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Brookfield agreement to acquire Forest City Realty Trust backed after hedge funds finessed new board, contentious debate over value, and narrow 7-5 vote

Months of contentious debate and the threat of a board takeover by activist investors--which produced a new board--presaged the July 31 announcement that Cleveland-based Forest City Realty Trust (FCRT) would be absorbed by Toronto-based Brookfield Asset Management in a $6.8 billion deal, a new document reveals.

And Forest City’s preliminary acceptance of the agreement--announced barely four months after the company rejected a buyout offer--hung on the vote of a single board member, the only company CEO from outside the founding Ratner family. Meanwhile, board Chairman James Ratner opposes the deal.

Scenes from Forest City's year-plus roller-coaster ride emerge in a preliminary proxy statement (bottom) FCRT filed Sept. 21 with the Securities and Exchange Commission, which presages a full shareholder vote. Notably, Forest City’s board was split evenly, 6-6, regarding Brookfield’s offer of $25.35 per share, until CEO David LaRue switched his vote. (The deal is described as a merger, but it's essentially an acquisition.)
From the proxy statement
In what seems an understatement, the document acknowledges “a concern among certain directors that the competitive nature of the strategic process may have been dampened by perceptions that our Board was subject to pressure from certain of our stockholders to consummate a sale transaction.” In other words, some board members suggest, the hedge funds that have pounced on an undervalued Forest City got their way.

Considerable pros and cons

The 223-page document, which recommends a “yes” from shareholders in a vote likely in December, does not detail LaRue’s specific rationale--it does disclose he could gain a considerable "golden parachute"--but describes the considerable pros and cons raised by board factions regarding the deal.

For example, Brookfield's offer represents a seemingly significant premium of 26.6% over FCRT’s closing share price of $20.03 on June 15, just before public speculation surfaced regarding Brookfield’s interest. But it remains far less than what Chairman Ratner and allies believe components of Forest City—which specializes in complex projects in major cities—are worth.

Such calculations, of course, are more art than science. Estimates of NAV (net asset value) like the ones below, which suggest higher valuations than the Brookfield offer, come with numerous caveats.

Ratner family losing ground

The document, however dryly descriptive, describes significant disagreements and hints at significant drama. Notably, descendants of the founding Ratner family, who’d retained corporate control of publicly traded Forest City until the 2016 removal of two-class share structure, have steadily lost ground. (The firm was founded in 1920 and went public in 1960.)

In the past few years, the former Forest City Enterprises has transitioned into a real estate investment trust (REIT), adopting a structure more comparable to peers, and narrowed its focus on its apartment and office segments. Beyond giving up that two-class share structure, a revamped board further disempowered the Ratner family.

Among the firm’s four holdover board members, only LaRue, who in 2011 became CEO, backed the merger. James Ratner will now vote his shares (2.46% of the company) in opposition. He is a cousin of Forest City New York Executive Chairman Bruce Ratner, who left the board in December 2016, when the dual-class share system was dropped and the board finally achieved an 8-5 majority of directors who were independent (without ties to the company).

New board, new decision

Only the most recent board revamp, announced this past March after the culmination of a six-month strategic review aimed to increase shareholder value, unlocked the Brookfield deal. During that earlier period, begun in September 2017, FCRT had rejected a Brookfield offer.

However, internal pressure from activist investors, detailed in the proxy statement, led Forest City to fear a distracting, expensive battle over board control. Such hedge fund investors often target a seemingly undervalued company, push for board or operational changes to raise the stock price, then take their profits.

So, in March, FCRT stated not only that it would focus on improving share value, it would revamp its board. Among the eight new directors, six voted for the Brookfield deal.

While Forest City's New York office goes unmentioned in the proxy statement, it might be seen as an partial catalyst for the Brookfield takeover. One of those activist investors, Scopia Capital Management, had in August 2016 created a presentation (filed with the SEC) that called the parent company's stock "grossly undervalued."

From Scopia presentation
Scopia blamed not only higher operational costs related to the dual-class share structure, but also criticized "value destructive transactions" that " have damaged credibility," including several projects from Forest City Ratner/Forest City New York: the B2 modular tower (aka 461 Dean Street), Atlantic Yards/Pacific Park, the Barclays Center, the Brooklyn Nets, and the Ridge Hill retail complex in Yonkers.

The corporate tensions, along with the stalled plan with Greenland USA to develop Atlantic Yards/Pacific Park, surely contributed to the decision by MaryAnne Gilmartin, the CEO of Forest City New York and a mainstay of predecessor Forest City Ratner, to leave in January and establish her own firm.

What to do about lagging value

Forest City’s stock price has long reflected a greater discount from NAV than comparable firms, as the document explains. (Go to p. 32, Background of the Merger, which is the 40th page in the PDF.) Thought the dual-class share structure—seen as a departure from best practices and thus a drag on share price—was dropped in June 2017, that discount persisted.

That month, the board agreed to meet with stockholders, “including several activist investors, to solicit feedback regarding our performance, business strategy, competitive position and corporate governance,” the document states. The board reviewed potential alternatives, such as selling the company, spinning off parts of the firm, or pursuing a merger.

Two months later, the board discussed feedback from major stockholders, including the hedge funds Starboard Value and Scopia. Some stockholders welcomed a sale. Some considered Forest City too complex, given multiple business lines. They also recommended changes in the board, given that five of 13 directors were still not independent.

Thus the board announced on Sept. 11, 2017 that it had begun that strategic process. The investment banks Lazard Frères and Goldman Sachs proceeded to contact "44 strategic and financial parties” regarding potential deals; 19 expressed interest.

By late Oct. 2017, Forest City had received seven preliminary bids, five of them (including one from Brookfield) all-cash, ranging between $24.50 and $27 per share, plus two proposals regarding specific business segments.

The pressure ramps up

Meanwhile, senior management prepared a potential cost-saving standalone operating plan, which contemplated the outsourcing of property-management, leasing and numerous back-office functions. On Nov. 15, 2017, the pressure ramped up: Scopia sent an unsolicited letter pushing for a “transformative transaction.”

On Dec. 12, 2017, Brookfield proposed an all-cash acquisition for $26 per share. Evaluating five potential deals, Forest City asked Brookfield and one other bidder to revise their bids. Brookfield didn’t.

The board approved a 45-day negotiating period with Brookfield, and was “closely divided” regarding a sale at $26 versus remaining as a standalone public company. Meanwhile, James Ratner asked the transaction committee to hire a nationally recognized commercial real estate broker to evaluate the firm’s assets.

The process was nudged by news reports. “On January 31, 2018, “ the proxy statement says, “Bloomberg News reported that Brookfield was in negotiations to acquire the Company at a price that was not meaningfully higher than the then-current trading price of our common stock.” Given that Forest City’s stock was then priced at $23.14, that seems imprecise.

At a meeting Feb. 18, representatives of Lazard and Goldman Sachs “also reviewed unsolicited feedback” from Starboard as well as other stockholders’ concerns, “ including the possibility that a large stockholder could initiate a proxy contest to replace a majority of our directors.”

On March 7, Brookfield proposed paying $24.50 per share if Forest City ceased future quarterly dividend payments, gained consents from certain joint-venture partners and governmental entities, and completed an internal reorganization at Brookfield’s direction.

Forest City asked Brookfield to revise its proposal before the board’s March 10 meeting. Meanwhile, Starboard and Scopia confirmed they might mount a board takeover.

The board asked Brookfield to raise its bid to $25.50 per share and to drop certain conditions. Brookfield offered $25 per share but retained those conditions.

The board balked at Brookfield’s final proposal, believing it could enhance stockholder value on a standalone basis. It also reached a settlement with the hedge funds, fearing that current management would lose in that board takeover fight.

In that settlement, nine of 13 directors resigned, leaving four holdovers. Six new agreed-on directors were named, plus Starboard and Scopia could each name a director. The founding Ratners no longer had four family seats but rather two designees, one of whom must be independent.

Moving toward a deal

Less than a month later, on April 16, as the eight new board members took office, Brookfield made a new proposal, for $24.50 per share (a $.50 drop), if Forest City ceased future quarterly dividends. The proposal lacked previous conditions, such as an internal reorganization. The board asked for more; Brookfield offered $25.25 and, by June 15, $25.35.

Soon, Bloomberg News reported that negotiations had resumed, with pricing between $25 and $25.50 per share, the document states, noting that Forest City had last traded at $20.03. (That suggests a premium of 26.6%.)

After two meetings on June 21, the directors were split, according to the proxy statement. Those opposed believed Forest City’s value was higher, and that paying ongoing dividends would reward stockholders more. The board even discussed the possibility of presenting Brookfield’s proposal to stockholders with no recommendation.

Trying one more time

Given concern about the uncertainty of such a tactic, the board, with LaRue newly agreeing to support renewed negotiations, asked Brookfield to try again. The latter firm had only recently confirmed it would accept Forest City’s position regarding “golden parachute” compensation in the wake of a takeover. (That represents significant sums to executives like LaRue, whose package is valued at nearly $12.7 million.)

Brookfield conceded that it no longer required third-party consents or an internal reorganization, and the two parties grew closer on ancillary matters. The most recent business projections were “less favorable” for Forest City, suggesting the firm had lost leverage, according to the proxy statement.

Brookfield reached merger support agreements with Starboard and Scopia, owning 5.63% and 8.15% respectively, along with the Forest City board agreement. But Brookfield could not get a similar support from Ratner family entities, owners of considerable chunks of stock.

On July 30, Forest City’s board approved the merger by that 7-5 vote, believing that the market had not reflected the company’s value. Optimistic NAV estimates were “likely not realizable” by a sale of assets before 2021 given tax implications, the board majority concluded. It also noted that an expected rise in interest rates increases risks for real-estate firms.

The losing argument

Chairman James Ratner was not enthused, saying it did not maximize stockholder value and did not reflect the company’s recent operating results.

He also criticized not only a perceived “lack of a highly competitive bidding environment”—presumably after the focus on Brookfield—but also “his perception of the fee structure of our outside financial advisors, which… he believed motivated our outside financial advisors to advocate in favor of the merger.”

There's no allegation that such arrangements are beyond the norm for such mergers, but the financial structure surely incentivizes the full deal: Lazard has earned $7 million so far, but would get another $20 million if it goes through, while Goldman Sachs has earned $4.7 million, but would get another $13.3 million.


What's it worth?

Ratner’s allies contended that the Brookfield's $25.35 offer was “effectively reduced by $0.36 per share” (resulting in an effective $24.99 per share), given that the dividend would be suspended for two quarters.

They suggested that Lazard and Goldman had undervalued assets like land in Washington, DC, and San Francisco. (The estimated current NAV they cite ranges between 8.1% to 32.1% above Brookfield’s offer, with two estimates at 17% and 18.8%.)

They also argued that Brookfield’s bid represented a greater discount to “analyst consensus NAV” than in comparable transactions.

All that is difficult to tease out beyond the document, given the enormous complexity not just of such valuations but Forest City's hard-to-value projects, which have historically made it difficult for investment analysts to assess the company.

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