Like a ship tossed on a stormy sea, battered by shareholders and under fire from borrowers, Kmart Corp passed a tempestuous winter. With new management and around $4 bn in non-core assets shed during the last year, the troubled retailer was downgraded to junk bond status and had to negotiate hard with creditors to stay afloat amid bankruptcy rumours. The company came through with flying colours, seeing in the summer with a capital raising of $4.7 bn, including $1 bn in convertible preferred shares, the largest ever non-investment grade retail financing.
There is something niggling at Kmart, however; something that might be dampening post-deal celebrations. On the eve of the June financing, two labour unions filed a lawsuit to remind the company of its responsibility to shareholders. The Inter-national Brotherhood of Teamsters and the Union of Needletrades, Industrial & Textile Employees (Unite) believe Kmart’s tally of votes in their May proxy contest was wrong. And they want it corrected.
Besides plying the depths of Wall Street for financing, Kmart spent the spring navigating the shoals of corporate governance. Newly-installed chairman Floyd Hall had enough on his mind when he arrived at his first annual meeting in May to report a fifth straight quarterly loss. But he also had to face shareholder activists from Teamsters and Unite proclaiming that they wanted the board to ‘hold Hall’s feet to the fire.’
The unions first approached Kmart in February, around the time the company was inking its massive financing plans with Chemical Bank. They told management they were nominating a director to replace Gloria Shatto, and proposed that Kmart destagger the board, eliminate outside directors’ retirement plans, and undertake a study of a sale or merger of the company. The unions’ board nominee was Stephen Hester, a lawyer for the Teamsters.
The unions’ proxy materials were still with the SEC when Kmart seemed to cut them off at the pass with an April 8 shareholder letter. With DF King as proxy solicitor, Kmart announced that Shatto was retiring, and noted her move had been planned for several months. Her successor was Stephen Bollenbach, president and CEO of Hilton Hotels, the former Disney CFO and financial engineer for Donald Trump during his troubled times. Kmart warned shareholders about the unions’ proxy solicitation, and sternly pointed out that the campaign was really just pressure on Kmart in an effort to gain concessions on local labour issues.
‘No-one bought the company’s line about a hidden agenda,’ says Michael Zucker, director of corporate and financial affairs for Unite. ‘The issues we presented were about shareholder rights, and our arguments resonated as valid criticism on performance. Here was a company whose stock price, despite improvement, was far below historical levels, run by a board of directors who were architects of the failed policies of the past. And though the company was continuing to lose market share, it was not taking dramatic steps to improve performance.’
As for the unions’ idea that the board consider a sale or merger of the company: ‘It is ill-advised and short-sighted to ask the board to effectively hang a For Sale sign on the company at a time when it is not in the best interest of shareholders,’ Kmart retorted. ‘Kmart’s operations are in the process of being revitalised. The results of this turnaround have only begun to reach the bottom line, and the company’s share price is beginning to respond… the proxy process is not the proper forum to debate or resolve local disputes that periodically arise between labour and management.’
With Kmart’s cards on the table, and viewing Bollenbach as a credible outside director, the unions withdrew their board candidate and pressed on with the other non-binding proposals. Enter George Garland as adviser to the unions, and a stranger to neither the Teamsters nor Kmart. Indeed, Garland jokes that a large segment of corporate America might see him as Public Enemy Number One.
Garland worked for The Carter Organisation, Drexel Burnham & Lambert’s proxy firm, until 1989 when he left to handle blossoming proxy solicitation duties for Calpers. He has built his niche serving public pension funds and small hedge funds – always in opposition to management; and he was a natural choice for the Teamsters, having worked for the union in its 1994 contest with Consolidated Freightways.
For Garland, Kmart has almost become an annuity business: he represented the New York State Common Retirement Fund and the State of Wisconsin Investment Board in proxy contests against the company in 1990 and 1994 respectively.
In this contest, Garland’s key role lay in identifying Kmart shareholders. With extensive knowledge of institutional investors and custodial arrangements, Garland traced the pathways of ownership to find decision-makers with 5,000 or more shares. He kept track of who was voting how, a task made more difficult by the fact that unions’ proposals were on management’s white card as well as their own blue card. ‘Shareholders don’t have to disclose anything,’ he points out. ‘We kept a running tally based on any kind of indication we could get.’
Michael Brinn of DF King, on the Kmart case for the first time, found it unusual for the unions to issue their own proxy statement and card. ‘They duplicated the mechanics that the company was required to go through,’ he says. ‘They could have just done a counter-solicitation. Having two proxy cards complicated the process. They did not know who was sending back which card, and that may have hurt their case.’
After its first blast at the unions, Kmart stayed relatively aloof, busy with the capital raising. Indeed, the dissidents’ proposals were not mentioned in management’s May 10 shareholder letter, which focused instead on Kmart’s turnaround story. ‘We had a number of significant issues to overcome as well as the proxy fight,’ confirms Robert Burton, director of IR.
‘Shareholders are more concerned about driving share price, and right now the driver is our turnaround, not corporate governance,’ Burton says. ‘This is a company with a good governance record. No-one can say management is entrenched and unresponsive when 19 out of the top 33 senior executives and more than half of the board are new, including the chairman and CEO.’
‘They are far from perfect,’ counters Zucker. ‘Besides the staggered board, they have super-majority requirements and blank check preferred stock. The compelling factor for shareholders is the combination of governance structure and performance. All companies should have the greatest level of shareholder democracy possible, and that’s especially true when performance is poor over a long period of time.’
The unions arrived at the Detroit theatre where the Kmart annual meeting was held on May 21 confident of winning the day, or at least their proposal to destagger the board. Zucker notes that the union only expected modest support for the proposal to consider a sale or merger. ‘But we thought we had a story to tell on the board’s focus going forward, including a broad view of strategic changes that could enhance shareholder value,’ he says.
William Patterson, corporate affairs director for the Teamsters, describes the meeting as an anti-climax after the proxy contest, with few institutional investors in attendance. ‘It was more of a cheer leading session for management,’ he says. ‘The company was clearly on the defensive, trying to shut down debate and discussion. We were not allowed to engage directors with specific questions.’ Among other criticisms, Patterson chastised Kmart’s board for not responding to a shareholder proposal a year ago in which 60.5 per cent of shares were voted for a destaggered board.
Perhaps the meeting wasn’t climactic, but what followed certainly was. At the meeting, Kmart said it would delay the results of the voting for one to two weeks, which prompted the unions to declare a 70 per cent victory on the destaggered board proposal while conceding defeat on the others.
Ten days later, the fireworks began: Kmart announced that the key proposal received only 39 per cent of votes cast. The unions, along with the Council of Institutional Investors, said two crucial mistakes had been made, which meant that 57 per cent of the votes actually supported the proposal.
Apparently Putnam Mutual Funds and the State Teachers Retirement System of Ohio, both large Kmart investors, favoured the proposals. But as a result of clerical errors at Institutional Shareholder Services and ADP, the institutions’ votes were accidentally voted the wrong way or received too late to be counted. Kmart acknowledged that it was notified of the mistakes after the annual meeting but said it was too late to make adjustments. Besides, even with the votes counted properly, the proposal still wouldn’t have the necessary 62 per cent super-majority.
‘This is another example of Kmart thumbing its nose at shareholders,’ Zucker was quoted in the press as saying, adding that the unions were reviewing their options in the legal arena. That threat turned real on June 12, with the unions’ lawsuit against Kmart (as well as CT Corporation which counted and audited the votes), alleging that there were at least 50 separate votes corrected during the tabulation process following Kmart’s annual meeting.
Shareholder opinion should mean something,’ declares Patterson. ‘Kmart is hiding behind technical glitches, which is alarming because it signals deep flaws in the proxy voting system. More importantly, it is not in the spirit of good shareholder relations.’ He points out that Kmart’s super-majority requirement over the board declassification issue is just creating confusion: ‘A voting majority should command the attention of top management. It’s that simple.’
‘Kmart’s resistance to these results provides the best evidence possible of the need for change,’ concludes Zucker. ‘It is using company assets to try and thwart the will and stated opinion of its shareholders.’
‘The proxy debate was largely smoke and mirrors used by the unions, and continues to be so,’ maintains Kmart’s Burton. ‘Our shareholders care a lot about the company, and the company is working very hard to meet their needs. But they simply do not care about the union agenda.’
Smoke and mirrors or not, as the unions’ court gambit plays out, all eyes are more on Kmart’s fight to turn a profit than its looming court battle with the unions. But perhaps corporate America has learned a lesson about underestimating the support unions enjoy among the nation’s largest institutional investors – most of whom care deeply about corporate governance as well as share price. Indeed, there is no shortage of evidence to support the view that the two issues are deeply intertwined. Voice of the Teamsters
Teamsters corporate affairs director Bill Patterson recognises the irony in the idea of a Teamster talking about principles of corporate governance. On the road three days a week during proxy season, he has become a prominent corporate gadfly in the US, but he stresses an even-handed approach.
‘The initiatives we have been involved in range from complete acrimony to staunch support for management,’ he notes. Patterson cites Tenneco, which was persuaded after a series of meetings to get on ‘the right track’; and Chrysler, which the Teamsters staunchly supported against Kirk Kerkorian.
‘We make credible arguments based on shareholder values, and large blocks of shareholders seem to agree with our critiques,’ Patterson says. ‘Sure there is ongoing tension over putting money into shareholder pockets or those of the workers, but that tension is not fossilised as it was from the 1950s to the 1970s. This is a new world order with no permanent enemies and no permanent friends. That makes alliances with other institutional investors possible.’
No-one can deny that the Teamsters carry shareholder clout. The 1.4 mn member union boasts 175 pension funds with assets of $48 bn. Its voice is being heard loud and clear in corporate boardrooms from Time Warner, where it this year unsuccessfully proposed to split Gerald Levin’s job as chairman and CEO into two positions, to an attack on executive pay at Union Pacific.
Patterson concedes that employee rights are never outside the Teamsters’ purview, even in a proxy fight, noting: ‘Employees and shareholders often have a common cause as victims of entrenched, unresponsive management. Workers are now significant owners in American corporations, but they are taking ownership more seriously than many companies would like. They are using stock holdings to participate in running the company by criticising or supporting management. Wall Street’s ethos is to use any means to a profitable end, but employee capital cares how profits are made.’ Kmart Turnaround
Crisis management may be an apt description of the role of Robert Burton, IR director at Kmart since last September. The potential for a rating downgrade to junk status tightened the company’s credit availability, then a Heard on the Street column in the Wall Street Journal spawned bankruptcy rumours.
Still, more impressive than weathering that storm, Burton insists, is the fact that a few weeks ago Kmart stock had one buy recommendation among analysts following the company; now it has four, and the share price has rocketed up 80 per cent since the beginning of the year on increased confidence in the retailer’s turnaround efforts. ‘Circumstances combined to put the company under a significant amount of pressure,’ Burton notes.
Kmart made clear from the beginning that it could resolve its problems, and told shareholders to ignore bankruptcy rumours. Its debt slid to junk level in January, with management in talks with its banks for an arrangement to solve near-term problems and enable the company to seek major refinancing. At the end of February, it agreed with bond holders and banks on an 18-month fixed borrowing window to refinance the company while operating on internal cash flows.
A deal was brought to market in just three months. It consisted of $3.7 bn in bank debt contingent on the successful placement of $750 mn in convertible preferred shares. By all accounts, Kmart was wildly successful, with the bank tranche oversubscribed by $1 bn. The underwriters for the convertibles tranche, Merrill Lynch and Morgan Stanley, twice exercised their over-allotment to bring that part of the offering up to $870 mn, then $1 bn.
Burton was kept busy throughout. He now had to communicate with bondholders and other audiences that don’t usually fall within the IR department’s remit. ‘In these circumstances their concerns were the same, and all the markets were sharing information,’ he says.
Burton organised many conference calls for management aimed at specific audiences from bondholders to stockholders to suppliers. The treasury team, with the support of Burton’s IR group, embarked on a series of one-on-one meetings with Kmart’s 70-odd banks to discuss the new facility and explain management’s strategy. Then, at the beginning of June, a ten-day roadshow was launched in New York and Boston for the convertible offering, with overwhelming demand cutting the trip to two days.
Standard & Poors calls Kmart’s refinancing a ‘major milestone’. Burton, and many relieved investors, including those involved in a spate of profit taking following the close of the deal, would probably concur.
