Here’s Why This Investment Fund Had to Refund $194 Million
On Monday, the mutual fund company compensated shareholders for the fact that Michael Dell, and his private equity backers, didn’t pay a fair price when they bought the computer maker in a leveraged buyout back in 2013. How T. Rowe Price (TROW) came to owe shareholders for the fact that Dell underpaid is a complicated story. (And you can read more about it here.)
Basically, T. Rowe had a bunch of Dell shares in a number of its funds. When the Dell deal was announced three years ago, T. Rowe Price came out against the deal, and said it undervalued the shares. Despite their public denouncements, T. Rowe, because of a glitch, ended up voting its shares—or, rather, its client’s shares—for the deal. Nonetheless, after the deal went through, T. Rowe sued, joining some other hedge funds, saying the deal was underpriced.
And that suit won. Last week, a judge in Delaware said the Dell buyout undervalued the company by $6 billion. But, by law, Dell only has to compensate those shareholders who voted against the deal, which means T. Rowe’s clients get nothing.
In order to look less silly to its clients, and perhaps to avoid being sued, T. Rowe has decided to cut a check to its clients for the money that they would have gotten from the suit: $194 million. Ironically, because most shareholders voted for the deal, Dell is only paying $35 million to dissidents. So T. Rowe is paying more then five times as much as Dell to compensate for the fact that Dell shareholders were shortchanged in a deal T. Rowe said was a rip-off from the beginning. Lesson learned.
As a result, on Monday, T. Rowe put $194 million of its own money into a number of mutual funds that were affected, as well as into the accounts of clients who owned Dell shares directly. The biggest beneficiaries will be investors who had money in T. Rowe’s Science & Technology Fund. For every $1,000 they have invested they will get $12, or a 1.2% increase.
Investors in the Equity Income Fund, which had the most shares of Dell of any T. Rowe fund, but is also a larger fund, will see a bump of $4.50 per $1,000 invested, or 0.45%. Appraisal arbitrage, at least as part of a larger investment fund, isn’t all that profitable, especially when you get it wrong.
Here are three other takeaways:
1. Matt Levine of Bloomberg thinks T. Rowe’s Dell flub is not as bad as it looks. Consider all the mutual funds that actually thought the Dell deal was a good one. T. Rowe’s analysts and fund managers didn’t flub as much as those guys. They got the analysis right and knew the deal was unfair, but messed it up because of technical reasons. But here’s the thing: If T. Rowe’s fund managers actually believed the deal was too cheap, they should have done what Magnetar did and buy up more Dell shares. Given their knowledge, they missed an arbitrage opportunity.
2. Andrew Ross Sorkin says that this will have a chilling affect on private equity deals. But I’m not sure I buy that. Look how much Dell is paying out: only $35 million. This may slightly increase the price of deals, meaning it will lower what people are willing to pay for acquisitions. But it won’t be by much, unless everyone starts voting against deals, and then deals won’t get done and the companies don’t have to pay anything.
The other possibility is that private equity firms may have to accept a lower rate of return, which isn’t a bad outcome. As Fortune reported, a big portion of the difference between what the judge thought Dell was worth and the deal Michael Dell and his private equity partners struck was due to the fact that the buyout factored in a 20% rate of return for private equity investments. If the courts force private equity firms to accept lower rates of return, more of that return will go to investors in public stocks, rather than to investors in private deals. That’s a great outcome for everyone, except of course for private equity firms.
3. Even in the age of activist investors, the whole mutual fund complex is basically set up to vote with management, or at least to vote on autopilot. Like many other mutual fund companies, T. Rowe outsources the voting of its shares. It’s not clear exactly why this is. Yes, T. Rowe manages billions of dollars of investment by tens of thousands of people into thousands of companies. But the company has most of its money in hundreds of companies, and it has dozens—if not hundreds—of analysts and portfolio managers who cover these companies. When there is an important vote, you would think they would have someone on it.
Nonetheless, T. Rowe does not do its own share voting. It outsources that function, along with a few others, to a firm named Broadgate, which then outsources the specific voting function to the proxy advisory firm Institutional Shareholder Services. And in most cases, T. Rowe doesn’t even tell ISS how to vote its tens of thousands of client shares. It’s on autopilot. Whatever ISS decides, that’s how T. Rowe votes—as presumably do most of ISS’ clients. This why some say the proxy voting firms have too much power.
For T. Rowe to not vote its shares as ISS decides, it has to go through a complicated process. It has to tell ISS not to vote the way it plans to vote, and ISS has to correctly relay T. Rowe’s voting instructions to Broadgate, which then submits that vote at the shareholder meeting of the company in question.
And T. Rowe apparently has to do this every time a vote comes up. T. Rowe told ISS to vote its shares against the merger the first time. But the Dell vote was delayed and rescheduled several times. T. Rowe apparently checked that ISS still had the correct information for a number of these rescheduled meetings—except for the last one, when T. Rowe’s instructions were dropped. At that meeting, ISS went with its default, which was to vote for the deal. T. Rowe declined to comment on whether it was considering suing ISS or Broadgate.
The lesson for management here is not to be all that worried about mutual funds supporting you. Even when they don’t support you, they may still vote their shares for you. It’s part of the system.