MSC Industrial’s Special Committee Needs To Stand Up For Its Shareholders (NYSE:MSM)

I’m not a fan of dual-class share structures with publicly-traded companies. While I understand why founders want to keep control, it strikes me as a modern equivalent of the Animal Farm quote, “all animals are equal, but some animals are more equal than others,” and I believe more companies would do well to unwind the structures.

This brings me to MSC Industrial (NYSE:MSM) today, as the company just announced that the holders of the Class B shares (shares owned by the founding Jacobson family, including CEO Erik Gershwind (nephew of Mitchell Jacobson, the current Chairman and the son of the company founder)) have approached the board with a proposal to exchange their Class B shares for Class A shares at a substantial premium.

While I believe that the basic idea of unwinding the dual-class structure is appropriate and good for shareholders, I believe the premium is excessive and the board needs to push for a more equitable settlement.

The Offer

Before trading on Monday (February 6), MSC announced that the Class B shareholders had approached the board of directors with an offer to exchange their shares for Class A shares (the shares that trade as “MSM”) and eliminate the dual-class share structure. Their offer was to execute the exchange at a 1.35x ratio of Class A shares to Class B shares.

The Shares Involved

As is often the case with dual-class share structures, only one of MSC’s share classes, the Class A shares, trade on a public exchange. The primary difference, apart from the liquidity, is that Class A shares get one vote each, while the Class B shares get 10 votes. This is an exceptionally common arrangement with these structures (and their primary purpose – to give privileged shareholders more voting power), and it gives the Jacobson/Gershwind family just under 66% of the total voting power.

There is no difference in the dividends paid between the two share classes, and I think it is worth noting that each share of Class B stock can be converted into Class A shares at the choice of the shareholder at a one-to-one ratio.

The Proposed Premium Is Too High

I do believe that the dual-class share structure at MSC should go, but I find the 35% premium proposed by the Class B shareholders to be unacceptably high. I’ll offer a couple of reasons why.

First, looking at those stocks where the Class A and Class B shares are both publicly-traded suggests that investors do not value the additional voting rights that highly. Between Bel Fuse (BELFA) (BELFB), Bio-Rad (BIO)(BIO.B), Central Garden & Pet (CENT)(CENTA), First Citizens BancShares (FCNCA)(OTCPK:FCNCB), Alphabet (GOOG)(GOOGL), H. Lundbeck (OTCPK:HLBBF)(OTCPK:HLUBF), Kelly Services (KELYA)(KELYB), Moog (MOG.A)(MOG.B), Rush Enterprises (RUSHA)(RUSHB), and Molson Coors (TAP)(TAP.A), the widest difference in value is at Molson Coors, where the more privileged shares trade at a 22% premium.

In some rare cases, like Bio-Rad, the privileged voting shares actually trade at a discount, and with Moog, which compensates the Class A shareholders with some dividend protection, there’s almost no split. In any case, when both classes trade publicly, it’s rare for the more privileged class to get a substantial premium. To be fair, among all of those examples are substantial differences in voting power (what those privileged votes mean in terms of percentage of voting control), and I think the Molson Coors example may be the most directly comparable here.

Perhaps publicly-traded examples aren’t the best ones to use. Okay, let’s take a look at cases where privileged class shareholders have exchanged their shares and collapsed the dual-class structure. There are two relatively recent examples – Hubbell (HUBB) and Constellation Brands (STZ). In the former case, Hubbell paid a 20% premium (about 3.5% of market cap), while in the latter case Constellation Brands paid a 26.5% premium (about 3.3% of market cap).

MSC’s proposal is a 35% premium that equates to about 5.4% of market cap.

I won’t pretend that there aren’t any benefits to Class A shareholders here. It is likely that there is some modest discount in MSC’s valuation because of this structure, and there are investors who simply will not invest in the company because of the structure (there are funds whose mandates exclude such companies). The move would also take away the ability of the Class B shareholders to unilaterally advance proposals that would not be in the best interests of all shareholders.

All of that being said, I simply see no reason why MSC’s Class B shareholders should enjoy a premium above and beyond what the privileged classes got in those two prior examples (Hubbell and Constellation), particularly as I see Constellation as pretty directly analogous (a founding family that ran the company until fairly recently).

What Happens From Here?

MSC’s press release said that the company has formed a special committee to evaluate the proposal, and the directors on this committee are independent (not Class B shareholders). If they recommend the transaction, the Class A shareholders would then have to vote for the proposal before it would go into effect. As part of the transaction there would likely be some sort of buyback to reduce the dilution.

I very much hope that the committee rejects the proposal as presented and suggests a transaction at a more appropriate price. I’d like to see a premium closer to 20% (more in-line with the Hubbell deal and the current spread with Molson Coors share classes), but could live with, and would vote for, a proposal closer to 25%.

The Bottom Line

I would refer readers back to my most recent article on MSC Industrial for more discussion of the current financial and valuation considerations with this company and stock. I do still see upside from here, and I can see some paths where this proposal would benefit shareholders, but I hope MSC’s special committee pushes back on what I believe is a proposal that offers too much to controlling shareholders as currently presented.