Company: Southwest Gas Holdings (SWX)
Companies: Southwest Gas Holdings buys, distributes, and transports natural gas in Arizona, Nevada, and California. The company operates in two segments, Natural Gas Operations and Utility Infrastructure Services. As of December 31, 2020, it had 2,123,000 private, commercial, industrial and other natural gas customers. The company also provides trenching and installation, replacement and maintenance services for power distribution systems and industrial construction solutions.
Market value: $ 4.0 billion ($ 69.18 per share)
Activist: Carl Icahn
Percentage ownership: 4.91%
Average cost: $ 70.89
Comment from the activists: Carl Icahn is the grandfather of shareholder activism and a true pioneer of strategy. He is very committed to shareholder rights and good corporate governance and will do everything to combat incompetent board members and overpaid managers. In this situation he is doing something again that has never been done in activism – the hostile takeover of a utility company. In activism, being able to offer to acquire the company is a very powerful weapon if your suggestions for creating shareholder value are not heeded, and Carl Icahn is one of the few activists with this tool.
On October 14, 2021, Icahn announced his intention to start a voting competition to replace the entire board of directors of Southwest Gas Holdings (SWX) and to launch a tender offer for all common shares at $ 75 per share in cash.
Icahn’s first advances came in response to the company’s announcement that the company would acquire Questar Pipeline Company. Icahn has spoken out against this deal for a number of reasons, including believing the company is massively overpaying and this transaction would dramatically dilute equity for shareholders. Icahn argues that the company would have to issue stocks at 1x the base rate to buy assets at 2x the base rate and that there is admittedly minimal, if any, synergy here.
Icahn wants the company to ditch this deal right away and focus on multiple value-adding opportunities. Icahn believes the company’s services division is worth $ 36 per share and the regulated utility business in its current form is worth $ 53 per share, but the company’s stock trades at $ 67.55. Therefore, he wants the real value of these assets to be reflected in the share price. He’s not outwardly asking management to monetize the service business to achieve its true worth, but it’s something management has considered and based on Icahn’s history and investment philosophy, he wouldn’t be against it at the right price.
The second option for the company is to improve its margins in the regulated utilities business, which can add $ 15 per share, according to Icahn. When a utility like SWX takes on a new project, the regulators analyze the company’s proposed costs for the project and grant them an ROE based on those costs. The SWX’s permissible ROE is 9.35%, but the actual ROE is only 7.1% compared to an average of 9.2% for its competitors. This is because SWX management is replenishing the proposed cost of its utility projects with prodigious personal expenses like golf memberships, massages, manicures, and extravagant dinners, according to the Las Vegas Review journal. More than once, these were not accepted as legitimate project expenses by regulators, reducing the company’s ROE to 7.1%. Fixing this margin problem can be done with good old-fashioned activism that Icahn knows better than anyone – reforming the board and replacing the management team with individuals whom the new board will hold to account. It’s no coincidence that the company’s P&A has increased 42% since 2015 when John Hester became CEO.
The third way to add value is to increase the tariff base by adding certain projects of the company that regulators have not approved. This can be done by bringing in a management team who would fix relationships with regulators, which Icahn said could add an additional $ 8 per share to the company’s value.
To fulfill his agenda, Icahn announced his intention to start a proxy battle to replace the entire board of directors and launch a tender offer for all common shares at $ 75 per share in cash. This is old school, creative activism that nobody can do better than Icahn. His strategy gets management in trouble. As part of their acquisition funding from Questar, they are proposing to raise $ 1 billion by selling common stock at approximately $ 65 per share, the current market price. It may no longer be consistent with their fiduciary duty to sell stocks at $ 65 a share knowing that there is someone out there to pay $ 75 a share for it. They won’t sell it to Icahn, however, as it would give him too much leverage and make it a lot easier for him to win his proxy battle. Your introduction of a poison pill (or as Icahn calls it – “The Plan to Protect Board and Management Jobs”) in response to Icahn’s letters clearly tells you that. Additionally, the board of directors will eventually have to recommend for or against Icahn’s takeover bid, and they have a hard time saying that $ 75 isn’t a fair price when the company is a seller at $ 65.
So how is that going to play out? Icahn will continue his takeover bid and proxy battle, but will not be able to execute the takeover bid as it depends on the company forgoing the poison pill, which they will never do. This leaves Icahn with his proxy fight. He will estimate his chances of success very well, depending on how many shareholders offer him shares. In defense of Icahn, the board relies on two things: (i) Icahn’s plan will not receive the required approval from state regulators in California, Arizona, and Nevada, and (ii) by the time regulators act, Icahn will be gone. In the first case, there is a very small chance that Icahn’s slate will not be approved. First, these are the same regulators that have been dealing with the company’s spending cushion all along and would likely welcome a new board of directors to be more understanding of the tariffs its customers pay. Second, Icahn has owned multiple casinos in the past and has had no problem navigating their way through the more stringent gambling regulatory process. And third, Icahn will do whatever it takes to win and we expect a very experienced and impressive roster of Directors that will include a maximum of two or three Icahn representatives as well as seasoned executives with the appropriate management skills. In the second case, Icahn has shown in his story that he is the most persistent and dedicated activist in the world. After an unsuccessful proxy fight at Forest Labs, he fought two more proxy fights over the next two years before reaching the desired representation on the board and ending up with a return of 188.8% on that investment, compared to a return of 55 .2% for the S & P500 over the same period. There’s no chance he’ll leave here. In other words, the company has two chances of avoiding a proxy battle here – lean and none. However, it is possible that the proxy fight will not take place until the next annual meeting because the official approvals have not yet been received. If so, Icahn will ask shareholders at the annual meeting to approve a proposal to call a special meeting of shareholders after the regulators have voted on the election of Icahn’s directors.
There is another possible outcome here. When an activist gets involved with a company, it often puts the company into a pseudo-game. If this activist makes a takeover bid for the company, the company will be in full swing. So there is a chance that someone else could come in and make a higher offer to buy the entire company. It is very likely that the company has been approached multiple times in the past, perhaps by a better-run utility, but they never let anyone through, which is not uncommon for established directors – seven of the nine “independent” directors have an average of 13 years on the board (14 years) and the chairman has served as director for nearly 20 years. The possibility of a sale by a third party increases as Icahn is offered more shares and the board sees the writing on the wall. If they think they are going to get unemployed one way or another, they might as well sell to the highest bidder.
Ken Squire is the founder and president of 13D Monitor, an institutional shareholder activism research service, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments.