IN-DEPTH: Starboard has ‘strong’ case at Box, top investor says

A top 10 shareholder in cloud technology company Box is supportive of Starboard Value’s intention to launch a proxy contest, saying the activist investor has a “strong” case for change.

The investor, which declined to be named, agrees with Starboard that a recently announced KKR Asset Management investment was unnecessary and smacks of “self-preservation,” particularly since it came shortly after a similar deal on better terms.

“They basically bought votes for the proxy,” the investor said in an interview with Activist Insight Online.

Bad timing

Starboard announced on May 3 its intention to nominate directors at Box, after private discussions failed to bear fruit. Among other things, Starboard said it was disappointed by the continued underperformance and recent financing transactions.

Amid pressure from shareholders to sell itself, Box reached a deal with private equity firm KKR to instead issue $500 million in convertible preferred stock with a 3% dividend, in exchange for a board seat. The deal could make KKR one of the largest shareholders with around 11% of the stock. The capital raise comes months after Box issued a convertible bond worth $345 million with zero interest.

“The only viable explanation for this financing is a shameless and utterly transparent attempt to ‘buy the vote’ and shows complete disregard for proper corporate governance and fiscal discipline,” Starboard said in the letter dated May 3.

With the proceeds, Box says it will launch a tender offer after it publishes its first-quarter fiscal results, and shareholders can either choose to monetize their investment now or “participate in any upside potential with KKR as a committed partner.”

The investor said it has not decided yet whether it will tender, but any decision to sell will depend on the price offered. Given the nominations, Starboard is unlikely to sell.

Too low

Box, a $3.3-billion market capitalization file sharing services provider, has benefitted from strong tailwinds as a growing number of businesses move online. However, competition from larger, well-heeled rivals like Microsoft have taken some of the wind from its sails, leading to market skepticism and weak shareholder returns. Box’s five-year total shareholder return is 78%, versus the median peer’s 206%, according to Activist Insight Vulnerability.

Shareholders also argue that poor execution by the management team is also at fault for the underperformance, and would prefer a sale at a premium. Activist Insight Online understands that Box has received inbound interest for a full takeover, but the price offered was not high enough for the management team led by CEO Aaron Levie. “Management has unrealistically high expectations about what the business is worth,” the investor said.

Poor defense move

White squire deals have had mixed success. In 2017, Cornerstone OnDemand, facing pressure from shareholders to sell itself, reached an investment agreement with private equity firm Silver Lake. Although it has not faced any more public pressure following that, its CEO and founder was subsequently replaced. The stock has moved sideways since, even though the company made a transformative acquisition by purchasing Saba Software.

More recently, USA Technologies, amid ongoing engagements with Hudson Executive Capital, made a private placement of shares and debt that some investors said was unnecessary. Shortly after the deal, Hudson Executive launched a successful proxy contest for the replacement of the entire board.

Strategic transactions with white squires can be a “very effective defense from activist pressure,” Aneliya Crawford, global co-head of activist defense at UBS, has told Activist Insight Online. “That said, the transaction must serve a legitimate business purpose to be viewed as a positive by shareholders. Otherwise there is a risk of just pouring oil into the fire,” Crawford added.

Indeed, one of the white squire transactions that was effective in eliminating dissident pressure involved Starboard in an unlikely role. At Papa John’s, a PIPE (private investment in public equity) deal that led to the appointment of Starboard CEO Jeff Smith as chairman of the board led to the removal of the dissident threat from estranged founder John Schnatter.

Amid pressure from Elliott Management to replace the CEO a year ago, Twitter partnered with Silver Lake, which made a $1 billion investment. Elliott blessed the deal and received a board seat, while CEO Jack Dorsey is still in charge.

To avoid an embarrassing defeat at the next annual meeting, Box will need to offer better explanations to shareholders or negotiate a settlement with Starboard.