Yahoo’s shareholders and many pundits were happy with Yahoo until Monday when the company announced that it is buying back 40 million of its shares from one of its largest shareholders and current board member, Dan Loeb of hedge fund Third Point LLC at last Friday’s closing price of $29.11. In addition, Loeb announced that he and two of his associates will step down from the company’s board. Since then Henry Blodget of Business Insider absurdly suggested insider trading, while Steven Davidoff of DealBook questioned the timing of the deal and its impact on other shareholders.
I will not address the insider trading charge since it was brilliantly refuted in this Bloomberg piece by Jonathan Weil. However, I will address the other charges, mainly that the timing is suspect given that Loeb got a sweetheart deal by selling at Friday’s closing price and not paying a discount as is ‘supposedly’ customary in all large share sale transactions. The main gripe here is borne out of the fact that the stock dropped by 4% on Monday when the transaction was announced. I do not know Dan Loeb nor do I have any position in Yahoo right now.
What most investors fail to realize is that the stock dropped not because Yahoo was the buyer but because Loeb announced the sale of two thirds of his stake irrespective of who the buyer was. Loeb, as the main catalyst for change at Yahoo, and later as board member and an insider, was followed into the stock by many investors and other hedge funds after he first purchased his stake claiming that the shares were deeply undervalued at the time. So when he announces an exit by dumping a majority of his holdings, rest assured that all the other investors who followed him will take notice and many will do the same as this will be taken as a signal that Yahoo’s shares are at, or near, fair value. Moreover, there is a precedent of this. Earlier this year, on Friday February 1 after the markets closed, Loeb announced that he has sold 11million of his roughly 74 million shares at the time or 15% in the open market. Not surprisingly, Yahoo’s stock dropped by 2% in heavy volume on Monday. So a 4% drop when that same big, and well informed, investor announces that he sold 65% of his shares is not surprising and has nothing to do with who the buyer is. This is what can be called a “signaling discount”. Arguing that Yahoo should have negotiated a discount to the Friday closing price would have only made the drop on Monday even worse as it would signal to the market that the company believed its shares were overvalued at Friday’s close. A 4% drop because of Loeb’s signaling that shares are nearing fair value would have been exacerbated by an acknowledgement from the company that this was not only true but that Friday’s close actually exceeds fair value. A large share sale between two private parties is a lot different than a buyback by the issuer.
Another criticism is that Yahoo’s buyback program was used to buy Dan Loeb’s shares while other shareholders “went to the back of the line”as Robert Cyran from Breakingviews put it. The problem with this reasoning is that it fails to acknowledge that when a company buys back its shares, all shareholders benefit irrespective of whom those shares were bought from since it decreases the supply of shares, or float, and boosts earnings per share. In hindsight and as of now, it looks like Loeb may have indeed made a good trade but that does not mean that other shareholders lost because Yahoo bought his shares. Had he not sold his shares to Yahoo he would have been selling them on the open market at a slower pace and putting downward pressure on the shares (let’s call that a liquidity discount) in the process to the detriment of all other shareholders. Furthermore, as I explained above, this liquidity discount is in addition to the signaling discount that will occur when Loeb publicly announces that he sold his shares. What Yahoo did is remove this liquidity discount from its shares to the benefit of all shareholders including Loeb.
The third most frequent condemnation of Loeb is that there was some dereliction of duty when he announced that he will be stepping down from Yahoo’s board before the company’s turnaround was complete and that he has “issued an enormously damaging vote of no confidence in the company”. This view is utopian to say the least and fails to take into consideration the initial motive for Loeb’s involvement with Yahoo in the first place. Loeb, just like any other hedge fund manager, got involved with Yahoo to realize value for his fund investors first and foremost. When he was elected to Yahoo’s board he had a fiduciary duty towards all Yahoo shareholders. When his respective fiduciary duties to his fund investors and Yahoo shareholders conflict, make no mistake about it, Loeb’s allegiance and commitment is to his fund investors first and foremost. It is only natural that he steps down if he sees that his fund investors are better served if his time and energy are invested elsewhere.