On2 dissidents are an example to all

Back in late November we cast a wary eye on Google’s first attempted takeover of a public company – then a $106m (£65m, €75m) bid for On2 Technologies. The issue, as we saw it, was whether On2’s management had been sufficiently vigorous in its defence of shareholders’ interests.

The suggestion had been made by some small shareholders that the On2 managers’ prospective future employment contracts with Google had led to their interests not being perfectly aligned with those of the shareholders. Neither I nor the Financial Times take a position on validity of this concern. Still, the managers’ relatively small collective stake in the company (less than 3.5 per cent of the stock), compared with their rather generous, fully disclosed, offers of future employment with Google, seemed to have created the appearance, if not the reality, of such a misalignment.

There were a couple of reasons why this small deal was of general interest. First, On2’s proprietary “codec” technology, which is highly efficient software for the compression and decompression of video image data, is a way of loosening the bandwidth constraints on mobile devices.

Using efficient codecs, people create fewer system delays when exchanging YouTube clips over phone networks. Anecdotally, such bandwidth limits had at times constrained the sales of 3G phones in dense centres such as New York. On2’s codec is said to be 40 per cent more efficient at using bandwidth than its main competitor.

Second, Google has been so often rumoured to be a prospective buyer for technology and media companies, that its conduct in the On2 deal was of interest to prospective target companies and their shareholders.

In the past two months the On2 dissidents have shown how a group of small shareholders can organise an effective response at low cost. The dissidents’ case is that the company’s codec technology is worth more than Google’s offer, and that management should have shopped the company to other strategic-buyer prospects.

The leaders, who could be characterised as tech-savvy but modest investors, worked to block the initial offer from going through in late December. Then, at the beginning of this month, On2 holders got an offer of an additional $26m-odd in cash from Google. The dissidents did this without the usual armies of lawyers and bankers that surround the Carl Icahns of the world. They say they have spent less than $100,000 up to now in their fight for better terms.

The core On2 shareholder activists are not the blog-first-ask-questions-later screamers found on many investor message boards. As Cornish Hitchcock, a Washington shareholders’ rights lawyer, says: “The disadvantage of the chatboards is all the usual ranting and raving about how management is just a bunch of crooks.” In the course of a shareholder activist campaign, he says, “it is materially false and misleading to make unproven allegations of criminal behaviour. This is a fairly regulated environment”, something not appreciated by the mad bloggers.

The On2 activists used public message boards to start organising, but also set up private, invitation-only sites to exchange information, devise strategy and organise agreed responses. William Pollock, one of the dissidents, says: “It is a more professional environment. Also, people on the public message boards are more likely to misrepresent [the] size of their positions.”

The On2 activists looked over public filings to identify arbitrageurs, the natural allies of those looking for better offers. One of those, Patrick Birnbaum, an investment director of London’s Centaurus Capital, says: “They found us by going through a list of the top 20 shareholders of the company. They were professional in how they conducted themselves, and had a good strategy.” Right now, Mr Birnbaum seems inclined to accept Google’s sweetened offer. To do even better, he believes, “you would have to have Apple Computer or the Chinese pre-empting Google. But no one came.”

Mr Pollock says: “We made contact with the heads of mergers and acquisitions at firms such as Apple, Cisco or Adobe that were logical competitors [for Google]. Obviously we would have wanted them to come in and make a counter-offer. We are not in a position to do anything officially other than making sure the [prospective competing bidders] are aware of the opportunity.”

Mr Pollock and the other dissidents didn’t bother to hire an investment banker, but as he says: “You do need a lawyer to advise you and do things properly.” They also used Moxy Vote, a low-cost, online proxy vote site used mostly by political and union activists.

For its part, the SEC has been working on what’s called “proxy plumbing” to make corporate governance more consistent with online documentation and organising.

The dissidents are still holding out for a higher offer before the shareholder vote on February 17. Even if that doesn’t come, they’ve given a good example of how a civil, knowledgeable and well organised group can do low-cost, effective, kitchen table investment banking.

johndizard@hotmail.com