A bitter breakup of a well-known Ohio company, Timken, approved by shareholders in a battle led by CalSTRS and one of its investment funds, Relational, has become a case study as activist shareholders try to squeeze more profit from companies.
Under the control of the Timken family, the company won praise for repeatedly investing heavily in modern steel-making equipment that keeps jobs in the rust-belt city of Canton, while also being a major donor to local education and arts.
Now some fear the vote to “maximize shareholder value” by splitting Timken into two separate companies, Timken and TimkenSteel, creates two weak takeover targets, more vulnerable to economic downturns and less likely to continue community support.
Suzanne Berger, an MIT political science professor who studied Timken for her book “Making in America,” told the New York Times it’s not “classical greed” but the creation of financial markets that harm long-term investments and industrial companies.
“We’ve got a financial system in the U.S. where California teachers have to protect their pension funds by hurting manufacturing in Ohio,” Berger told the Times, which tracked the Timken split and published a lengthy report in December.
Since the split in September, Relational Investors and CalSTRS (except for an index fund) have sold their Timken shares. Relational bought shares at $40 and sold at $70, a gain of $188 million in about two years, the Times said.
The California State Teachers Retirement System, with investments worth $189 billion at year‘s end, stands by its role in the Timken breakup, seeing no long-term harm to Canton, home of the Pro Football Hall of Fame, which elected its 2015 class Saturday.
“The family remains as involved in both companies as it was in the old one,” Ricardo Duran, a CalSTRS spokesman, said last week. “In fact, the stock appreciation gives them greater wherewithal to make the local investments that have so endeared them to the community.”
Relational, a San Diego firm, targeted Timken after calculating the company might be worth more if it split. (In 1965 the Timken family established the free-admission Timken Art Museum in San Diego, which has a Rembrandt and other masterpieces.)
Both CalSTRS and the larger California Public Employees Retirement System have more than $1 billion invested in Relational. But CalPERS did not join the drive to split Timken.
“Timken was a risky target for Relational’s executives,” said the Times story. “They could be painted as Gordon Gekko types trying to make a fast buck by attacking a well-regarded, family-run company that had outperformed the stock market.
“Getting CalSTRS on board helped neutralize that threat. The pension fund, long a champion of better corporate governance, made the case that Timken’s board was dominated by family members who paid themselves liberally and put their own interests ahead of shareholders’ interests.”
Pushing a principle of the shareholder rights movement, CalSTRS argued for more independent board members, noting that nine out of the 12 Timken board members were from Ohio.
A Relational co-founder, Ralph Whitworth, quoted in a CalSTRS news release in September, said the Timken split created two industry leaders and “ensures the long-term vitality and competitiveness” of the two companies.
“It’s the right answer for all constituents, including the city of Canton, which will now be the home of two world-class companies,” said Whitworth.
Much of the focus on public pensions has been on their impact on government budgets. Pension debt soared during the recession, and state and local governments are putting more money into pensions, squeezing funding for other programs.
But state and local public pension systems, which often expect investment earnings to pay two-thirds of their pensions, also have an impact on the business world through huge investment portfolios. CalPERS was valued at $294 billion last week.
Public pensions have been leaders in the drive for better “corporate governance” through corporate board independence and diversity, the Sarbanes-Oxley financial reforms after the Enron scandal, and Dodd-Frank after the 2008 debt-binge meltdown.
And public pensions, seeking above-market returns, were early investors in private equity leveraged buyouts, regarded as “creative destruction” that helps the overall economy by some, mainly destruction by others but a major force in the corporate world.
In a leveraged buyout, companies are bought, often with loans using the company’s own assets as collateral, made more cost efficient, sometimes through layoffs and splits, and then sold for tax-advantaged profits.
Activist investors like Relational are a smaller and less controversial trend. Instead of buying a company, an activist buys a large number of shares in a company and then, as a shareholder, urges changes intended to increase the company’s value.
CalSTRS has $5 billion invested in nine “governance” funds that are activist investors. CalPERS has $3.8 billion invested in the governance funds of eight activist managers, three in addition to Relational that also are in the CalSTRS portfolio.
Ted White, a managing director of one of the CalSTRS funds, Legion Partners, is a former CalPERS governance portfolio manager. CalSTRS invested $200 million in the small fund that had $20 million under management and took 30 percent ownership.
Legion Partners had been managing investments for private individuals in small companies, said Duran, the CalSTRS spokesman, and the big pension fund had been having difficulty finding a “true small-cap activist manager” in an area with growth potential.
“The folks at Legion presented a solid investment thesis, a good investment team and a compelling incentive structure,” said Duran. “The 30 percent ownership aspect is a mechanism to reduce our fees as the seeding partner while simultaneously better aligning our interests.”
Not all corporate breakups under activist shareholder pressure are bitter battles. A Wisconsin company, Manitowoc, announced last week that it will split into two companies, one manufacturing cranes and the other food and beverage equipment.
Manitowoc’s management and board of directors said they agreed with Relational Investors and billionaire Carl Icahn that the split should produce more value for company shareholders.
How is the CalSTRS portfolio of activist funds performing? Charts in the corporate governance annual report last fall show the CalSTRS funds yielding a little more than the public equity index.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 2 Feb 15