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As Forest City shareholder vote approaches, a lawsuit from former CEO Al Ratner aims to stall Brookfield deal (updated)

Updated: Forest City, according to the Plain Dealer, called Ratner's filing too late and charged he was trying to game the system. A judge denied the request to delay the vote, saying Ratner couldn't prove irreparable harm.

Citing “materially inaccurate information and omission of material facts” in the proxy statement produced for shareholders to evaluate the pending acquisition by Brookfield Asset Management, former Forest City Enterprises (now Forest City Realty Trust) CEO and co-Chairman Albert Ratner two days ago filed suit in federal court to postpone the special meeting of shareholders set for tomorrow, 11/15/18.

His goal: a more honest proxy statement regarding the firm’s potential value and the process behind the sale. (See press release, suit, and proxy statement at bottom.)

Ratner, building on themes expressed in three previous press releases, argues, more pointedly than before, that the sale, endorsed by Forest City’s board majority after a narrow 7-5 vote that featured an about-face by the current CEO, amounts to a gift to hedge funds seeking a short-term gain and an example of self-dealing by that CEO, set to gain a substantial “golden parachute.”

Ratner is a not insignificant but by no means key shareholder, owning about 1% of the shares. Among the extended Ratner family that once controlled Forest City via a two-class share system (and now owns about 10% of the company, according to today's Plain Dealer), only current board Chairman James Ratner (who owns 2.46%) has publicly opposed the deal.

The others have not publicly allied with either camp, though the proxy statement indicates that representatives of the extended family did hold talks with Brookfield, but did not come to an agreement. (Depending on when they bought shares--and family members bought $20 million worth at one-quarter of the current price during the 2009 recession--they may be contemplating profits, rather than unrealized value.)

One of Al Ratner’s contentions is that the proxy statement misled investors by not specifying the Ratners' ownership percentage. Indeed, it wasn’t clear from the proxy statement nor even his first press release, but he has specified it subsequently.

Ratner believes that the value of Forest City’s properties, both now and in the future, is worth substantially more than the $25.35 cash offer, seen by the board majority—and endorsed, somewhat gingerly, by two advisors to institutional shareholders—as a worthwhile deal.

While that total value is indeed debatable—it depends on assumptions about the ability to monetize standalone properties, as well as variables like interest rates—other Ratner points seem more solid, though it remains to be seen how much legal weight they have.

Forest City, according to Crain’s Cleveland Business, had no comment on the filing. It’s not clear whether the court will take any action, but the lawsuit also asks, if the merger goes through, that the court unwind it.

A "gaping chasm" in value?

"It is unfortunate that I have had to take this action in order to protect the interests of Forest City stockholders, who deserve adequate disclosures in the interest of ensuring full and fair value for their ownership of the company,” Ratner said in a statement. “No matter how you slice it, there is a gaping chasm in valuation between the figures and framework depicted in the proxy and the true value of the company.”

Ratner says the effective value of Brookfield's offer is not $25.35 per share as announced, nor even $24.99 per share—the offer minus two quarters’ worth ($.36) of dividends, which were suspended—as he and the board minority had previously contended.

Ratner calls Brookfield's offer price effectively “a paltry $23.09 per share,” since it doesn’t take into account the value of Forest City’s recent performance: $2.62/share in net earnings for the first nine months of this year. (If you add $23.09 and $2.62, the total is $25.71, then subtract the first two quarters of paid dividends to reach $25.35.)

“What has occurred in the third quarter report was never projected in anything put forth and that is wrong,” Ratner told The Real Deal. “People bought and sold stock without this information.”

Ratner, of course, takes an optimistic scenario of the company’s value, $43.78/share, based on a 2020 estimate that the board majority, and its advisors, found questionable. But he makes a strong case that the current price is a bargain for Brookfield, and an attractive deal for certain parties. And he argues that the proxy statement should have done far more to explain those calculations.

In his lawsuit, Ratner charges that the board “was or should have been aware of these dramatically improved results when the Proxy Statement was filed,” and, indeed, a company press release quoted LaRue as saying third quarter results “met our expectations.” Had he “been aware of this information at the time the Proxy Statement was filed, he would have engaged in a proxy fight,” aiming to sway shareholders, he says.

The Financial Times reported that board members supporting the deal questioned Ratner’s calculation, saying that the complex ownership structures behind Forest City’s properties would make them tough to monetize.

The Wall Street Journal quoted Brookfield Chief Executive Brian Kingston as saying they can buy cheap because it seeks "either more complex transactions or contrarian investments where we're pursuing assets that are out of favor at the moment.” Analyst Hemant Kotak put it differently: "Brookfield is well-known to seek assets when there's blood in the water.”

Whatever the outcome of the lawsuit, it looks like even more blood in the water now.

A questionable set of decisions

As detailed in the company’s proxy filing, the 7-5 vote turned on a decision by CEO LaRue to change his vote. As Ratner points out, LaRue apparently made no effort to negotiate a better price but did receive assurances of his $12.6 million golden parachute, and thus changed his vote, resulting “in a nearly unprecedented split vote (7-5) by the board of a public company determining to proceed to negotiate a merger.” Ratner calls it an “apparent quid pro quo.”

Moreover, six of the seven board members—other than LaRue—were voting just 66 days after being appointed. Ratner charges that the deal seemed wired: the board didn’t contact other buyers or consider “other strategic options,” such as refinancing existing assets, to reward shareholders. The proxy statement, he notes, fails to disclose what stockholders might receive were Forest City liquidated.

He also points to the machinations of hedge funds. Notably, Scopia, one of the funds that threatened a proxy contest and thus got Forest City to replace eight of 12 board members—in retrospect, a risky move—no longer supports Brookfield’s offer because it has already sold its 8.15% of Forest City stock, thus locking in short-term gains.

Once the new board was in place, Brookfield offered less money than its previous offer, which had been rejected, Ratner notes, but the proxy statement doesn’t explain why. He suggests—without specific evidence, that Brookfield’s bid was done at the urging of Scopia and Starboard, another hedge fund.

Ratner questions the advisory opinions the board got from Lazard Freres and Goldman Sachs, saying the financial incentives for a merger tainted their advice. Indeed, as I wrote 9/24/18, Lazard has earned $7 million so far, but would get another $20 million if the deal goes through, while Goldman  has earned $4.7 million, but would get another $13.3 million.

However, he got only a partial backup from the advisory firm ISS, which, while issuing a guarded recommendation in support of Brookfield’s proposal, did note “valid concerns with the approval process and transaction terms.” That recommendation likely would be sufficient for large stockholders like Vanguard, which invest via index funds, to vote yes.

False or misleading statements

But the lawsuit is not about business strategy. Ratner argues that the proxy statement contains misleading statements, such as saying stockholders will get $25.35 per share, since that doesn’t acknowledge the $.36 in foregone dividends or the significant value in the recent earnings report.

He also argues, more debatably, that the document misleadingly portrays Forest City’s stock value. The proxy statement states that $25.35 “represents an approximate 26.6% premium over the closing price of common stock on June 15, 2018, the last trading day prior to a Bloomberg News report that Brookfield was engaging in discussions to acquire the Company, and an approximate 26.7% premium over the volume weighted average price of common stock over the 30-day period ended June 15, 2018.”

That's one way to frame it, though presumably a different time period would've produced a different number. Ratner, for example, compares that number to the $26.20 price on September 11, 2017, the day that Forest City announced that it had begun a strategic process. Then again, presumably, the lower price reflected some new pessimism after Forest City's strategic process led not to a sale but a decision this March, to remain as a standalone company: the price dropped below $20 after that announcement. He also says the NAV (net asset value) should have been supplied.

Ratner also points out that, while the proxy statement “prominently touts” that the “Board recommends that you vote ‘FOR’" the Brookfield deal (see below), it does not disclose that a split board is rare and “attempts to bury the legitimate arguments against approval” by using a subheading that cites “of our Directors” rather than opposition.

Moreover, while the proxy statement cites the ownership percentages of pro-merger hedge funds Starboard (owning 5.63%) and Scopia (then owning 8.15%), it doesn't disclose that Ratner family members, who had not agreed to the deal (though weren’t necessarily opposing it) owned a significant chunk, some 10%.

The Proxy Statement, he argues, is misleading because it refers generally to actions taken by the “Board” without explaining that previous board was unanimous in rebuffing Brookfield, while the reconstituted board, with several activist-selected directors, was split.

A question of relationships

The lawsuit states that Forest City didn’t disclose communications between the board, Brookfield, and the hedge funds “regarding the odd and extraordinarily well-timed bid by Brookfield and information regarding contact between Brookfield and Board members before the meeting of the directors.”

Not only were two new directors “principals of Scopia or Starboard,” at least one new director “had pre-existing but undisclosed business relationships with a principal of Starboard," the lawsuit charges. That doesn't get detailed but, presuming the lawsuit goes forward, would be tested in court.

Al Ratner Lawsuit by Norman Oder on Scribd