Saturday, 24 March 2018

Elliott's support for Melrose shows why GKN must not be taken over

Yesterday afternoon, Elliott Advisers announced that it plans to support the Melrose bid for GKN. This was duly reported, without much scrutiny, as support for Melrose from GKN's second largest shareholder.

Actually it's more complicated than that. In fact, Elliott's support for the Melrose bid demonstrates how short-termist this deal is, and the sorts of "investors" that stand to benefit at the expense of GKN workers if it goes ahead.

First up, Elliott Advisers is not actually a GKN "shareholder". If you read the intro to Elliott's statement carefully this is implicitly acknowledged:
Elliott Advisors (UK) Limited, which advises funds (together “Elliott”) that collectively have an economic interest in the shares of GKN plc (“GKN”) representing over 3.4% of its capital
If Elliott Advisers held shares. why not just say they hold over 3.4% of its shares? Because actually they hold derivatives, CFDs by the looks of it. Here's a market disclosure issued on Friday that makes this clear:

So, based on this disclosure, Elliott is not a GKN shareholder, it holds derivatives linked to GKN shares. Indeed it may never have been a shareholder during its two and a half month old economic interest. Elliott could, of course, have chosen to buy shares in the company it says it has a close interest in. Many other investors have done this. Instead apparently Elliott chose derivatives.

Two things flow from this. If Elliott isn't a shareholder, will it get to vote on the bid? I think it probably will, having read a bit around M&A arbitrage. But if so, that presumably means there is a counterparty on the GKN share register that will accept Elliott's voting instructions. This is how the future of the company may be decided.

Secondly, if they are not a shareholder, are they actually party to the bid? The offer is to GKN shareholders, not to holders of derivatives linked to GKN shares. In financial terms Elliott still cashes in of course, because presumably the counterparty passes on the economic return. But I don't think there is a direct transaction between Melrose and Elliott. So Elliot is telling other shareholders to accept an offer for the company that it may not actually be part of (though it will benefit from it).

Another important point did not get raised in press coverage of Elliott's statement yesterday. It has a very large large short position in Melrose - the second largest in the FCA list:

So actually the big investor unveiled as supporting Melrose yesterday is also betting heavily against Melrose shares in the expectation that a successful bid will hit them. Its short position is 1.8%, in the top 10% of shorts by size in the FCA list. So Elliott, despite apparently not being a shareholder in GKN, has a LOT of money on both sides of the deal riding on this bid going ahead.

Finally, Elliott is one of the firms that the ITF identified as using cut and paste copy to explain why they don't comply with the Stewardship Code. The Code was developed to try and increase shareholder responsibility after investors failed to tackle short-termist risky behaviour by banks in the run up to the crisis. Risky short-term behaviour may resonate a bit here.

Despite being willing to take a very public position on the future of a major UK company, which surely falls into 'stewardship' territory, Elliott doesn't seek to comply with the Stewardship Code. Instead it has posted a meaningless bit of copied blurb on its website to get out of it. As a result we put Elliott in the list we sent to the FRC and FCA highlighting cut and paste reporting by hedge funds. We've also suggested that the Code be amended to capture activity around M&A activity.

The fact that Elliott is the only investor with a really sizeable interest - not shareholding - in GKN to have spoken out in favour of Melrose's bid says a great deal. If your most vocal supporter also has one of the largest short positions in your shares it says a lot about who your allies are. And the fact that Elliott has only had an economic interest in GKN since January, and apparently not even a direct shareholding at that, shows you how much of a long-term interest they have.

This is a short-termist bid, backed by short-term speculators playing both sides of the deal. It deserves to fail.

PS - If I have any of the technical info wrong if anyone from Elliott, Melrose or Montfort wants to get in touch I am happy to correct it.

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