In the closing days of 2010, The New York Times' Dealbook published an excellent piece documenting how Abercrombie & Fitch Co. (ANF) is quietly seeking shareholder approval to reincorporate the company in the state of Ohio. This is an exceedingly rare move, as ANF is currently incorporated in the state of Delaware, a state that is home to 63% of the Fortune 500, 73% of all new U.S. IPOs and more than 879,000 other business entities.
American states engage in a form of horizontal regulatory competition, the result of a conflict of laws principle that allows companies to choose their place of incorporation separately from their place of operations. Over the last century, Delaware has emerged victorious as the leader in new business entity formation, as well as attracting existing entities which initially incorporated in other states.
Why do such a disproportionate number of business entities choose Delaware? Among the many reasons, the most compelling include its non-existent income tax on out-of-state filers, flexible General Corporation Law, and, most importantly, its unique court structure. The Delaware Court of Chancery is a 219-year-old institution devoted solely to corporate law issues. The result of its long history and specialist judges (called chancellors) is that Delaware has the most well-developed body of corporate case law in the nation, which provides a predictability in interpretation and outcome that corporations seek. Former Chief Justice William Rehnquist said the following of the Delaware Court of Chancery:
[S]ince the turn of the century, it has handed down thousands of opinions interpreting virtually every provision of Delaware’s corporate law statute. ... Perhaps most importantly, practitioners recognize that ‘[o]utside the takeover process...most Delaware corporations do not find themselves in litigation. The process of decision in the litigated cases has so refined the law, that business planners may usually order their affairs to avoid law suits.'
Given the depth and breadth of case law arising from Delaware, and the consequent predictability it affords in-state corporations, it is quite surprising that ANF seeks to reincorporate in Ohio partly so as to gain clarity on corporate governance issues. ANF provides the following as a rationale behind the move:
We believe that Ohio law affords directors a clearer balance of corporate governance rights and obligations than Delaware law and would thereby enhance our ability to attract and retain highly qualified individuals to serve as directors.
Seeing that numerous Delaware-based Fortune 500 companies have no problem attracting and retaining competent directors, this is a questionable claim. Beyond this, ANF also cites tax savings, but these savings are a meager 0.000062% of revenues and are certainly offset by the costs of creating and distributing a proxy, and the legal fees associated with effecting the reincorporation. The company's final rationale is a vague "commitment" to the state of Ohio.
The reasons provided don't appear to justify the effort, so what is the real reason for the move? A close inspection of ANF's filing reveals a common thread - the threat of takeover and associated liability. ANF says it will gain "operational and statutory benefits" in Ohio that will allow it to remove its supermajority voting requirement and poison pill, both of which are designed to decrease the ability of potential acquirers to be successful.
Further, it states that Ohio's law provides "explicit guidelines regarding the matters that are appropriate for directors to consider ... when deciding whether a proposed takeover is in the best interests of the corporation," which provides clarity on potential director liability arising from a takeover. Additionally, as Chief Justice Rehnquist stated, the one area of litigation that arises for Delaware corporations is the takeover process, the consequence of being relatively less clear. As Dealbook points out:
Abercrombie will benefit from Ohio’s stricter anti-takeover rules. This includes Ohio’s business combination statute that, unlike Delaware’s business combination statute, is set off when a shareholder acquires 10 percent or more of Abercrombie instead of the 15 percent threshold in Delaware. More important, Ohio also has a control share acquisition statute. According to Abercrombie, this statute “requires shareholder approval of any acquisition of shares of an Ohio public corporation that would entitle the acquiring person to exercise more than one-fifth, one-third or one-half of the total voting power of the corporation in the election of directors.” Abercrombie could have opted out of this statute but did not. ... The net result of this reincorporation will make it much easier for Abercrombie to steer an acquisition to its preferred acquirer and for shareholders to challenge the acquisition. In connection with the change, Abercrombie appears to be lowering the vote required to approve an acquisition via merger to 50 percent instead of the Ohio default of 66.66 percent. Ohio is also much laxer in regulating directors’ decisions to sell, rejecting Delaware’s Revlon doctrine.
Thus, the real drive for the reincorporation to Ohio appears to be greater control over potential acquisitions and clarity over potential liability arising from an acquisition. Does ANF have a legitimate reason for worrying about a takeover attempt? Although ANF has nearly doubled its share price over the past six months, it is still nearly 30% below its 2008 highs.
Additionally, there have been several recent high profile buy-outs announced of clothing retailers in the past few months, including Gymboree (GYMB) by Bain Capital, J. Crew (JCG) by TPG and Jo-Ann Stores (JAS) by Leonard Green & Partners LP, and buyout rumors have been swirling around Aeropostale (ARO), American Eagle Outfitters (AEO), and Chico's (CHS). Below, we provide a comparison of ANF's current valuation with those deals announced over the past few months:
|ANF (Current)||JCG (Post-Announcement)||JAS (Post-Announcement)|
Additionally, here is a comparison with other specialty retailers that have been the subject of takeover rumors:
|ANF (Current)||ARO (Current)||AEO (Current)|| |
Despite the industry-wide rumors of imminent takeovers, it would seem that ANF has less reason to fear a takeover given its premium valuation, though the market may simply be factoring in more margin upside for ANF in coming years when compared with some of its peers.
While we were unable to uncover other successful reincorporations away from Delaware and into Ohio, we should note that over the past several years, there has been an increasing push from activist investors for target companies to reincorporate into North Dakota.
In 2008, North Dakota, prompted by Carl Icahn, passed a set of shareholder-friendly laws that require the annual election of directors (rather than staggered boards, long the bane of activist investors seeking quick change). Shortly after North Dakota's enactment, activist investor John Chevedden sent shareholder proposals to Oshkosh Corp (OSK), Hain Celestial Group Inc. (HAIN), Whole Foods Market Inc (WFMI), and PG&E Corp (PCG) to reincorporate to North Dakota. Several months later, in April 2009, seven more companies were targeted for reincorporation, including Exxon Mobil Corporation (XOM), Lowe's Companies Inc. (LOW), Marsh & McLennan Companies Inc. (MMC), Amgen Inc. (AMGN), Sempra Energy (SRE) and Qwest Communications International Inc. (Q).
North Dakota, for example, is recognized as having the most shareholder-friendly corporate laws in the nation, thanks to recent legislative action. By incorporating in the state and adopting its provisions, a public company would in one easy step improve rights for its shareholders and eliminate the often too-cozy relations between managements and boards.
Icahn then proposed that Amylin Pharmaceuticals, Inc. (AMLN) and Biogen Idec Inc. (BIIB) reincorporate in North Dakota.
The purpose of the Reincorporation is to enable the Company to reincorporate from Delaware to North Dakota and become subject to the North Dakota Publicly Traded Corporations Act. The North Dakota Publicly Traded Corporations Act provides a governance structure for publicly traded corporations that generally provides shareholders greater rights than they currently have under other state laws and, specifically, will afford shareholders of the Company greater statutory rights to involvement in the Company’s corporate governance process than they currently possess under the Delaware General Corporation Law (“Delaware Corporate Law”). ... These rights are intended to decrease management entrenchment and increase management accountability to shareholders. Accordingly, the board of directors believes that the Reincorporation is in the best interests of the Company and its shareholders and will help maximize shareholder value.
Naturally, ARII is majority-controlled by Icahn. Shareholders approved the transaction and effective June 30, 2009, the company reincorporated from Delaware to North Dakota.
It will be interesting to see over the coming years whether more companies leaving Delaware choose shareholder-friendly states like North Dakota or management-friendly states like Ohio. Our pessimistic side wouldn't be surprised if it's the latter.