When does it become helpful for managers to boast about the bad shape of their staff pension plans? When their companies are under siege from hostile bidders. And what should pension fund trustees do about such boasting? Become more independent, as the new UK law suggests. Those are two of the lessons from the recent takeover flurries over Marks & Spencer and WH Smith, two troubled UK retailers.
Take M&S first. The company has a pension problem. The size of the problem depends on the accounting methodology. According to the old SSAP 24 standards, the deficit was relatively small – £185 million against total fund assets of £3.6 billion. The newer and more conservative FRS17 calculation came up with a more substantial £470 million ($865 million).
But a much higher number can be concocted. During the recent takeover fight, the company released a range of actuarial valuations. The most conservative, based on investing only in risk-free bonds, suggested a deficit of £1.8 billion. For a company with a market capitalization of about £9 billion, a pension deficit that size would make a big difference to shareholders. Had Philip Green succeeded in his takeover bid – which would have involved much higher leverage – the gap would have been enormous.
There is a lot of sophisticated maths in all of these calculations, but also a lot of judgement. After all, they are based on predictions that stretch half a century into the future. That means that managers can use them in various ways. Usually, they try to minimize their importance.
Sometimes, however, it’s good to plead pension poverty. M&S was in that position. It had every interest in showing that the new owners would have a huge pension-funding problem. So in addition to releasing the gigantic potential total deficit data, it showed what would happen if the deficit had to be paid back in three years, as compared with the current 12. The combination produced an annual contribution of £785 million – about six times the current rate.
The company’s press release was short and easily misunderstood. And the headline writers did misunderstand it. They focused on the highest number, although a contribution of that size would have been sensible only if bankruptcy was imminent. M&S chose not to explain that this interpretation was almost ludicrous.
The M&S pension fund’s trustees have been criticized for not trying to clarify the position. They certainly could have been more assertive. And the contrast between their concern over Philip Green’s potential leveraged takeover and their total silence in the face of management’s own major credit downgrade is hard to explain.
Traditional inaction
But the M&S fund trustees were just following the traditional practice. Pension fund trustees at all UK companies have always acted as if the fund were a semi-autonomous branch of the sponsoring company. They rarely complain about underfunding or ask for more conservative return assumptions. They almost always let the company do the talking.
This passivity should be disappearing, for two reasons. First, economics. Since most of the UK company funds are now closed to new employees, the weight of ex-employees in the funds is steadily rising. Their trustees will care less about the company’s share price and more about its solvency. Second, the law. The newest pension bill will set significantly higher standards for trustee independence and liability. Pension funds are going to get their own regulator to defend them against irresponsible funding companies.
Pension fund trustees trying to understand the new system can learn from the WH Smith example. When venture capital fund Permira came after the troubled retailer, the pension fund trustees responded promptly. They took a leading role in the negotiations and gave clear information to both current and potential future management. WHS has a much worse pension problem than M&S, but Permira was able to take it into account. A new, lower offer is said to be coming.
The two situations are not directly comparable, most notably because WHS had agreed to open its books to Permira while M&S refused to negotiate with Green. But appearances are important in takeover deals. And the WH Smith pension trustees, led by former company chairman Martin Taylor, appeared a lot more independent. They were loyal to the interests of the pensioners and neutral about who ran the company.
These two deals are unlikely to be the last times that UK pension fund management gets in the headlines. There are many signs that pensions are becoming more important. Pension lawyers and consultants are in demand, funds are increasing the number of truly independent trustees and potential acquirers are calling in pension experts at earlier stages of discussions.
The basic trend is clear – funds are getting more distant from the sponsoring companies. The two examples suggest that leveraged bidders will have to think more carefully. But managers should not relax. Underfunded pension funds are not poison pills. On the contrary, pension funds should be as interested as shareholders in getting rid of weak managers. After all, the funds cannot sell their interest in the company’s future success. Managers might think that independent pension funds will be natural allies. But they should be careful what they wish for.
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