A Tale of Two Takeovers

“The net effect [of the corporate raiders] has been to force every company to look at its productivity. Industrial America is in healthier shape in 1986 than in 1976.” Irving Shapiro, Founding Member of The Business Roundtable and Former CEO of Dupont as quoted in Takeover by Moira Johnston

“But these new Wall Street warriors [corporate raiders] have touched a lost chord in America. Individualists in the traditional American mold, they are demonstrating that the code of gray caution lived by post-World War II corporate man falls pitifully short of a full-blown experience of life” Moira Johnston, Takeover

This is an historical story. The topic is entrepreneurially driven hostile takeovers and the historical period, one of the most exciting and high energy periods in the U.S., is the late 1970’s through the 1980’s. More specifically, this is the story of two hostile takeovers by Sir James Goldsmith, the Anglo-French entrepreneur and financier. The first was completed and highly successful. The second had a fundamentally sound investment thesis but was not completed. More importantly, it is the tale of how capitalism is significantly distorted and the implications of this distortion.

Takeover #1: Diamond International Inc.

In the early 1970’s, Diamond International Inc. (formerly Diamond Match Co.) began a program of diversification ostensibly in an attempt to break its dependency on consumer spending cycles. The company began its life in the 19th century and introduced the safety match to America in 1882. However, the Diamond of the latter part of the 70’s held little resemblance to its origins. The board and CEO of Diamond believed that the diversification program was sound and did little to question its efficacy. What they saw was a company, which as a member of the Fortune 500, was well established and solid. This was the extent of their view even though profits had stalled and the share price had been stagnant for a significant period of time.

In 1979, Jimmy Goldsmith, the Anglo-French corporate raider began to build a position in Diamond International. Goldsmith’s view of the company was quite different from that of Diamond’s board and management. What Goldsmith saw was a company that was horribly managed and that was comprised of a hodge-podge of materially undervalued and underperforming assets. And hidden in the midst of this conglomeration was an asset that had been on the books since the late 19th century and was carried on the Diamond balance sheet at its original value of $27 million: 1.6 million acres of timberland.

After fighting a series of battles, Goldsmith was finally able to acquire Diamond, paying a premium to Diamond’s shareholders. Once fully in his possession at the end of 1982, he started taking the steps that would realize the full value of the Diamond assets. By the end of 1983 he had sold off the various operating companies with the 1.6 million acres of timberland the only asset of Diamond remaining in his possession. After completely retiring the substantial debt incurred to acquire all of the shares of Diamond, he had made a profit in excess of $500 Million.

Fortune magazine said that the Diamond transaction was one of the financial events of the 1980’s. It was also one of the most profitable during that decade of many successful deals. Even a bit of celebrity status accrued to him outside of the business community. On one occasion, he flew into Kennedy Airport after spending Christmas in London. A customs official inquired as to whether or not he was the man who had made $500 Million on the Diamond deal. When Goldsmith acknowledged that he was, the customs official insisted on shaking his hand stating that anyone who could do this must be something. A crowd of additional customs officials also lined up to shake hands.

And, not only was there a degree of celebrity status but Goldsmith’s eloquence and clarity in remarks during Senate Finance Committee hearings on takeovers won him considerable admiration and support, especially from the Republican senators.

Later, Goldsmith would be vilified as an “asset stripper.” Yet, nothing could have been further from the truth. It is clear from the following results of the operations that were sold that the assets were not “stripped” but instead were liberated from the yoke of a poorly managed, bureaucratic conglomerate structure:

· The Packaging operation was sold to one of Ireland’s leading entrepreneurs, Michael Smurfit, and it went on thrive under his ownership

· The Playing Cards company was sold to its management. It soon moved from a loss making operation to one that was profitable

· The Wesray investment group acquired the Can company. Sales were increased 40% and profits 50% in short order under Wesray’s ownership.

· The Egg Carton maker was sold to its management who eliminated 3 layers of bureaucracy and turned the company from a money loser into a profitable operation within one year.

· The Pulp and Paper business was sold to one of the best managed companies in the U.S. at the time, James River Corp.

The shareholders of Diamond received a premium for their shares. Jimmy Goldsmith, after retiring all debt made over $500 Million. And all of the operations that were sold quickly improved in performance and thus, value, now that they were liberated from the stifling bureaucracy of Diamond. Increased value and performance accrue on three different levels. This really begs the question as to why Diamond’s board and management did not see the hidden values that Sir James Goldsmith saw. More fundamentally and directly related to the underlying theme of this article is why would someone who was a catalyst of such positive results be made out to be the villain? Why does the capitalist, in a country with a capitalist system, receive so much scorn?

Goldsmith was driven by his long held theme that companies are not sacrosanct institutions but are instead owned by their shareholders. He believed that far too many managements had come to believe that some kind of proprietorial rights had accrued to them and thus viewed shareholders as nuisances. In the early stages of the hostile takeover boom Goldsmith and other raiders received a reasonably sympathetic reception. Yet, the drums of resistance, fueled by fear, on the part of entrenched boards and managements were slowly beginning to be heard beating in the background.

Takeover #2: The Goodyear Tire & Rubber Company

Like Diamond, The Goodyear Tire & Rubber Company had been in business for a long period of time. It was founded August 29, 1898 with the sole purpose of manufacturing and distributing tires. Also like Diamond, rather than retain its focus on this core business, it had diversified into oil and gas, dirigibles, consumer products, real estate and advertising ventures. Goodyear was a great example of a company that was extremely good at its core business but had no clue about the businesses into which it diversified.

In an additional and blatant example of how the company had lost its way, Goodyear had become the poster child for “corporatism.” The company had become very powerful in its home state of Ohio and in the U.S. Congress. Along with other Akron, OH based tire companies, Goodyear was successful in lobbying Congress to block Michelin (France) steel-belted radials from the U.S. market. Why bother to be good enough to compete when it is possible to get the government to throw up a moat around you?

Though the diversification had taken Goodyear to $10 Billion in sales, from 1982 to 1986, its shares dropped in value by 20% while the broader stock market rose 230% during this same period.

With the diversification, the corporatism and the poorly performing share price coupled with the complacent board and management that was accountable for these poor practices and results, Goodyear was a solid target for a takeover: Replace the CEO, sell off the diversifications and reinvest heavily in the core tire business. That is exactly what Jimmy Goldsmith saw and intended to do.

Goldsmith and his partners began to accumulate Goodyear stock on September 25, 1986. By October 25 it had been established and published that Goldsmith was a purchaser. This led first to a meeting between Goldsmith and Goodyear senior executives and then to a lunch meeting with Robert Mercer, Goodyear’s chairman, at Goldsmith’s New York home.

On November 5, 1986, Goldsmith now having acquired 11.5% of Goodyear’s shares, called Mercer. He told him he was going to launch a tender offer at $49 per share for the remaining Goodyear shares. Mercer asked him to hold off on announcing the tender offer until he could meet that same day with Goodyear’s board of directors.

After the board meeting Mercer met with Goldsmith and presented a plan, approved by the board, that was believed to be worth $50 per share. This plan included the sale of the oil and gas interests, aviation operations and a buyback of a portion of Goodyear shares. As this was in essence what Goldsmith intended to do if he got control, he basically liked what he heard and agreed to a request from Mercer to sign a two week standstill agreement. This turned out to be a disastrous mistake.

Immediately after the execution of the standstill agreement, Mercer and Goodyear went into frenzied action. They mounted one of the most extraordinary public relations campaigns in the history of U.S. business. While a similar campaign had been launched by Phillips Petroleum against T. Boone Pickens, it paled in comparison to the Goodyear avalanche:

> Goldsmith was portrayed as the man who was not only going to destroy Goodyear but also the state of Ohio.

> The previously bland Ohio press clamored to proclaim that Goldsmith would destroy the small town blue collar way of life. Corporate America’s leaders succeeded more broadly in coopting the broader media to support their “cause” during this period. Companies were portrayed as sacrosanct institutions rather than businesses that must compete aggressively in order to survive, much less thrive. And in so doing, in something akin to what would be seen from a populist politician, the public was whipped into a frenzy against the corporate raiders.

> Anti-Goldsmith bumper stickers appeared and his name was involved as evil incarnate at football rallies.

> Ohio school children chanted anti-Goldsmith songs and sent hate mail to Goldsmith

> Mercer went on a rant that Goldsmith and others like him were destroying the competitiveness of Corporate America (note Goodyear’s performance and need to seek federal protection from Michelin under Mercer — this truly begs the question as to who was stifling U.S. competitiveness. Mercer was not the only underperforming CEO to play the competitiveness card).

> Ohio legislature moved to enact anti-takeover legislation.

> Goodyear’s unions, which had a tradition of poor relations with management, now rushed to support the management against Goldsmith.

> Due to Goodyear’s clout in Washington, a hearing was called in front of a Congressional panel on Goldsmith’s battle with Goodyear. The two Ohio senators made the unusual move of visiting the House to participate in this hearing. The senators told the panel that this was the greatest shock to Ohio since Pearl Harbor.

> Busloads of Ohioans, including union members, school children and retired persons descended on Washington to demonstrate and protest before Congress.

Goldsmith’s analysis of Goodyear was accurate and his thesis sound. In the Congressional hearing, he tried mightily to provide reasoned arguments for the state of Goodyear as a result of complacent and bureaucratic management. In addition, he clearly articulated his plans for the company and the positive impacts that would result. This was all to no avail as no one was listening. Caught up in a populist-like fervor, the house members and senators cared nothing for what he said.

The hostile reception at this hearing was the antithesis of what Goldsmith had experienced in the aforementioned Senate Finance Committee hearing. In what should be capitalist America, the tide had turned materially. Corporatism, the unholy alliance among big business, big government and big unions was alive again and was fueled by big (and small) media. Entrenched boards and management, many unable to compete thus seeking government protection, were able to convince state and federal governments that American business was under attack and at risk. They were also able to convince the media who in turn dumped a large load of nonsense on the all too gullible public. In short, many facets of society were outraged by events that should have been standard for businesses within a capitalist system.

Consider the following:

> Corporate America had become complacent. Boards of directors were weak as they functioned with a governance model similar to the “stakeholder” model currently being advocated. They were beholden to imperial CEOs who acted as if they owned the company rather than the shareholders. And, there was a significant focus on the part of big company CEOs on social rather than commercial issues.

> In the 1970’s a material threat from international competition, especially from Japan and Germany, surfaced and was picking up steam in the 1980’s. Complacent companies in the U.S. were not prepared to deal with this new level of competition. While Corporate America’s CEOs were spending much of their time pontificating about social issues and acting as “statesmen” Japan and Germany were relentlessly focused on building better and less expensive products.

> Adding fuel to the fire was the fact that due to inflation, the assets of many companies were worth far more than the stock price reflected. Incumbent boards and managements were doing nothing to close this valuation gap.

> Capitalism and complacency do not mix.

> Well managed and governed, high performance companies are never targets of “hostile” takeovers. It is only those that reflect a material gap between their potential and their current performance/value.

> To whom are “hostile” takeovers hostile? Not to shareholders. It is the entrenched and underperforming managements and boards to whom these takeovers are hostile. Like tinpot dictators, many during this historical period were so desperate to remain in power that they went to any length to obscure the real situation (see Goodyear’s actions above).

> Capitalism thrives on competition. When an upstart company with a better product or service begins to complete with established larger companies no one thinks twice about this. And, this is the case even though the new entrant(s) may have a negative impact on various aspects of the established player(s) including putting them out of business. So, why is the competition from a takeover entrepreneur any different? The takeover entrepreneur takes action because he or she sees potential in the target company that the current board and management either do not see or are unwilling to develop. At its core, this is no different from any other kind of business competition.

In the early days of the wave of hostile takeovers, there was considerable positive sentiment for the so called corporate raiders. Many saw them as the embodiment of the rugged individualism and frontier spirit that underpinned the building of the United States. But over time this changed as the actions taken by the heretofore entrenched imperial CEOs and their lapdog boards put forth a distorted message about the raiders that was eventually bought by unions, state and federal governments, the media and ultimately the public. Goodyear can’t compete against Michelin's tires — no problem — get the federal government to ban their use in the U.S. No underperforming company is safe from the corporate raiders — no problem — spew propaganda to the government, unions, media and the public in order to shut down the raiders.

By and large, history consigns the corporate raiders to the dust bin of greedy thugs and CEOs/boards/companies during this period as their victims. But, is this characterization correct? Analyzed through the lens of capitalism it is not. The raiders were the capitalists in this story and as such, functioned like other entrepreneurs who see and act on opportunities. The CEOs/boards were not functioning like capitalists — if they had been, then the complacency and stagnation would never have materialized. Instead, and especially after having to deal with the raiders, CEOs and boards took the path of corporatism: Running to the government (and others) for protection against the takeover entrepreneurs is no different than the Akron tire manufacturers, including Goodyear, doing so for protection against the superior tires produced by Michelin.

What is most interesting about this activity during 1980’s is the extensive disconnect between the positive impact/results of the capitalists’ (raiders) activity (Shapiro quote) and how this was perceived in the mainstream. The media picked up on and bought into the calls of doom from the frightened CEOs, their sycophant lawyers and politicians. This doom was then repeatedly communicated to the public who also accepted the conventional “wisdom” as to the threat of hostile takeovers, especially those pursued by individual entrepreneurs. The end result: A force, albeit disruptive, for economic good was demonized and the understanding of the dynamics of capitalism was swept further away from the public’s grasp.

Fortunately, for the United States, before the activity of the raiders could be totally shut down, enough of a wakeup call was received by many of the leaders in Corporate America as described in the Irving Shapiro quote at the beginning of this article. Absent this wakeup call the economic landscape of the U.S. would likely look very different today. Had the leaders of Corporate America been acting as capitalists, neither the raiders nor the wakeup call would have been necessary.