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Tuesday, Dec 5, 2023



Proxy war veteran John Kelly is a ground commander for a budding movement: institutional shareholder activism.

Kelly, senior vice president for the proxy solicitation firm of MacKenzie Partners Inc. in Century City, helped rally the shareholder forces that killed the planned merger of Burbank-based Iwerks Entertainment Inc. and Showscan Entertainment Inc. of Culver City.

The Iwerks case illustrates why institutional shareholders money managers, mutual funds, pension funds, insurance companies so frequently drive the biggest rigs on Wall Street today.

“You read about the executives, and they make speeches, but more and more it’s the shareholders who control what’s going on,” Kelly said.

In Iwerks, just three large shareholders controlled 35 percent of the stock, Kelly noted.

Kelly’s boss in the proxy fight was New York-based Herbert Denton, president of the money manager Providence Capital Inc., who is known for head-butting with corporate management when he believes shareholders aren’t being considered.

“I didn’t like this deal at this price,” said Denton.

Denton quickly convinced a sometime client of his, Milwaukee-based Heartland Advisors Inc., to pass on the proposed Iwerks-Showscan combo. Heartland owns 24.7 percent of Iwerks, and Santa Monica-based Dimensional Fund Advisors Inc. owns 7 percent.

Lord Abbott, the New York money outfit, owned about 3 percent, and Denton controlled a little under 2 percent.

It was Kelly’s job to make sure appropriate anti-merger literature was sent to shareholders, and to make educated guesses about the prospects for victory (from Denton’s point of view).

“(Iwerks) was an extraordinarily concentrated shareholder structure,” said Denton. “But we are seeing more and more of this; it’s the change from water to ice (the solidifying of institutional shareholder power in recent years, due to concentrated ownership).”

Financial potboiler

Louis “Skip” Miller, partner at the Westside law firm Christensen, Miller, Fink, Jacobs, Glaser, Weil & Shapiro LLP, has gotten himself involved in a plot worthy of a paperback potboiler, replete with “death-spiral” bonds and “toxic convertibles.”

It all started when Champion Financial Corp.’s stock fell off a cliff.

Champion, a health care management company based in Scottsdale, Ariz., needed financing last year to acquire another health care company, HealthStar Inc. To that end, Champion retained the services of Florida-based Select Capital to finance the buyout.

Select Capital suggested issuing $4 million in convertible bonds, which were sold Dec. 5, according to a federal lawsuit filed by Miller against Select on March 19.

But shortly after Champion issued the bonds and successfully raised the dough, something funny happened its stock began a free fall, from $11.50 a share on Dec. 5 to $5 on Jan. 15, despite the lack of any material announcements from the company.

“Business was fine, financing was in place,” said Miller.

Why the stock drop? The investment bankers manipulated down the thinly traded stock, having taken large short positions in Champion, Miller alleged.

So the bankers made money shorting but that’s not all, according to the federal suit.

Having driven down the price of Champion stock, the holders of Champion’s convertibles have applied to convert their bonds into a much larger fraction of stock outstanding and thus figure to make a killing when the stock rebounds. (Convertible bonds are usually convertible into a certain dollar amount of stock so as a stock’s price goes down, the more shares are needed to honor a bond conversion.)

Moreover, if the bond buyers convert, they might even get enough shares to take control of the company that’s why the bonds are known as toxic convertibles, according to the suit. Champion has decided not to honor the bond conversion and has filed suit instead.

Neither Select nor its attorney returned calls for comment.

But one local broker-dealer said the scenario, if true, should not have surprised Champion because of the inherent risks in issuing convertible bonds.

“What did they think was going to happen?” asked Bryant Riley, president and founder of the Westside-based B. Riley & Co. Inc. securities firm.

“If you issue a convertible preferred, then your stock is going to be under pressure (since a conversion would dilute the stock value). A lot of bankers will short a stock. They are in this to make a return on an investment,” he said.

Miller said the underwriting agreement specifically forbade shorting Champion stock. “But (Select) did it anyway,” he said.

The upshot of this story?

Whether or not the Champion allegations are true, it seems prudent for investors to be extra cautious when buying thinly traded stock, especially if convertibles have been issued. And for middle-market companies, the lesson may be to be careful about issuing convertible bonds.

The alleged scenario of being shorted, and then having convertible bonds exchanged for lots of stock, is frequent enough that catch phrases such as “death-spiral,” and “toxic convertibles” are blithely tossed about by stock market insiders.

South Korea investing

The brave who invested in South Korea starting this year have been rewarded by the end of the first quarter, noted Stewart Kim, managing partner of Pacific Gemini Partners LLC in downtown Los Angeles. Through the first quarter, an index of South Korean stocks rose 25 percent. Some securities, of blue-chip nature, recorded breath-taking returns, as foreign investors gingerly bought up stocks with which they were familiar. Accordingly, Samsung Electronics Ltd. rose 126 percent in dollar terms.

But Kim counseled against enthusiasm, and noted weakness in Korea since the first quarter. “It is premature to bet on the end of Korea’s economic crisis,” said Kim. The gains won’t continue unless real reforms take place in the Korean economy, he said.

Contributing Reporter Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal.

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