One test of Macquarie Group’s corporate governance reforms is summed up in the question: does it make it easier for hostile corporate activity to occur?

The question has been raised because corporate governance experts have claimed that externally managed funds with management agreements in perpetuity, such as Macquarie Infrastructure Group, are structured to preclude a change of control.

Why would the manager of a fund like MIG, which last year paid Macquarie $56 million in management fees, leave itself open to losing management control?

But precluding the possibility of a change in control removes the prospect of a takeover premium being paid for the stock. That lack of an acquisition premium could go some way to explaining why stocks like MIG trade at a significant discount to net assets.

MIG for example last traded at $2.09, about 27 per cent below its net assets. The MIG market capitalisation is about 70 per cent below its enterprise value of $18.6 billion.

Hostile corporate activity could close the gap between net assets and the share price by forcing Macquarie to be more aggressive in releasing the fund’s inherent value.

Over the past 12 to 18 months, funds trading at a discount to net assets have been attacked by hedge funds managed out of London and the United States such as Laxey Partners, Pendvest, Carrousel Capital, Weiss and North Sound Capital.

Typically, these funds buy shareholdings of 15 to 20 per cent and then agitate to force the manager to buy back or redeem units. They usually threaten to have the manager removed.

Hedge fund activity has been confined to funds with a market capitalisation of less than $1 billion. Funds that have been hit include Linq Resources Fund and Everest Babcock & Brown Alternative Investment Trust.

The hedge funds involved in recent incidents have tended to hunt in packs. Their combined stakes on the table have been between $300 million and $400 million.

Full blown takeovers have occurred, most notably in the fight over Lion Selection. Also, there have been isolated attacks against listed funds that have fizzled out such as the Pendvest move on Babcock & Brown Capital and the Arkmile attack on Challenger Infrastructure Fund.

An attack on a fund like MIG, which has a market cap of $5 billion, would be a significant step up for the hedge funds or single hostile bidders. It would probably require combined investment stakes of at least $800 million and the support of other shareholders.

However, in the case of MIG, the prize is a big one. It has quality infrastructure assets in Australia, Europe and the United States and it will have cash of $1.26 billion by March next year.

MIG has tried to close the gap between its share price and net assets by launching a $1 billion buy-back of 10 per cent of its issued capital. It has being buying stock at about $2.20 a share, a 23 per cent discount to net assets.

Chairman of MIG’s responsible entity and former Macquarie deputy chairman Mark Johnson told the MIG annual meeting on Wednesday that if the fund received a takeover offer it would consider it.

MIG is one of three of Macquarie’s listed funds that have responded to investor pressure for improved corporate governance by making changes to director appointments and publishing management agreements that dictate the relationship between Macquarie and the funds.

Johnson, who was appointed by Macquarie, will stand for re-election at next year’s annual meeting. Other directors can be nominated by anyone backed by 100 security holders or 5 per cent of issued capital.

MIG has two trusts in Australia and a company in Bermuda, which is advised on investments, divestments and operational issues by a Macquarie subsidiary.

Management of MIG is a cooperative effort between the boards and management of the trusts and the directors of the company with advice from Macquarie.

The publication of the management agreements for the various Macquarie funds will provide potential bidders with greater certainty about the relationships between Macquarie and the funds.

But it will not change the fundamental protections in the structure of the funds that make it difficult to remove Macquarie as manager.

Although the trusts and the company may terminate the appointment of Macquarie as responsible entity and adviser without cause, it requires a 50 per cent majority of votes cast at a meeting of security holders. The company adviser can only be removed on a vote if the responsible entity of the trusts is also removed.

Macquarie is able to vote its 17 per cent shareholding, which means a hostile move would need to gain the support of about 60 per cent of the available capital not owned by Macquarie. That is a big ask. But hedge funds have shown that aggressive agitation can be sufficient to encourage funds to come to the table.

Another line of attack would be to take advantage of the changes to MIG’s method of director nominations and voting.

In line with its improved corporate governance Macquarie has said it will give security holders the right to nominate and vote on the appointment of all directors. Macquarie said it will abstain from voting the stapled securities it holds as principal in MIG.

Macquarie will give effect to the unit-holder vote by allowing its two special voting shares to be cast in favour of the voting decisions by unit-holders. Macquarie owns an A special share which is entitled to appoint up to 50 per cent of the directors of the company and one of its two responsible entities owns a B special share which is entitled to appoint up to 25 per cent of the directors.

Macquarie’s latest changes will effectively allow a hostile bidder to achieve majority control of the boards of the trusts and the company with only about 42 per cent of the shares on issue, assuming all unit-holders vote and that more than half the directors stand for election at the first unit-holder vote in 2009. A 100 per cent turnout would be unusual so board control could change with as little as 30 to 35 per cent of the issued capital.

We will not know the details of the director nomination criteria and relevant board composition criteria until December, but it would appear that Macquarie has made changes that will serve to weaken its vice like grip on MIG and the other listed funds Macquarie Communications Infrastructure Fund and Macquarie Airports.

It would seem that Macquarie has made it easier for hostile corporate activity to occur, a move that could unleash up to $1.7 billion in hidden value.

Peter Fray

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