Since last week, Under Armour (UA) started trading three different classes of shares differing only in voting rights. A class share (NYSE: UAA) has one vote per share, B class share (NYSE: UA-B) has 10 votes per share, and C class share (NYSE: UA-C) has no voting right.
A dual-class share structure is often designed “to ensure the long-term company growth based on the vision of the founder not to be affected by the market’s short-term earnings driven pressure.” The dual-class share structure is industry specific, more in communication, technology, special retail, and in IPOs, as these companies require visionary founders, including News Corp., The New York Times, and The Washington Post. The founding families of these companies—the Murdochs, Sulzbergers, and Grahams—use dual class structures to keep control within their families. Other examples include Larry Page and Sergey Brin for Google, Mark Zuckerberg for Facebook, Gordon Bowker, Zev Siegl, and Jerry Baldwin for Starbucks, and of course, Redstone family for Viacom.
The intended purpose of the dual-class shares is to separate the control from the ownership of the company. Due to the 10-to-1 voting right per share, Ford family owning 4% equity of Ford has 40% of the voting power of the company. UA CEO Kevin Plank, owning the entire 35 million UA-B shares or 6.5% of Under Armor equity, has 65% of controlling voting interest.
On a more basic level, there is a fundamental conflict between the corporate governance and dual-class share structure. CEOs of public companies, founders or not, should be governed and evaluated by the Board of Directors who represent by the public capital market. The dual-class share structure allows the founders to circumvent the public capital monitoring. The most recent example is the power struggle between the CEO Shari Redstone and other members of the management team, which have since been booted from Viacom. Naturally, dual-class share structure is an obvious defense for takeover bids, hostile or not, from inside or not.
One of the arguments for the dual-class share structure is to reduce the “agency cost” from parties other than the stockholders. These parties, such as employee, customers, suppliers, and creditors, often operate rationally not to maximize company’s wealth but to their own wealth. However, in doing so, dual-class share structures by creating a class system within the stockholders will replace the existing agency cost with a new agency cost within the shareholders. Most of higher class shares, other than enjoying disproportional voting power, are often equipped with other private perks, such as higher dividend payout and higher priority of receiving liquidation payoff. So, dual class share structure is also perceived as a tool of “moral hazard” to transfer wealth from non-voting shareholders to voting shareholders. Though, for the case of UA, three class shares receive the same dividend payout.
In the early part of this year, Plank stunned the street by delaying 2015’s $800 million operating profit target till 2018, citing “to invest the money in the company in the moves of moving in footwear and the connected fitness space with these mobile fitness app acquisitions.” In the meantime, Plank has instituted two changes in dual-class share structure to preserve his controlling interest, while sold over $240 million of his holding. Both moves happened in 2016.
The stock market has priced in both the value of control and the agency cost associated with dual-class share structure. That is, non-voting shares usually traded at a discount of the voting shares.
To individual shareholders with no intention to manage the company, there is little value assigned to the voting power. On the other hand, institutional investors or activists investors who want to take the company to the direction different from founders’ vision will be willing to pay a premium for the voting rights. All shareholders will pay less if they see agency cost incurred.
Therefore, the discount usually varies over time depending on market pricing of the controlling values and agency cost. Viacom A shares (voting) have traded at a premium between 10%-15%, reached at 30% during the recent internal fight. For the last 6 months, UA-C shares have been traded at 20%-30% discount to the UAA shares. The higher-than-usual UA discount may reflect shareholders’ concern that the recently devised dual-class structure may have been a precursor for Plank’s defense of potential takeover bids — a very likely scenario since UA stocks have underperformed more than 40% for the past 12 months.
That said, Under Armour is the same economic entity which generates the same cash flow for all UA Class A, B, and C shareholders. For investors buying in Under Armour for Kevin Plank’s visions, it is not a bad deal to buy at a 20% discount.