Shareholders Rights Caught in the Middle Schottenstein Stores Corp.'s Jay Schottenstein has an offer for Burnham Pacific Properties on the table. The REIT's board says the offer is inadequate. What's a shareholder to think? by Barry Vinocur Illustration by Mark Kseniak

Of 18 shopping center REITs that have been around for at least three years and have enough analysts tracking them to have earnings estimate coverage by First Call, Burnham Pacific ranks 14th (see table on page 22) based on its trailing three-year total return through October 1. (Martin joined Burnham in early October 1995.) If you look at other performance measures, Burnham hasn't fared any better.

Though the company's total asset base has grown from roughly $350 million when Martin joined the company to roughly $1.2 billion currently, Burnham's FFO (funds from operations) growth has been among the lowest of its peers (see table below). To add insult to injury, Burnham's dividend growth—usually REITs' strong suit—has been anemic, to put it mildly (see Dividend Growth table on next page). Moreover, based on analysts' projections, Burnham's future doesn't appear much brighter than its recent past.

During a telephone interview, Malin Burnham, the company's 71-year-old chairman, conceded that the "numbers are disappointing to me, David, and the board." But Burnham, who has been in the real estate business for roughly 50 years, underscored that real estate is a cyclical business. "Can I tell you when it will rebound? No. But it will rebound." Burnham stressed that since Martin joined the company, the San Diego-headquartered REIT has pursued a long-term plan focused on maximizing shareholder returns. Burnham reacted incredulously when told that based on annual returns, as well as FFO growth per share, the company ranked near the bottom of its peer group. "There's no way that we have done that poorly," he said.

The company's performance and in turn that of its CEO have come under intense scrutiny because in late July its board unanimously rejected a buyout bid from Schottenstein Stores Corp., a closely held firm based in Columbus, Ohio. (On June 6, Realty Stock Review Online [www.realtystockreview.com], Property's sister publication, broke the story that Jay Schottenstein planned to offer $13 per share for all of the company's outstanding shares.) At the time Jay Schottenstein made his initial bid, he owned roughly an 8.2 percent stake in Burnham. He has since increased that stake to within 100,000 shares of the 9.8 percent stake he can hold without prior board approval. On July 13, Schottenstein upped his bid to $13.50 per share. Since Burnham rejected his offer, Schottenstein has made no public statements, nor has he made any additional filings with the Securities and Exchange Commission. Despite the silence, sources close to the Schottenstein camp have told us that Schottenstein's offer, which is subject to due diligence, is still on the table. When asked if Schottenstein still wanted to buy the company, the source, who spoke on the condition of anonymity, said, "Yes." The source stressed that Schottenstein's goal is to buy Burnham and take it private. "He believes there are synergies between his family's existing portfolio of shopping centers and the Burnham portfolio," the source added.

Feinberg Makes Some Waves
In late August, Schottenstein got a measure of support, albeit indirectly, from another large shareholder. Stephen Feinberg of Blackacre SMC Master Holdings, which holds roughly a 7.5 percent stake in Burnham, filed a 13-D with the Securities and Exchange Commission on August 20. In his filing, Feinberg states the New York-based firm is the holder of 1,599,990 preferred operating partnership units. (Burnham has the option of either redeeming those units for cash or converting them into 1,599,990 shares of the company's Series 1997-A convertible preferred stock.) Blackacre's holdings are convertible into 2,601,626 shares of Burnham's common stock.

Though Feinberg's filing states that his firm's position in Burnham is being held as an investment, it also states that Blackacre may decide to communicate with other shareholders or individuals who might want to become Burnham shareholders about a number of matters, including the replacement of the company's executive officers and/or board members. Blackacre's filing also states that the firm might seek the removal of one or more members of the company's board as well as one or more of its executive officers. It also may solicit proxies to be used at the company's regular annual meeting or a special meeting for the purposes noted. Feinberg's filing goes on to say that his firm may seek to cause Burnham to merge with or transfer all of its assets to other parties. Though this portion of Blackacre's filing makes interesting reading, that's it.

More noteworthy is the letter that Blackacre delivered to Burnham on June 15, roughly one week after Schottenstein made public his original $13 per share bid for the company. Prior to the Blackacre filing, Realty Stock Review reported that Blackacre was working behind the scenes to get Burnham to "do the right thing." The letter, which is attached as an exhibit to the August 20 filing, provides specifics. Simply put, Blackacre's letter underscores that it expects Burnham's management and its board "to take all steps necessary, to insure that [Blackacre], as well as the other holders of equity interests in the company, receive maximum value for [those] interests." The letter continues, stating, "It is imperative that you [the letter is addressed to Martin] act in a manner that makes it clear to the market and your shareholders that the company's actions are not motivated by a desire to perpetuate management's and the board's control over the company."

The next section of the letter is perhaps the most significant. Blackacre's Ron Kravit wrote that it had come to his firm's attention that the Burnham board was considering adopting "defensive takeover mechanisms" in response to the Schottenstein offer. "A poison pill or other defensive mechanism does not, in our view, represent a reasonable response to the Schottenstein proposal," Kravit stated in the letter. What did seem reasonable to Blackacre? Again, the emphasis is on engaging in a process designed to maximize value for all shareholders. (Nowhere in the Blackacre letter, nor in the filing, does Blackacre suggest that Burnham accept the Schottenstein bid.) Kravit's letter urged Martin to vote against the adoption of a poison pill or other anti-takeover mechanisms. The failure to act in a "shareholder friendly manner," Kravit wrote, would further depress the market value of the company's stock and subject the board's actions to scrutiny by the courts. On June 19, Burnham's board adopted a poison pill.

In an August 20 letter to Burnham's board, Blackacre's Kravit wrote that after reviewing the company's shareholder-rights plan, his firm believed certain modifications were required to "avoid the inadvertent trigger" of the rights by Blackacre's conversion of its preferred OP units into Burnham stock.

During our interview with Malin Burnham, he stressed that the rights plan's sole goal is to help ensure that in the event of a takeover, the company's shareholders get the highest possible price. "Every study we looked at showed that companies with rights plans sell for a higher price than those without them." (See sidebar on page 28.)

A Bit of Background
How did Blackacre and Westbrook end up with their stakes in Burnham? In late 1997, Blackacre sold a portfolio of shopping centers to Burnham for roughly $300 million. The purchase was financed, in part, by the sale of preferred stock and preferred operating partnership units to Blackacre ($50 million) and Westbrook ($70 million). Those securities have a conversion price of $153/8. Among the terms of that deal is that Blackacre and Westbrook have the right to veto any sale of Burnham at a price under $153/8. Further, though Blackacre and Westbrook wanted a board seat, Martin refused that request. Instead, it was agreed that Blackacre/Westbrook could nominate someone to serve on Burnham's board. Their nominee was Nina B. Matis, an attorney with Katten Muchin & Zavis in Chicago. Though Matis is the Blackacre/Westbrook nominee, she is independent of them.

The Conference Call
Prior to the Blackacre filing, there were rumors that the firm might "go public" via a 13-D filing—however, the "final straw" for Blackacre reportedly was Burnham's second quarter conference call on the afternoon of August 12. Dan Platt, Burnham's CFO, led off the call by reporting the company's earnings, which can only be characterized as disheartening. First, the company's second quarter FFO of 34 cents per share was flat with the year-ago period. (After excluding one-time gains, such as lease termination fees, which totaled $800,000, Burnham's same-store net operating income also was flat in the second quarter.) Further, the company's planned sale of the Bergen Brunswig building for $19.3 million was well below analyst expectations. In his note, Morgan Stanley Dean Witter's Drew Jones wrote that the price was 30 percent below what he had expected. Following the company's conference call, several analysts reduced their 1999 and 2000 estimates for the company.

Institutional Holdings

Name Shares Held (millions) Pct. Outstd. Morgan Stanley Asset Mgmt 3.7 11.7% Schottenstein Stores Corp 3.0 9.5% Blackacre SMC Master Holdings 2.6 7.5% Westbrook Real Estate 2.3 7.1% Morgan JP Inv Mgmt 1.2 3.8% Van Kampen Amercian 1.1 3.6% Vanguard Group 0.8 2.6% Morgan Guaranty Trust 0.6 1.9% PNC Bank Corp 0.6 1.8% Data as of June 30, 1999 Source: Technimetrics, Bloomberg

Morgan Stanley Dean Witter's Jones wrote in his note that the combination of the implementation of golden parachutes (more on those, later), the sale of the Bergen Brunswig building at a price well below what he had expected, and the sale of four San Diego retail properties at cap rates worse than he expected led him to reduce his 1999 FFO estimate from $1.40 to $1.38 per share. He reduced his year 2000 estimate from $1.54 to $1.45 per share. Merrill Lynch analysts Eric Hemel and Craig Schmidt dropped their estimates as well (and coverage of the company). Their 1999 FFO estimate went from $1.39 to $1.37 per share, and their year 2000 estimate went from $1.53 to $1.43 per share.

As of the end of the second quarter, management said it had spent $875,000 on matters related to the Schottenstein bid and estimated it would spend at least an additional $2 million. In response to a question, Burnham's Martin said he believed the company's 20 largest institutional holders (excluding index funds) had been asked about the bid and, with the exception of one "small holder," all had backed the company's decision not to pursue the Schottenstein bid. He added the feedback from the company's retail shareholder base, which he said had been virtually unanimous, also had supported not pursuing the Schottenstein bid. One large holder, who obviously was not happy with management, responded during the question period that his firm, which he said owned more than 400,000 shares, had never been queried.

Phantom Stock Awards

Name Shares Percent of Total David Martin 425,926 78.0% William Byrne 30,000 5.5% James Gaube 30,000 5.5% Dan Platt 30,000 5.5% Scott Verges 30,000 5.5% Total 545,926 100% Source: Company 8-K

The "hot button" for conference call participants was the company's recent adoption of golden parachutes for its senior executives. (A more modest plan was put in place to cover less senior employees.) Though analyst and investor estimates vary, generally, they value the program at between 35 and 50 cents per share. The employee retention program includes severance agreements as well as a phantom stock plan. The senior executive severance agreements, which cover Martin, Joseph William Byrne, James W. Gaube, Daniel B. Platt, and Scott C. Verges provide that, following certain triggering events (a change of control followed by the employee's dismissal), the named senior executives would receive three times their then current salary plus three times their then current annual bonus target. The severance agreements also provide for the reimbursement of certain tax payments.

Most of the attention was focused on the phantom stock plan (see table on page 24), however. In total, Burnham issued 545,926 phantom stock awards. The shares are to be awarded over 10 years. In the event of a change of control, however, the shares would be awarded immediately. Malin Burnham defended the plan, pointing out that with a bid on the table, the company needed to ensure that employees stayed focused on Burnham's business plan and that the company didn't lose key middle management personnel.

Analysts and investors said they could live with the plan covering middle management, but what they found egregious was the plan covering the senior executives, generally, and Martin, specifically. "When Martin signed on at Burnham, he didn't want an employment contract. Now, all of a sudden, he thinks employment agreements are a great idea," said one industry veteran who spoke on the condition of anonymity. (Calls to Martin's San Francisco office weren't returned.) One investor on the conference call said he thought it was unconscionable to award phantom stock at a strike price below an offer on the table that had been rejected.

Where's Jay?
Burnham's stock price dropped by more than 10 percent following the conference call. Is Schottenstein throwing in the towel on Burnham? Schottenstein has not returned our calls. Nevertheless, since Realty Stock Review Online broke the story that Schottenstein would make a bid for Burnham, that publication has spoken with dozens of people who know Schottenstein. Plus, Schottenstein is no stranger to a number of REIT CEOs. Everything Realty Stock Review and Realty Stock Review Online heard and continue to hear about Schottenstein suggests that his bid is 1,000 percent real. Further, based on dozens of conversations with people who know Shottenstein, there's no reason to suggest he'll fold his tent and abandon his bid for Burnham.

Several analysts and investors have questioned whether Schottenstein really wants to own Burnham's assets. Might his goal have been to put Burnham in play? Again, based on conversations with sources close to Schottenstein, it's clear that his goal is to own Burnham's assets. Period. Several sources close to the Schottenstein camp said Schottenstein dispatched a team of 12 people, who spent 3 1/2 weeks visiting every one of Burnham's properties. His conclusion: He wants to own Burnham's assets. Why does he want Burnham? Schottenstein owns roughly 50 shopping centers. His centers' gross leasable area is roughly twice that of Burnham's. Schottenstein reportedly believes not only that Burnham's centers are undermanaged, but also that there are a number of synergies that he can achieve by merging the portfolios. Another plus: Schottenstein likes the West Coast exposure the Burnham assets would give him.

Why hasn't Schottenstein gone hostile? Good question. According to several sources, Schottenstein will go hostile if necessary, but his advisors reportedly believe he should sit tight for now. Several sources said they believe other large investors will follow Blackacre's lead and go public with their views. If that happens, they believe, Burnham's board and Martin will be forced either to sit down with Schottenstein and cut a deal or look for a white knight. Said one source: "The outcome is preordained. The pressure on Martin and the board will increase to the point at which they'll have to negotiate. From Schottenstein's point of view, you're far better off negotiating if you haven't gone hostile."

Calpers
Last year, Burnham entered into a joint venture with the California Public Employees' Retirement System (Calpers). It's an 80 percent (Calpers) and 20 percent (BPP) joint venture. At the outset, Calpers contributed $80 million in properties to the joint venture. Burnham contributed $20 million in cash. Early this year, the Calpers/Burnham joint venture agreed to acquire a package of retail assets—in three tranches—from AMB Property Corp. (Two of the three tranches have closed.)

The deal's terms call for Burnham to be paid 50 basis points as an acquisition fee (on gross asset value; to be paid at the time the acquisition closes), a 50-basis-point disposition fee (on gross value; paid at disposition), a 40-basis-point asset management fee (on gross asset value; paid quarterly), a 300-basis-point property management fee (based on gross revenues; paid monthly), a 300-basis-point development fee (not including land; paid over the development period), and leasing fees at 75 percent of market rates.

In discussions with some investors, Burnham's Martin has stressed the value he believes is "embedded" in the Calpers deal. Martin has reportedly told a number of investors he doesn't want to focus too much attention on the deal's terms because he doesn't want Calpers to think the deal is too rich on Burnham's end. Nevertheless, he has reportedly said that his estimate that Burnham is worth in the range of $16 to $17 per share is based largely on the payoff from the Calpers deal over the next five years.

Calpers has been a leader in the movement to improve corporate governance. Its Web site at www.calpers.ca.gov includes a section devoted to its efforts on this front. We wanted to ask Guy Jaquier, who heads the pension fund's real estate division, for his thoughts on Burnham's poison pill, golden parachute, etc. Since Calpers has battled effectively against poison pills and executive compensation programs that entrench existing management, we wondered whether Jaquier had discussed Burnham's recent actions with Martin or Burnham's board. Jaquier was on vacation when we called. However, a spokesperson for Calpers explained that since the pension fund isn't an investor in Burnham per se, it wouldn't focus on such issues. He underscored that Calpers has been very satisfied with Burnham's performance thus far.

Analysis
Whether Burnham's board sits down with Schottenstein before it's dragged kicking and screaming to the negotiating table is tough to know. What is clear, however, is that as more time passes, and investors take the time to look at the job Martin has done since he joined Burnham, shareholders are likely to grow impatient. In the company's 1997 annual report, Martin stressed that the company's goal was "to remain a dominant retail REIT on the West Coast while maximizing the total return to our shareholders." Despite phenomenal growth in the company's asset base, Martin hasn't done that. Moreover, the argument that "the market just doesn't give Burnham the credit it deserves" doesn't wash. As the data show, Burnham's performance—by every conceivable measure except growth in its asset base—has seriously lagged behind its peers.

When Realty Stock Review Online broke the story on the Schottenstein bid in early June, it made Burnham a Strong Buy because whatever Martin's take on the offer, the newsletter believed the board and Malin Burnham would do the right thing for shareholders. Malin Burnham is an icon in San Diego and is well known for his good works. Malin Burnham is a very wealthy man and, at this stage of his life, he cares far more about how his fellow San Diegoans regard him than hanging on to a title.

When Realty Stock Review spoke with Malin Burnham, he stressed several things. First, he underscored and highlighted that he and the board weren't hanging a "for sale sign" on the company. He also emphasized that the board wasn't there to entrench management. "We're not looking to sell the company. We have a business plan, and we're pursuing that plan. But if someone puts forth what we believe is a fair offer, we'll present it to the shareholders." Malin Burnham added that he thought Schottenstein's initial offer, as well as his current $13.50 bid, constitute low-ball offers. (See sidebar on page 28.) "This company is worth a lot more than that," he said. Though he declined to provide a specific number, he noted it wasn't unreasonable to think that Burnham could trade at $16 to $17 per share. "If the market turns and investors decide to come back to REITs, that's certainly possible," he emphasized.

Malin's Missive Malin Burnham, chairman of Burnham Pacific Properties, recently sent a letter to the REIT's shareholders. In his letter, Malin Burnham wrote that the company's board of directors believes Schottenstein Stores Corp.'s current $13.50 per share (unsolicited) bid (subject to due diligence, of course) is inadequate. "We believe the company you own is worth more," he explained. On that score, Malin Burnham and Burnham's board are not alone. Over the past couple of months, a number of shareholders, including some of Burnham's largest institutional shareholders, have made it clear they agree that if Schottenstein Stores' Jay Schottenstein really wants to own Burnham's assets, he'll have to up the ante. Mind you, a lot of these investors aren't happy with the way Burnham's board and management team have handled themselves, but that's a separate issue. How much Schottenstein has to up the ante to get Burnham is the question. On that score, opinions differ. There is a consensus, however, that it will take "a number with a 14 in front of it," as one institutional investor put it recently. The number being bandied about is $14.50, though there are a number of investors who think $14.75 has a nice ring to it. If shareholders agree with Malin Burnham and the Burnham board on the subject of price, they don't agree with them on much else. For instance, Malin Burnham's letter references the company's decision to implement a shareholder rights plan. He argues that a shareholder rights plan doesn't entrench management. He goes on to point out that roughly 60 percent of the companies in the Standard & Poor's 500-Stock Index have shareholder rights plans. Perhaps. But how many of those "poison pills" were implemented after there was an offer on the table? Second, if poison pills are as shareholder friendly as Malin Burnham argues, why are so many institutional investors dead set against them? Surely, they wouldn't be opposing something that could earn them a higher return on their investment. Perhaps Malin Burnham and the Burnham board should point their Web browsers to the Georgeson & Company Web site at www.georgeson.com. If they click on "Publications," they'll find a report that points out "nearly 40 percent of the shares outstanding were voted in favor of poison pill recissions in 1997—the highest level of support since recission proposals were first submitted in 1987. (By the way, Georgeson & Company is no fan of recission proposals.) Moreover, Malin Burnham and the Burnham board may want to ask their friends at the California Public Employees' Retirement System—their joint venture partner—why it is that Calpers is so adamantly opposed to poison pills. If they're not already well acquainted with Calpers' strongly held views on shareholder rights plans and other corporate governance issues, they need only point their Web browsers to the Calpers' Web site at www.calpers-governance.org/forumhome.asp to review them. Malin Burnham's defense of the company's employee retention plan is another issue. Generally speaking, investors don't have a problem with implementing an employee retention program to cover middle management. Most don't have a problem with a plan that covers senior management. The problem isn't with the concept, it's with the Burnham board's execution. The issue, as Malin Burnham well knows, is with the plan covering David Martin, specifically. Investors—even those who agree with Malin Burnham and the Burnham board on other issues—believe Burnham's phantom stock awards were way over the top. In fact, according to several sources, there's been grumbling within Burnham about the deal that was cut with David Martin. The letter to shareholders also references letters from Westbrook and Blackacre. First, according to several sources, contrary to Malin Burnham's assertion, neither Westbrook nor Blackacre has ever encouraged Burnham to engage Schottenstein. What they have asked Martin and the Burnham board to do is come up with a plan that maximizes value for all shareholders. Period. Second, though Westbrook has indeed communicated its thoughts in writing, it has never made its letter(s) public. Since Malin Burnham has referenced a Westbrook letter, he should make that letter public so shareholders can draw their own conclusions regarding Westbrook's views. One final point, albeit a small one: In his letter, Malin Burnham writes that Burnham's eight directors—seven of whom are independent—decided to reject the Schottenstein proposal. In fact, two of the eight directors—Malin Burnham and David Martin—are not independent directors. So, it's six independent directors, not seven. —Barry Vinocur