Cross post from today's TheStreet.com:
03/24/08 - 09:00 AM EDT
The Take-Two Interactive(TTWO - Cramer's Take - Stockpickr) saga continues, with Electronic Arts(ERTS - Cramer's Take - Stockpickr) having gone hostile with its previous $26 a share offer for the company that was made public on Feb. 24. The EA offer represented a 50% premium for Take-Two's shareholders. Yet, Take-Two's board and management team rejected the offer as "too low," especially in light of the pending April release of the next installment of their Grand Theft Auto video game franchise.
Take-Two has a history of a lurching stock price and financial and legal scandals.
Last year, it culminated in a sizable number of Take-Two shareholders openly revolting and seizing control of the company.
Back then, the video game publisher couldn't get its act together. The stock's price had dropped by 50% in the summer of 2006, going to $10 after financial and legal problems surfaced. Its founder admitted to backdating stock options, and discussions of a possible buyout with EA, which hadn't been publicly disclosed until a couple of weeks ago, fizzled.
Shareholders were understandably upset. And, in a remarkable moment of collective exasperation, several well-respected hedge funds and institutional investors banded together behind ZelnickMedia -- a "group of experienced executives who provide management expertise" according to its website -- to oust Take-Two's former management team and much of its board.
ZelnickMedia is not well-known for activist boardroom coups. Led by Strauss Zelnick, a formerly successful media executive at BMG Entertainment and 20th Century Fox, with offices in Santa Monica and New York, they won over the support of D. E. Shaw (9% holders in the company), SAC Capital (7.8% holders), Tudor Investment Corp., and even traditionally passive mutual fund company OppenheimerFunds Inc. (the largest Take-Two shareholder at the time at 24.5%) to say changing the status quo is much better than keeping faith in a management team and board which hadn't delivered for shareholders.
ZelnickMedia sold themselves to their supporters at the time as "corporate turnaround specialists." However, Strauss Zelnick soon admitted after he took control of the company that this turnaround assignment was ''the biggest thing we've done". The firm's previous wins were in selling the marketing rights of Time-Life to Reader's Digest for $91.8 million and selling the money-losing needlepoint cataloger Lillian Vernon -- two companies operating in industries an order of magnitude slower than Take-Two's.
Zelnick himself took on the Chairman role, with his colleagues Ben Feder as CEO and Karl Slatoff as EVP. For filling these three roles, the new board approved a pay package paying Zelnick Media $62,500 as a monthly management fee (or $250,000 per executive per annum, if you assume the three were paid equally although such a sum would be high for a Chairman). On top of this, ZelnickMedia had the opportunity to receive an annual bonus of $750,000 and buy a block of shares.
Yet, despite making executive changes, ordering new business plans for the different organizational units and holding town-hall meetings at which employees asked their new leaders whether they knew anything about the video games Take-Two made, ZelnickMedia has not been successful in repositioning Take-Two in the year since its ascension.
From March 29, 2007 (the date of the shareholder meeting at which the dissidents took control of Take-Two's board and management team) to Feb. 22, 2008 (days before the E.A. offer went public), Take-Two's stock returned -20.66% vs. -4.41% for EA, which about the same as the S&P over that time.
What's worse, however, is that they've given all activist investors a black eye with how they've paid themselves.
As mentioned, the Electronic Arts offer went public on Feb. 24th at $26 a share. That followed a previous, private offer from E.A. at $25 a share in early February. A week later, on February 14th, the Take-Two board approved a much higher compensation plan for ZelnickMedia (for the second time since the original employment contract was struck in March 2007). This time, ZelnickMedia gets additional stock grants worth $20 million at the current offer price if there's a change in control. Additionally, the three Zelnick executives who serve on the Take-Two management team get $208,333 a month (or $833,332 per executive per annum) and the potential annual bonus was raised 233% to $2.5 million.
ZelnickMedia's response to critics who say A) this pay package is outsized given the company's returns and B) is opportunistic given what they knew E.A. was contemplating is that they have been working much more at Take-Two than originally planned. Strauss Zelnick said they thought it was only a six-month engagement when they took it on. Curious then that the original terms of employment for Zelnick Media approved by the board specified an annual bonus.
Zelnick added that the fuss is much ado about nothing: "I'm a boy scout - everyone knows that about me". Well, unfortunately, actions speak louder than do-gooder words.
Why would Zelnick's supporters from OppenheimerFunds, D. E. Shaw, and SAC Capital on the board, who had backed him last year, approve such a high pay package? Well, none of these shareholders is actually on the board. Instead, the board is made up of insiders Zelnick and Feder, plus two ex-BMG executives, a former William Morris executive, and two pre-Zelnick directors. In other words, by a 5 to 2 count, this is a Zelnick-friendly board.
Activist investors need to earn a return for their shareholders, but it should be done through their investments not through executive compensation on top of their investments. In this case, ZelnickMedia's actions appear self-serving even if they were somehow legitimate.
They are also being short-sighted. They gained the support and trust of several large and respected hedge funds and mutual funds in taking control of Take-Two. Even if the E.A. buyout goes through, and these investors pocket a gain on it, I would be surprised if they weren't reluctant to partner up again with ZelnickMedia after observing these pay increases.
This story also suggests investors who join an activist coalition need to examine who will be serving on the boards of companies after a new regime takes over. Understandably, many investors would rather not take on the time requirements and potential legal liabilities of serving on a public company board. Without proper oversight, however, problems like the ones in evidence at Take-Two can happen.
Monday, March 24, 2008
Cross post from today's TheStreet.com: