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Offline Esther D.

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Presentation of case stuy: The Children's Investment Fund
« on: December 11, 2009, 12:21:38 am »
Please find the presentation of the case attached.
Regards, Esther

The Children‘s Investment Fund     (Randolph B. Cohen, Joshua S. Sandbulte)



Overview

•   Foundation of Children’s investment fund in January 2004
•   Large investment in Deutsche Börse in August  2004, becoming one of the largest shareholders
•   Public dispute over acquirement of London Stock Exchange in December 2004
•   Withdrawal of bid



TCI’s history


Founding
•   Launched in January 2004 by Christopher Hohn, whose fund had won the Eurohedge Event Driven fund of the Year Award in 2000 and 2001
•   Combination of value-oriented and event-driven  strategy
Clients and investment terms
•   Portion of management and investment fees contributed to the Children’s Investment Fund Foundation, a related charity
•   Investments not limited to socially responsible businesses
The Children’s Investment Fund Foundation
•   Primarily investing in Africa and India
•   $100 million available for distribution in 2005



Combining charitable giving into a For-Profit Hedge Fund

Attracting investors
•   Investor’s perspective:
   “all-in fees” no worse than those of others
   fewer management fees à hard to attract and retain talent
Being a role-model
•   Primary purpose of giving publicly rather than privately:
        Making a statement to other hedge fund managers and wealthy individuals not donating yet
Reinvesting oneself
•   “Money doesn’t keep good people.”
•   Charitable aspects often more important than financial stability



Investment Approach

TCI’s investment approach is a combination of value investing and activism
=
Value Investing
1.   Significant difference of price from TCI’s assessment             
à significant margin of safety
2.   Evaluation of an independent view of a stock’s value
3.   Long-term orientation
4.   Ownership of fundamental strong businesses (monopolies, oligopolies)
5.   Limitation of stock selection to own sphere of confidence
+
Event-Driven Investing
•    dialogue with management of companies
•   “activist orientation”

Investment Universe
•   Focus on the equity and debt securities of large-cap and mid-cap societies
à mid-cap societies underresearched, disparity more likely
•   Majority of investments in Europe
Portfolio composition
•   Long and short positions with a net-long bias, because Hohn expected the market to rise over time
•   TCI did not seek to match long and short positions
•   Concentration on few securities instead of diversification
Organizational structure and investment process
•   Limited number of experienced, high-quality analysts with a value-oriented investment



Deutsche Börse

Facts

•   CEO: Seifert
•   Established in 1992 as a holding company of Frankfurt Stock Exchange
•   Represented one of TCI’s largest positions
Deutsche Börse’s competitive position
•   Early adapter of electronic trading platforms and market models
à Limited competitive threats from entrants



Largest competitors

Deutsche Börse

•   Great profitability
London Stock Exchange
•   Largest exchange in terms of trading volume among the European exchanges
•   Second-largest market in the world behind NYSE in market capitalization
•   Largest competitor in securities exchange business
Euronext
•   Performance of central clearing
•   Operating a large derivative market
•   Largest competitor in derivative markets business



TCI’s Investment in Deutsche Börse – Chances


1.   Earnings power of Deutsche Börse underestimated
2.   Formidable competitive position due to liquidity and connectivity-based network effects
3.   Derivative market attractive, Deutsche Börse largest derivative market in Europe
4.   Clearing and settlement also dominant business
5.   Attractive returns on invested capital due to fixed-cost nature of exchange/ clearing business
6.   Cheap stock price

TCI’s Investment in Deutsche Börse –Risks


1.   High reservation price for
2.   Mergers could only be approved by supervisory board, not by shareholders
3.   Regulation risks for exchanges

BUT: Accumulation of 1.8 million of Deutsche Börse stock in 2004



Post-Investment Developments

London Stock Exchange Acquisition Announcement
•   December 13, 2004: Deutsche Börse announced to acquire LSE
•   Hohn: “Use of cash to acquire LSE is misuse of Deutsche Börse’s capital!”
A bitter public dispute
•   Exchange of public letters between Hohn and Seifert
•   Refusal of Deutsche Börse management to give shareholders a vote on the deal
LSE bid abandoned
•   Withdrawal of purchase offer after LSE demanded a higher price



Decision Point
•   Time for TCI to begin to realize its investment?
•   Broader ramifications for TCI’s business?
•   Public dispute with CEO of Deutsche Börse beginning to damage the company?
•   Continue to push for government changes at Deutsche Börse?
•   What strategy should TCI pursue to bring about governance changes?


Offline Esther D.

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #1 on: January 25, 2010, 02:22:10 am »
These are the main questions that can be used for Exercise XI

Main decision question

Should hedge fund managers try to implement governance changes, as they seem to be suited poorly to running public companies?

Case questions

•   Was now time for TCI to begin to realize its investment?
•   Was the public dispute with CEO of Deutsche Börse beginning to damage the company?
•   And what were the broader ramifications for TCI’s business due to a continuing public dispute with a widely respected management team?
•   Should Hohn continue to push for governance changes at Deutsche Börse?
•   If so, what strategy should TCI pursue to bring about governance changes?

Offline O. Krebs

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #2 on: January 27, 2010, 12:49:09 am »
Just as in my case the main decision question is whether or not to give in to a demand made by an activist hedge fund. In this case Hohn opposes the deal proposed by Deutsche Börse to buy the LSE. Obviously, it is impossible to give a general answer. Instead, the decision depends on a multitude of factors and the exact situation and setting. However, one can say that there are two main aspects about such situations that one has to consider: information and motives. One the one hand investment funds only possess external information while management can additionally rely on such information internal to the firm. As a result one can argure that they can make "better" (at least more informed) decisions. On the other hand their is the issue of the motives driving both investment funds and managers. This situation of an "external" manager of your own money is well-known as the principal agent problem. Management will probably decide in their own best interest (salary, bonusses, keeping their job etc.) and not in the best interest of the shareholders. Yet, the same argument can be made for hedge funds who will genereally only be interested in making a short term profit (speculation) with the share in the company in which they invested. This, howwever, can be a moral problem when considering the jobs connected to a comapny and the short-sightedness of such goals - maybe the overall gain to society in a 10, 20 yera horizont is way larger then the short term profit considered by investors.

Offline Adamtk

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #3 on: January 27, 2010, 03:05:12 pm »

Generally, in this case we have again an example of Principal-Agent Problem- disagreement between investors of the company and managers of the company deriving from different objectives of these two groups. However, we should keep in mind, that in such cases Investor is the "Principal", because he could be considered as the owner of the company and he hires managers which are "Agents". That is why the investors should have the right to influence the strategy of the company. Nevertheless, there is also a question of morality- sometimes investors tend to count only on profits and forget about the long term strategy of the company.

In this particular case, the manager of Deutsche Borse thinks about aquireing London Stock Exchange. The investor is against it, as it would have to use a lot of firm's capital. Finally, the acquisition is abandoned. It shows, that investor counts only on short- term gains and doesn't care about long- term development. But question that comes to my mind is: wouldn't investor gain much more if he allowed for this transaction and considered the participation in the firm on a longer basis? It would of course consider risk, but considering the synergy effect the profits could be also vast.

Offline Kathrin D.

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #4 on: January 27, 2010, 03:19:43 pm »
The question arising in this case is really difficult to answer, especially because we are dealing with moral aspects and investors who invest in social actions in third world countries. Those investors should not undertake too much risk and seek for a healthy and stable investment.
Nevertheless, managers should undertake those investments with the highest present values compared to other investments with lower present values.
In this case we do not really learn if the investment in the London Stock Exchange would be such a bad idea. It does not say anything about risk-return levels, variance, and so on. Therefore we cannot really decide who's right and who's not.

If TCI however invested in the Deutsche Börse at first place, they should have made clear their interests. Maybe they should not even have made such a huge investment into one company, because now they are very reliant and dependent on actions, the Beutsche Börse does undertake.
Also, combining charity projects with activist hedge funds does seem a little controversial and might directly lead to conflicts between the two parties...

Offline Nadezhda

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #5 on: January 27, 2010, 08:11:18 pm »
Taking big corporate decisions, such as the acquisition of the LSE requires objectivity and knowledge of the industry , the own company and the competitors. In my opinion ,  hedge fund managers are the more objective party, since he can observe the company from a more detached , and more impartial viewpoint. Exactly this impartiality makes them suitable for giving opinions in corporate changes, since their only goal is to increase profitability They could point out different strategic options which are not known or taken into consideration by the management.Yet trying to interfere and implement changes aggressively, producing public disputes causes negative reputation effects for both the hedge fund and the company. Hedge funds , as large investors, using their legitimate right to participate in corporate decisions can prevent a disaster or produce benefits , however at a high price.

Offline DorotheaBerner

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #6 on: January 28, 2010, 12:46:21 pm »
The main decision question is basically answered already. I agree that Principal-Agend-Problems have to be considered as difficult to solve and that it takes deep knowledge of the case and objectivity to judge whether one party was right or the other. In my opinion both parties theoretically have the right to influence the company´s governance. TCI-managers of course because it is their task to govern the firm but also the hedge fund - by providing capital - earns a certain right to affect important decisions. In the end it is up to each party´s bargaining power, who will win the dispute.

Besides the principal-agend-problem discussed in detail before I wanted to hit another aspect: The field of mergers and aquisitions.
I think the case is a very good example for the variety of issues that can lead to the failure of big mergers and/or aquisitions. The field is highly sensitive in almost every aspect of doing business (from balance sheet structures to human resource management) and we can learn from the case that as well activist hedge fund managers can become a major problem for a planned aquisition if they disagree. And considering the public disputes that have taken place after the announcement of the aquisition, such arguments always damage a company´s image. Just the signal that the management is somewhat dependent on the investing company´s opinion can provoke doubts about the internal stability of a company and therefore lower its value.

Offline Katha

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #7 on: January 28, 2010, 01:36:23 pm »
Was the public dispute with CEO of Deutsche Börse beginning to damage the company?
 
In order to answer this question I found an interesting article not only on how this public dispute damaged the company, but how this case made the phenomenon of “Shareholder Activism” apparent to the public. It not only influenced the stance of the Deutsche Börse, which was apparently damaged as the CEO and the head of the supervisory board had to leave, but also had an impact on the influence shareholders would have on the management of a company.
Basically, the shareholders did not agree with the company’s planned takeover of the London Stock Exchange (LSE). They claimed that the capital of the investors was not managed with due diligence, which led to the annoyance of traditional long-term investors like Fidelity, Merrill Lynch and Capital Group.
After the management had to leave due to the shareholder’s pressure, the organization of the shareholder of the Deutschland AG had been restructured significantly. While the Börse has been owned almost entirely by institutional investors when it went public, in December 2004, merely about one third of the shares was held by German investment fonds. The failure of the takeover which was mainly caused by the resistance of the shareholders, according to the FAZ marks a turning point in the relation between shareholders and the corporate management on German capital markets. Now, the influence of shareholders in Germans on strategic and operational decisions has gained importance. Investors have become more active and the dispersion of shareholder structure has increased. In my opinion, this has not damaged the reputation of the Deutsche Börse, although it has significantly changed the way it is being operated. The fact that the management had to leave was surely damaging, though.

Offline david.feierabend

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #8 on: January 30, 2010, 02:14:14 am »
Was now time for TCI to begin to realize its investment?

In the situation, TCI could have reacted in two ways (under the premiss that the acquisition of LSE was a misuse of Deutsche Börse´s capital).

1. Sell the stocks of Deutsche Börse and invest somewhere else.

2. Oppose the deal.

TCI finally did the second and was successful with its request. Was this a good strategy? Well, if we have a look at the stock price (see attached chart), we can assume it was. Of course, it is not sure how the stock price would have behaved if LSE would have been aquired, but it was definitively not the moment to sell the stocks.

Offline Jessica82

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #9 on: January 31, 2010, 02:09:55 pm »
I´d like to comment a bit on the question why TCI could not just sell its huge stake (over 20%) in Deutsche Börse to cash in the gain from the latter´s 47% appreciation (since TCI bought the stock) on the stock market. This is actually very simple! If an investor wants to buy or sell more than a certain percentage of a stock in Germany, bafin (Bundesanstalt für Finanzdienstleistungsaufsicht) requires the stock exchange to make this public. Also, the share price will go down. Other investors get afraid and withdraw their shares, too, fearing that there is some good reason for the big investor to get rid of his shares (insider information on the company´s future performance etc.). A vicious cycle is started.
Of course, TCI could hedge itself against possible future declines in its share prices resulting from the company´s selling of its stake in Deutsche Börse by opening short positions. However, this would be illegal under insider information regulations.

Offline marlene.karl

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #10 on: February 02, 2010, 06:24:37 pm »
How should a hedge fund that invests its revenues in social projects act on the market

As the main question seems to be answered already, I want to think about the ethical implications of a hedge fund that wants to raise money for the poor.
Should these kinds of charitable hedge fund be held to different moral standards than typical hedge funds?
A hedge fund tries to maximize his gains. But this may not be in line with the public interest. Specifically, there may be negative externalities, so that the hedge funds gain is matched by someone's bigger loss. A hedge funds actions may be a zero, positive or negative-sum game.
It seems logical that a hedge fund that wants to be a positive force in the world shouldn't destroy value while gaining the money to do good. But one could argue that the rescued African children matter more than shareholders who loose some dividends.

The short-term and long-term consequences of hedge funds intervention are difficult to predict, but it is clear to mear that charitable hedge funds should take the general welfare into account when they make business decisions.

Offline Esther D.

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Re: Presentation of case stuy: The Children's Investment Fund
« Reply #11 on: March 14, 2010, 12:53:29 am »
Dear all,
here are my answers to the case study questions:

Hohn faced the decision of what to do next. Deutsche Börse’s shares had appreciated 47% since November 2004, giving TCI a sizable unrealized gain and now representing over 20% of the TCI fund’s NAV.

Was now the time for TCI to begin to realize its investment?

TCI decided to oppose the merger and was successful with its request. After this success, the question arose whether to realize the investment or not. TCI decided not to sell the shares, hoping for another "catalyst" event that would bring convergence of trading and fundmental value.
In order to decide whether TCI should have begun to realize its investment, we first look at the share prices: After Deutsche Börse’s abandonment of the LSE bid on March 6, 2005, the stock price kept rising. So we can say that it was a good decision that TCI did not sell its shares at that point of time. TCI finally sold their shares in April 2009 with so called "cash settled swaps". At this time however, the value of the share was at a very low level relative to 2008/ 2009, because of new competitors entering the market and a loss of revenues thereafter. So we can say that the point of time at which TCI realized its investment, was quite poorly chosen. Of course, it is not sure how the stock price would have behaved if the LSE would have been acquired. But from today’s point of view we can say that 2005 was not the time to realize the investment.
I addition to the share price, the investigation by BaFin has to be taken into account. The accusations of being “very short-termist” could have been confirmed if Hohn would have sold the shares right after the abandonment of the LSE bid. So if TCI would have realized its investment in 2005, it would have put its reputation at stake.

Was the public disagreement with the CEO of Deutsche Börse beginning to damage the company?
I don’t think that the public disagreement between Hohn and Seifert was damaging the company. The public shareholder revolt actually incited a recovery of Deutsche Börse’s common stock.
Seifert had a good reputation as Deutsche Börse’s leader, but many investors were concerned that Seifert’s vision of a pan-European exchange would be achieved through overpaying in an acquisition. This was why Deutsche Börse’s common stock was relatively cheap in 2004 and began to rise heavily shortly after TCI announced its intent to lead vote to remove Deutsche Börse's Supervisory Board. As can be seen from the attached graph, the stock price did not go down after Deutsche Börse abandoned the LSE bid. This could have been the case because many outside investors believed that the acquisition of the LSE would have been an inefficient use of capital.
So I think that in the long run, Deutsche Börse even profited from the public disagreement with TCI: More investors were attracted, believing that Deutsche Börse could make use of its capital in a more efficient way than acquiring he LSE.

And what were the broader ramifications for TCI’s business due to a continuing public confrontation with a widely respected management team?
The continuing public confrontation with a widely respected management team made the phenomenon of “shareholder activism” apparent to the public and alerted the German politicians. German politicians called foreign investors such as TCI “locusts”, destroying everything before moving on. The public discussion even leaded to an investigation of BaFin, the German stock market regulator. The accusation was "acting in concert". Shareholders combining their efforts to exert influence on a company in order to achieve their own activist objectives, are considered to be acting in concert.
With the first rumors and rising share prices, more and more uninformed investors sold their shares, making a profit. Those shares were bought by other hedge funds like Atticus that bought more than 5%. TCI also decided to raise its ownership stake to more than 5%. When TCI started to oppose the merger in public, other large institutional investors started sending letters to Seifert stating that they opposed the proposed terms of the merger. Those letters all sounded very similar and so the suspect arose if TCI and other investors acted in concert. BaFin, was opening an investigation into whether TCI and other investors broke securities laws in their opposition to the LSE bid. However, although there were some indicators, BaFin could not ascertain acting in concert at Deutsche Börse.
I don't think that investors withdrew their funds from TCI because of the public discussion. TCI's investors are mainly institutional investors that are mostly concerned about the returns and these returns were extremely high. In the beginning, the fund was even oversubscribed, so I think that finding investors was not a problem.

Or should Hohn continue to push for governance changes at Deutsche Börse?
In my opinion, Hohn should continue to push for governance changes at Deutsche Börse, if he is really convinced that the governance changes he wants to push are in the interest of the shareholders. In my theoretical tool, I tried to take the view of a value-investor and to calculate different ratios as well as the value of intangibles of LSE. Of course I know that the portfolio analysts of TCI use research and valuation methods that are far more advanced. But if their approach was similar to the one that I used in my theoretical tool and if their findings were slightly similar, then they must have truly thought that Deutsche Börse would overpay in an acquisition of LSE, that the acquisition would be an inefficient use of capital.  In my opinion, if he is really convinced that the governance changes he wants to push are in the interest of the shareholders, then he should continue to push for them.
Hohn believes that share repurchases could maximize the share price. When a company repurchases its own shares, it reduces the number of shares held by the public. With profits remaining the same, the reduction of publicly traded shares results in an increase of earnings per share increase. Repurchasing shares, particularly when a company's share price is perceived as undervalued or depressed, may result in a strong return on investment.
So I think that Hohn should continue to push for the share repurchasing program.
Of course, he should only do that if he did not violate regulations before, if he did not act in concert with the other hedge funds. Pushing for governance changes at Deutsche Börse would certainly get BaFin's attention and a violation of regulations would be discovered more likely.

If so, what strategy should TCI pursue to bring about governance changes?

The way to bring about governance changes in Germany differs substantially from the one in the UK, where The Children’s Investment Fund is based. Typical German firms are composed of a supervisory board, representing both shareholders and employees.  This supervisory board elects and oversees a board of managing directors, composed of members of the management team. Selection and removal of management by shareholders was done indirectly through election of supervisory board members. This procedure differs from the procedure in the United Kingdom, where a vote of the broader shareholder group can approve mergers. TCI’ options to bring about governance change appear to be very limited. What TCI can do is seeking to replace the board like it did before. Owners of more than 5% of the company for at least three months can propose to replace the board. To decide the replacement, it would require a simple majority of shareholder votes at the company’s annual general meeting (AGM) or at an extraordinary general meeting (EGM). So TCI would need the agreement of the majority of shareholders to replace the board. If we look at the development of Deutsche Börse shareholders by country, we find that between December 2001 and April 2005, there was a shift from many German-based investors to Anglo-Saxon and other international investors. Whereas in 2001, 68% of Deutsche Börse’s ownership was from Germany, in 2004 and 2005 it was only 35% and 7% respectively. According to public reports, shareholders agreeing with TCI’s position opposing the merger owned between 50% and 60% of Deutsche Börse’s stock. With this broad shareholder base in his favor, Hohn can continue to make issues public and push for further changes in the company’s government.
« Last Edit: March 15, 2010, 08:07:20 pm by Esther D. »