I did not understand the Investment Company Act before. This set of regulations would be extremely onerous for Liberty Media if it were deemed to be an “investment company”. In particular, Liberty would likely run into problems with the following:
- Tracking stocks: These inherently have conflicts of interest between each other. This structure could be disallowed.
- Supervoting shares: Malone holds a high degree of voting control over many of the parts of his empire. He knows the importance of control as it allows him to correct mismanagement. These shares would likely be disallowed. I suspect that Malone would not receive a fair premium if his supervoting shares were converted into normal shares.
To avoid this regulation, Liberty cannot own more than 40% of its assets in stocks that it does not control. Liberty is presumed to control a company if it owns more than 25% of the stock. So far, Liberty has been buying shares of Live Nation and Charter simply to keep its ownership above 25%. If these regulations had not existed, I do not think that Liberty would have made those purchases. It would make more sense to repurchase Liberty shares, which Liberty was doing a year ago. It seems to me that Liberty is losing a small amount of money due to the threat of regulation.
One of the reasons why Liberty may fall under regulation is that a Charter merger could result in substantial share dilution, potentially pushing Liberty’s ownership below 25%. If Charter shares were to rise sharply, Liberty could be in a position where it would have more than 40% of its assets in stocks it does not control. Lately, Charter and Time Warner has announced a deal where (among other significant deals) Time Warner would spin-off a portion of its cable assets into a SpinCo. Charter would issue shares for partial ownership of this new SpinCo. This results in an unusual arrangement. Charter will manage the SpinCo. A downside to the structure is that there will be potential conflicts of interest between SpinCo shareholders and Charter shareholders. A merger between the SpinCo and Charter would be much simpler. However, it would result in more dilution of Charter shareholders and force Liberty to buy more shares of Charter. It seems that Tom Rutledge likes Malone and did him a favour by keeping dilution down.
Liberty’s Risk Factors
In the past, the threat of onerous regulation was listed as a risk factor in Liberty’s SEC filings (e.g. this 1999 S-4):
Our operations are subject to constraints imposed by the Investment Company
Act. Our operations are primarily conducted through subsidiaries and business
affiliates, and certain of our investments in those companies have been made
with strategic partners where we have a less than 50% voting interest. Under
the Investment Company Act of 1940, a company that is deemed to be an
“investment company,” and which is not exempt from the provisions of the
Investment Company Act, is required to register as an investment company under
that Act. Registered investment companies are subject to extensive, restrictive
and potentially adverse regulation relating to, among other things, operating
methods, management, capital structure, dividends and transactions with
affiliates. Registered investment companies are not permitted to operate their
business in the manner Liberty operates its business, nor are registered
investment companies permitted to have many of the relationships that Liberty
has with its affiliated companies.
Liberty’s current holdings in its subsidiaries and business affiliates are
such that Liberty is not an “investment company” required to register under the
Investment Company Act, and Liberty intends to conduct its business in a manner
designed to avoid becoming subject to regulation under that Act. To avoid
regulation under the Investment Company Act, Liberty’s operations will to an
extent be limited by concerns that it acquire investments in companies that
assure to it majority ownership or primary control of a magnitude sufficient to
cause Liberty not to fall within the definition of an investment company. These
considerations could require Liberty to dispose of otherwise desirable assets
at disadvantageous prices, structure transactions in a manner that assures
Liberty has a majority interest or primary control, irrespective of whether
such a structure is the one that is most desirable, or avoid otherwise
economically desirable transactions, including the addition of strategic
partners in Liberty’s current majority-owned subsidiaries and business
affiliates that it primarily controls. In addition, events beyond our control,
including significant appreciation in the market value of certain of our
publicly traded investments that may be deemed investment securities, could
result in our becoming an inadvertent investment company. If Liberty were to
become an inadvertent investment company, it would have one year to divest of a
sufficient amount of investment securities and/or acquire other assets
sufficient to cause Liberty to no longer be an investment company subject to
registration under the Investment Company Act.
If it were established that Liberty is an unregistered investment company,
there would be a risk, among other material adverse consequences, that we could
become subject to monetary penalties or injunctive relief, or both, in an
action brought by the SEC, that we would be unable to enforce contracts with
third parties or that third parties could seek to obtain rescission of
transactions with us undertaken during the period it was established that we
were an unregistered investment company.
The rules seemed to have changed since then. In the past, it seems like 50% was considered to be a threshold that constitutes control of a company. This seems to have changed to 25%. The SEC website has a copy of the Investment Company Act that confirms the 25% threshold on page 5.
Forbes had a good article in 2001 on the implications of the Investment Company Act for John Malone.
Liberty Media predictions – This is an old post where I goof and predict that Liberty would buy back shares and potentially get rid of Live Nation shares. Liberty ended up buying Live Nation shares (to stay ahead of 25% ownership) and did not buy back any shares.
*Disclosure: Long LMCA common shares.