Concentration committee goes for the gap

Panel invented special corporate governance regime for top businesspeople

Business Mediation Center 311 (photo credit: MELANIE LIDMAN)
Business Mediation Center 311
(photo credit: MELANIE LIDMAN)
Israeli businessmen, such as Shaul Elovitch, Chaim Katzman, Gershon Salkind, Nathan Hetz, Eli Barkat, and Zadik Bino may wake up one morning to discover that they, too, are part of the problem of over-concentration in the economy, and that the Committee for the Promotion of Competition in the Economy (aka the Concentration Committee) is aggressively targeting them.
When the committee was set up in October 2010, it was clear tycoons such as Nochi Dankner and Yitzhak Tshuva would take the brunt. They control huge conglomerates whose subsidiaries operate in many sectors of the economy, including sectors with little competition. It was therefore clear they were waiting tensely to see how the Concentration Committee’s recommendations would affect their business.
The committee came through, recommending that Dankner’s IDB Holding Corp. sell Clal Insurance Enterprises Holdings Ltd., and that Tshuva’s Delek Group sell The Phoenix Holdings. It even recommends that Bino will have to choose between Paz Oil Company and First International Bank of Israel.
But alongside these predicted recommendations is an entire chapter that will have a massive effect on at least a third of the companies on the Tel Aviv 100 Index. Some of these companies are subsidiaries of IDB or Delek Group, but 18 of them do not readily come to mind when concentration in the economy is the subject of conversation. They are the “gap companies,” companies in which, because of the ownership structure, a shareholder with a small stake has a high proportion of the voting rights, giving de facto control. They will have a special corporate governance regime, an Israeli invention.
“Several large conglomerates operate in Israel, and their common denominator is a pyramid structure,” says the report. “Pyramids are common around the world, but the committee was surprised to discover the greater extent of the phenomenon in Israel, in terms of the pyramid’s depth and their size relative to the economy.”
The committee said these pyramids should be dealt with, and set out some rules for doing so, with the goal of reducing the power of their controlling shareholder.
The public companies were taken by surprise.
“I called the CFO of one gap company to talk to him about this, and he didn’t even know that his company would be affected by the recommendations,” a capital market source told Globes.
Sources at the gap companies are infuriated by some of the Concentration Committee’s recommendations.
“Some of the measures are simply hallucinatory. If I hadn’t read them, I would have believed it. It would be better to nationalize the companies rather than apply these rules,” one executive said.
Some of the Concentration Committee’s recommendations for the gap companies could have far-reaching implications for the management of public companies. Below are the three most problematic proposals:
1. Expansion of the matters for which a general shareholders meeting must be convened
The Concentration Committee recommends that the shareholders of gap companies must approve large acquisitions, the acquisition of the controlling core of another public company and the raising of a large amount of capital or debt, including by a subsidiary. The expansion of topics is designed to strengthen the position of the minority shareholders. On the face of it, the recommendation adds red tape, possibly leading to legal complications, which could paralyze business.
“Imagine that I’m in talks on a large acquisition, and I’ve already agreed on all the details, but then I have to tell the seller, ‘Wait, I now must wait 45 days for a general shareholders meeting to approve the deal. I’ll get back to you when I have the votes.
Who will wait such a long time for me? The need for approval by a general shareholders meeting will result in us competing on deals with our hands tied behind our back,” an executive at one company told Globes.
“And what will my competitors do while I’m waiting for shareholders’ approval of the deal? Sit quietly?” Shareholder approval of debt and capital offerings could also push gap companies into a corner.
“A shareholders meeting could reject a debt offering, and instead demand that we sell assets to finance the company’s business. Does the regulator understand these consequences?” continued the executive.
Another contention against the great power given the shareholders is that, ultimately, the vote of minority shareholders is usually decided by the consultants to institutional investors (headed by Entropy Consultants Ltd.), which publish recommendations on how to vote at shareholder meetings.
Institutional investors usually abide by these commendations.
“With all due respect, they are not managing the company, and they cannot fully understand the issues, but in the end, they will have a massive influence on the company’s dayto- day conduct.”
There are some more problems. Do institutional investors know who to run a company better than the CEO and controlling shareholders? What is the investment institutions’ responsibility for the consequences of decisions? What about investment institutions’ conflicts of interest, as some of them are likely to be shareholders in competitors of the company seeking to obtain approval for a major move?
2. Mandatory offer to purchase
The Concentration Committee sets out two instances in which the controlling shareholder must publish an offer to purchase. The first is the sale of the controlling core in a deal that will turn the sold company into a gap company. In such a case, the new controlling shareholder (the buyer) must make the public shareholders an offer to buy their shares at the same price at which he bought the shares of the previous controlling shareholder. This proposal would enable the public to benefit from a company’s added value.
In the second case, in which the controlling shareholder must make an offer to purchase to the public is more problematic. The committee proposes that if the controlling shareholder rejects an offer from a third party to buy his shares, the controlling shareholder must make an offer to the public shareholders to buy their share at the price he rejected.
The controlling shareholder is not always required to submit an offer to buy under these circumstances. The Concentration Committee lists conditions, such as that the company has been traded on the TASE for at lease seven years and the offer is 10 percent above the market price. Nonetheless, there are circumstances in which the controlling shareholder will be compelled to make the offer to purchase, even though it is not clear if that’s the correct thing to do from an economic point of view, of if he has the wherewithal to do it.
For example, had Nochi Dankner rejected the offer by Leo Noe and Yakov Shalom (Shulem) Fisher for the controlling interest in Shufersal, he would have had to publish an offer to purchase the public’s shares in the national supermarket chain at the price he had rejected. Would it be right for the already highly leveraged IDB to buy more Shufersal shares? Wouldn’t this increase IDB’s risk, and harm its bondholders and shareholders, who are, in the end, the investors? Worse, the proposal is open to manipulation, especially in times of crisis.
“There will be institutional investors who will exploit this clause to submit offers at a ridiculous price, since prices on the TASE are already low, in order to take over companies, because the controlling shareholders will prefer, or be compelled, to sell, rather than submit an offer to purchase at the price offered,” a company source told Globes.
3. Changing the vote-counting at general shareholder meetings
To prevent a controlling shareholder who indirectly owns only 20% of a company, but whose weight in the shareholders meeting is 40% (the size of the holding of the parent company through which the controlling shareholder controls the gap company), the Concentration Committee recommends capping the controlling shareholder’s vote to the indirect stake in the company, i.e. 20%. This proposal is legally problematic, since it effectively annuls the votes of the minority shareholders in the parent company.
The Concentration Committee is aware of the problem, which is why it says the proposal is open to comments from the public. Sources doubt the proposal will pass.
The Concentration Committee’s recommendations have not yet been officially submitted. Last week, it announced an extension for the public to respond to the recommendations until November 27. The cabinet will discuss the proposals in December, after which the legislative process will begin, and will likely continue through the summer of 2012.
The companies defined as gap companies have no intention of conceding anything, and some of their controlling shareholders intend to submit their reservations about the recommendations.
“Israel is the only country that intends to enact such rules for gap companies,” a company source said.
“Initially, they wanted Israel to be like the rest of the world, so they applied International Financial Reporting Standards. Now they’re inventing a new business method, using us as the experiment. We won’t accept this, and we’ll go to court to fight it.”