Dual Share Class Blundering
We used to send letters to companies and stock exchanges extolling the virtues of single share classes, tag along-rights and ‘one share, one vote’. Today, we actively seek out companies with dual share classes. What has changed?Download PDF version
"At present, more than 70% of votes are controlled by the Novo Nordisk Foundation. This gives management the ability to deflect two negative influences on proper business planning: M&A pressures driven by activist shareholders, whose only motive is scoring a run-up in the stock price; and financial reporting biased toward short-term quarterly results at the expense of long-term performance. Novo Nordisk has never been for sale, even though over the years some prominent competitors have tried to buy us. We are one of the few multinational companies operating on a 10-year planning cycle.”
- Jesper Hoiland, Novo Nordisk
Firstly, the collapse of time horizons has increased the damage that short-term markets can inflict on listed businesses. Companies lacking a long-term, protective shareholder are much more likely to succumb to the increased short-term pressures of markets. This pressure manifests itself in many ways. Currently the most obvious example is the metamorphosis of many traditional utility companies into financial engineering spreadsheets, designed to maximise ultra-short-term profitability, regardless of what damage that does to the future value of the business. When we meet with utility company management teams today, they are much more keen to discuss the dark arts that are tax shields, ‘nols’, reverse Morris trusts and Geoffrey the Giraffe’s loophole, than water leakage rates, customer complaints or capex plans.
More broadly, short-term pressures have been responsible for the proliferation of value- destroying share buyback schemes, short-term bonuses that can be met simply through reckless balance sheet gearing and highly questionable accounting practices designed to bring forward profits.
Secondly, our appreciation of the value of long-term stewardship has increased as we have placed greater emphasis over time on the investment importance of long-term sustainability positioning.
It can take decades, rather than years or months, to manoeuvre listed companies towards more sustainable business models. The larger the company, and the older the company, the longer this can take. Only those companies with long-term stewards at the helm are able to take such long-term decisions.
Of course, dual share classes and control structures come with significant risks for minority shareholders and many of them exist for the wrong reasons. Find the right combination of structure and steward and those risks are worth the benefits. Find the wrong combination and those risks can be extremely painful.
As usual we have no clear answers. We suspect the best long-term solution may be the separation of capital markets, into a long-term, slow, long-only equity market and a high- turnover casino for short-term speculators. The former would match long-term investors’ needs with companies keen to seek them out. The latter would match companies that want no-strings-attached funding with speculators after a quick bet and no commitments. The marriage versus the one-night stand!
We have no idea, however, how such a system could be designed in theory or introduced in practice. We are hoping to launch a stock exchange competition some time in 2015 to invite smarter people than us to apply their brains to the problem.
Until financial markets find a way of separating investment from speculation, we remain attracted by the idea of dual-listed share classes, and have invested clients’ money in a number of such structures. We are still learning the hard way that some dual structures come with greater risks than others. For example, we were recently left helpless bystanders as the controlling shareholders of the Swiss materials company Sika sold their unlisted control shares at an 80% premium, without triggering usual takeover rules.
As the saying goes, ‘by seeking and blundering, we learn’. We have been blundering as a team for over 25 years now! We have a small but growing checklist when it comes to odd share structures. Most obviously, the integrity of the steward must be beyond question. There are plenty of controlling shareholders who have repeatedly demonstrated their willingness to cut environmental, social or governance corners. It is relatively easy to spot them, thanks to our friends at RepRisk, Business and Human Rights, Wikipedia and the Worldwideweb! In the case of family stewards, assessment needs to be made generation by generation. It is neither fair nor sensible to judge the children by their parents’ actions, and there are good examples of generational change leading to a dramatic improvement in the integrity of the controlling shareholder.
Secondly, we have a strong preference for a simple system with both classes of shares listed, thereby giving investors the choice between votes and liquidity. Ironically, it is often the case that the more liquid non-voting share class will trade at a premium to the voting class. In other words, the market sadly prizes liquidity over voting rights. For us it is generally the other way around.
We currently invest clients’ money in a number of dual share companies where we are able to purchase the voting/control line of shares. In each case, the presence of a long-term steward is a key part of our investment case.
Third, beware of cross shareholdings and pyramid structures. They create too much scope for misalignment. This is the major drawback of many Asian control structures. It is often very difficult to work out where the strategic shareholders’ interests really lie. Even when it can be identified, it is usually very hard to be fully aligned as a minority shareholder. There is much angst currently in Hong Kong on this topic after Alibaba was forced to list in the US as a result of the HKSE’s strict adherence to ‘one share, one vote’. In our view, a simple, transparent dual share structure where both lines of stock are listed would be much preferable to an impenetrable tangle of cross-holdings or an aggressive pyramid control structure.
In addition to these three simple guidelines, there are additional nuances we are still learning about, particularly around voting caps and takeover waivers. For example, we invest clients’ funds in a wonderful Swiss engineering company formed from a management buy-out several years ago. Their reciprocating compressors can take over 10 years to design. Most of them are in operation for 30-50 years, while their longest customer relationship dates back to 1883! This is a business that greatly benefits from the presence of a long-term steward. Having seen at first hand the damage the wrong shareholder can cause, management inserted a clause at IPO stating that “the voting rights per shareholder is restricted to 5% of the total number of the registered shares recorded in the commercial register. This does not apply to shareholders who were in possession of more than 5% of the shares before the initial public offering.”
We are yet to discover if the holding group can transfer this privilege to another owner, thereby selling the company under our nose at a huge premium to a new owner in whom we may not have so much belief. This is exactly what happened in the case of Sika. Similarly we still don’t fully understand whether the Novo Foundation could in extremis sell their control shares in Novo Nordisk. More blundering is required!
A simple headcount suggests that at least 85% of each of our Sustainability strategies is invested in companies with a strategic shareholder. We tend to avoid open registers. We are entrusting our clients’ money to long-term stewards. The challenge for us is to make sure they are the right stewards with the right structures in place. Simple control structures with listed dual share classes seem like a sensible option for listed companies in today’s ‘Financeland’.
Perhaps in another fifteen years’ time, our views will have shifted again. Hopefully this will be because there is no longer any need to protect companies from market short-termism.
View our list of investment terms to help you understand the terminology within this document.
Subscribe to our updates
To get regular updates and content from Stewart Investors, please register here.
This material is for general information purposes only. It does not constitute investment or financial advice and does not take into account any specific investment objectives, financial situation or needs. This is not an offer to provide asset management services, is not a recommendation or an offer or solicitation to buy, hold or sell any security or to execute any agreement for portfolio management or investment advisory services and this material has not been prepared in connection with any such offer. Before making any investment decision you should conduct your own due diligence and consider your individual investment needs, objectives and financial situation and read the relevant offering documents for details including the risk factors disclosure.
Any person who acts upon, or changes their investment position in reliance on, the information contained in these materials does so entirely at their own risk.
We have taken reasonable care to ensure that this material is accurate, current, and complete and fit for its intended purpose and audience as at the date of publication. To the extent this material contains any measurements or data related to environmental, social and governance (ESG) factors, these measurements or data are estimates based on information sourced by the relevant investment team from third parties including portfolio companies and such information may ultimately prove to be inaccurate. No assurance is given or liability accepted regarding the accuracy, validity or completeness of this material.
To the extent this material contains any expression of opinion or forward-looking statements, such opinions and statements are based on assumptions, matters and sources believed to be true and reliable at the time of publication only. This material reflects the views of the individual writers only. Those views may change, may not prove to be valid and may not reflect the views of everyone at First Sentier Investors.
To the extent this material contains any ESG related commitments or targets, such commitments or targets are current as at the date of publication and have been formulated by the relevant investment team in accordance with either internally developed proprietary frameworks or are otherwise based on the Institutional Investors Group on Climate Change (IIGCC) Paris Aligned Investment Initiative framework. The commitments and targets are based on information and representations made to the relevant investment teams by portfolio companies (which may ultimately prove not be accurate), together with assumptions made by the relevant investment team in relation to future matters such as government policy implementation in ESG and other climate-related areas, enhanced future technology and the actions of portfolio companies (all of which are subject to change over time). As such, achievement of these commitments and targets depend on the ongoing accuracy of such information and representations as well as the realisation of such future matters. Any commitments and targets set out in this material are continuously reviewed by the relevant investment teams and subject to change without notice.
Past performance is not indicative of future performance. All investment involves risks and the value of investments and the income from them may go down as well as up and you may not get back your original investment. Actual outcomes or results may differ materially from those discussed. Readers must not place undue reliance on forward-looking statements as there is no certainty that conditions current at the time of publication will continue.
References to specific securities (if any) are included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. Any securities referenced may or may not form part of the holdings of First Sentier Investors' portfolios at a certain point in time, and the holdings may change over time.
References to comparative benchmarks or indices (if any) are for illustrative and comparison purposes only, may not be available for direct investment, are unmanaged, assume reinvestment of income, and have limitations when used for comparison or other purposes because they may have volatility, credit, or other material characteristics (such as number and types of securities) that are different from the funds managed by First Sentier Investors.
Not all First Sentier Investors products are available in all jurisdictions.
This material is neither directed at nor intended to be accessed by persons resident in, or citizens of any country, or types or categories of individual where to allow such access would be unlawful or where it would require any registration, filing, application for any licence or approval or other steps to be taken by First Sentier Investors in order to comply with local laws or regulatory requirements in such country.
This material is intended for ‘professional clients’ (as defined by the UK Financial Conduct Authority, or under MiFID II), ‘wholesale clients’ (as defined under the Corporations Act 2001 (Cth) or Financial Markets Conduct Act 2013 (New Zealand) and ‘professional’ and ‘institutional’ investors as may be defined in the jurisdiction in which the material is received, including Hong Kong, Singapore, Japan, and the United States, and should not be relied upon by or be passed to other persons.
The First Sentier Investors funds referenced in these materials are not registered for sale in the United States and this document is not an offer for sale of funds to US persons (as such term is used in Regulation Spromulgated under the 1933 Act). Fund-specific information has been provided to illustrate First Sentier Investors’ expertise in the strategy. Differences between fund-specific constraints or fees and those of a similarly managed mandate would affect performance results.
About First Sentier Investors
References to ‘we’, ‘us’ or ‘our’ are references to First Sentier Investors, a global asset management business which is ultimately owned by Mitsubishi UFJ Financial Group (MUFG). Certain of our investment teams operate under the trading names FSSA Investment Managers, Stewart Investors and Realindex Investments, all of which are part of the First Sentier Investors group.
This material may not be copied or reproduced in whole or in part, and in any form or by any means circulated without the prior written consent of First Sentier Investors.
We communicate and conduct business through different legal entities in different locations. This material is communicated in:
- Australia and New Zealand by First Sentier Investors (Australia) IM Ltd, authorised and regulated in Australia by the Australian Securities and Investments Commission (AFSL 289017; ABN 89 114 194311)
- European Economic Area by First Sentier Investors (Ireland) Limited, authorised and regulated in
- Ireland by the Central Bank of Ireland (CBI reg no. C182306; reg office 70 Sir John Rogerson’s Quay, Dublin 2, Ireland; reg company no. 629188)
- Hong Kong by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. First Sentier Investors, FSSA Investment Managers and Stewart Investors are the business names of First Sentier Investors (Hong Kong) Limited.
- Singapore by First Sentier Investors (Singapore) (reg company no. 196900420D) and this advertisement or material has not been reviewed by the Monetary Authority of Singapore. First Sentier Investors (registration number 53236800B), FSSA Investment Managers (registration number 53314080C) and Stewart Investors (registration number 53310114W) are the business divisions of First Sentier Investors (Singapore).
- United Kingdom by First Sentier Investors (UK) Funds Limited, authorised and regulated by the Financial Conduct Authority (reg. no. 2294743; reg office Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB)
- United States by First Sentier Investors (US) LLC, authorised and regulated by the Securities Exchange Commission (RIA 801-93167).
- other jurisdictions, where this document may lawfully be issued, by First Sentier Investors International IM Limited, authorised and regulated in the UK by the Financial Conduct Authority (FCA ref no. 122512; Registered office: 23 St. Andrew Square, Edinburgh, EH2 1BB; Company no. SC079063).
To the extent permitted by law, MUFG and its subsidiaries are not liable for any loss or damage as a result of reliance on any statement or information contained in this document. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment products referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.
© First Sentier Investors Group