advisory Firms Weigh In

On April 24, 2012, TELUS announced that the two leading independent proxy advisory firms,hInstitutional Shareholder Services Inc. (ISS) and Glass, Lewis & Co. (Glass Lewis) wererecommending that shareholders approve the proposal. In response, Mason issued a press releasestating that ISS and Glass Lewis had drawn their conclusions prematurely and should reviewMasons dissident proxy circular before making final recommendations.26 ISS and Glass Lewis bothwithdrew their reports and issued revised reports several days later. While both firms stillrecommended that shareholders approve the proposal, they did identify some concerns. ISS wrote:

6

no economic interest in the company. Empty voting could also occur if an investor used short sales or derivatives (e.g., putoptions) to reduce his/her economic exposure while maintaining the voting position of the long position. Source: JuliusMelnitzer, Empty voting clouds shareholder rights law; Solution elusive, Financial Post, November 14, 2013, accessed viaFactiva in July 2013.

g The 64% = [175 million voting shares * 33.3% + 150 million non-voting shares] / 325 million total shares.

h Independent (or third-party) proxy advisory firms assisted institutional investors in casting their votes in shareholderelections and shareholder proposals by analyzing proposals and making recommendations.

his document is authorized for educator review use only by PR Bhatt HE OTHER until February 2015. Copying or posting is an infringement of copyright. [email protected] or617.783.7860

We had already considered different conversion ratios and there was no reason to second-guess or revisit the boards reasoning simply to please an empty voter. Mason did not hold anyshares in TELUS at the time we announced the proposal, so if we had changed course, it wouldhave been to please a short term shareholder at the expense of what our long termshareholders wanted. For us, it was a matter of principle to stick to the one-to-one ratio.


7/9

This proposal represents another meaningful step forward in the companys governance regime, in resuscitating the principle that voting rights should be commensurate witheconomic interest. The proposed exchange ratio, however, in veering off from the well-established, enduring market ratio, is a cause for concern [However,] as the proposed

ransaction would align voting rights with economic interest, offers shareholders meaningfuleconomic opportunity through increased trading liquidity and a dual listing on the NYSE, andhas been ratified by a strong market responseand as the companys Articles effectivelypreclude any exchange ratio other than the proposed one-for-one exchangea vote FOR theproposal is warranted.27

The Glass Lewis report read:

Mason has indeed raised some valid points regarding the terms of the proposedConversion. . . .[T]he Companys common shareholders have historically paid a premiumshare price, and accordingly, may recognize some economic shortcomings as a result of theConversion. However, we believe any short-term costs will be outweighed by the overallbenefits of a simplified share structure and [that the] improvement in corporate governance

resulting from the Conversion [is] in the long-term best interests of both common and non-voting shareholders.28

After reading the reports and seeing the approval recommendations, the TELUS team breathed asigh of relief. Mercier explained, We know how influential the independent proxy advisory firmscan be, and we had worked very hard to demonstrate that our proposal was beneficial forshareholders and part of our efforts to be a leader in good corporate governance.

The Annual Shareholder Meeting

TELUS needed high voter turnout in order to achieve a two-thirds majority, as Mason was sure tocast its 33 million common shares against the proposal.29 TELUS CFO McFarlane added, Retail

shareholders in particular are notorious for not bothering to vote. . . . Even if you have 90% of non-Mason people vote yes for the proposal its possible that the proposal gets defeated because only 60%or 65% of [shareholders] bother to vote.30

To persuade shareholders to vote for the proposal, TELUS sent letters to shareholders, hired aproxy solicitation firm (to call and e-mail shareholders, and provide information regarding theproposal), gave presentations, called institutional shareholders, and issued a series of press releasesabout the proposal. In addition, TELUS hired the Canadian Imperial Bank of Commerce (CIBC) assoliciting dealer manager to form and manage a group of brokers to solicit proxy votes in favor of theproposed conversion from retail common shareholders.31 As compensation for the extra work, TELUSpromised to pay the brokers ten cents for each favorable vote if the conversion was approved.32 Thismethod of increasing voter participation was fairly common in Canada during proxy fights. ButMartino thought otherwise, [TELUS] tactics are particularly hypocritical in light of . . . us[ing] thecompanys money to pay for shareholder votes, but only those that are in favor of its proposal. Thisconduct is abusive of TELUS shareholders such as Mason who disagree with managementsposition.33

As the annual meeting date approached, Entwistle and Mercier received word that at least oneother major shareholder might vote against the proposal. Mercier recalled:

7


8/9

We realized quite quickly that we were going to need a Plan B. On the one hand, Darrenand the board were very convinced the proposal was the right thing to do and that the one-to-one conversion ratio was fair and made sense. But on the other hand, we were facing a possibledefeat and needed to respond. We decided to convene an emergency board meeting and asked

counsel and Scotia to develop some alternatives for the special committee to consider at themeeting.

At the emergency board meeting on April 17, legal counsel suggested that there might be a way torestructure the proposal as an exchange (rather than a conversion) that would affect the rights of thenon-voting shareholders without amending the articles of incorporation. This would allow a changein the approval thresholds needed by both share classes to 50% of voting shareholders and 66.6% ofnon-voting shareholders. This alternative, however, would have some tax disadvantages foremployee option holders and meant that references to the non-voting shares would remain in thecorporate articles (even though there would not be any non-voting shares outstanding after theexchange).

In connection with this alternative plan (Plan B), Scotias Tuer and Kitmitto described threeoptions for the board to consider: first, cancel the vote and withdraw the conversion proposal forgood; second, withdraw the proposal just prior to the annual meeting if it were unlikely to succeedand announce Plan B at the meeting to prevent the spread from widening and Mason from profitingfrom the trade; or third, withdraw the proposal just prior to the annual meeting and remain silent aso future plans. Then, when Mason had exited its position, the board could introduce Plan B with a

short window between the announcement and the record date. Although the board discussed theseoptions in detail, they did not make a final decision during the meeting.

The outcome of the vote remained uncertain as the meeting date drew closer and the votes startedcoming in. In a research report dated May 7, two days before the annual meeting, one analyst noted:

On May 8, the day before the annual meeting, all options were still on the table. With timerunning out, the special committee and then the full board had to decide whether to proceed with orcancel the shareholder vote. If they decided to cancel the vote, they had to decide which option topursue and how to explain their decision to shareholders the next day.

8

. . .the Mason position has created considerable uncertainty. . .While we believe that the votemay be too close to call, in our view, TELUS proposal may well be accepted. . .the vastmajority of long-term shareholders that we have spoken with are in favor of the collapse dueo increased trading liquidity if [the proposal] is rejected we would expect TELUS to

reintroduce its proposal at a later date... In summary, we are much more interested in TELUSoperating fundamentals than its share structure. 34


9/9

Download - The TELUS Share Conversion Proposal- Part I

Top Related