Simple arithmetic suggests Gregory Shepard will not succeed in his tender offer for Donegal Group Inc.'s Class B shares, but that isn't stopping the activist shareholder's efforts to force a merger or sale of the Lancaster County-based insurance holding company.
"I think his endgame is to put as much pressure as he can from as many angles as he can on the board of directors," said Michael Hussey, associate professor at the Harrisburg campus of Widener University School of Law.
Shepard's price: $30 in cash per share. That's 42 percent more than the share price March 19, the day before he made his offer.
The offer initially expired April 19. Last week, Shepard extended the deadline to May 20. He dropped the condition that he be allowed to designate three members for the board of Donegal Group and Donegal Mutual and his condition that Donegal Group stop offering new Class A stock options.
Donegal Group advised shareholders not to accept Shepard's March 20 offer, but with the changes, "Donegal should have no trouble recommending my offer to the stockholders," Shepard said in a statement.
Shepard's motive is as follows, according to his filings with the U.S. Securities and Exchange Commission: "The purpose of the offer is to enable offeror [Shepard] to increase his voting securities from 9.99 percent of the company to 22.7 percent because he believes the company's shares trade at a substantial discount to their realizable value if combined with another mutual insurer."
Shepard's SEC filing states he has the financial resources necessary to complete the nearly $29 million transaction. Donegal Group, however, called the offer "illusory" in its statement recommending against it. And the company appears to have a compelling argument.
According to the tender offer, Shepard will call off the transaction unless shareholders offer him at least 925,000 shares.
However, Donegal Group Chairman, President and CEO Donald Nikolaus owns 186,375 of the outstanding shares. And in case there was any doubt, he told the Donegal Group board by letter March 22, he would not sell any shares to Shepard.
That leaves a maximum of 776,261 shares available for purchase.
"The math isn't going to work on that," Hussey said.
Shareholders tendered Shepard 362,745 shares in response to his offer, plus another 8,872 shares submitted by guaranteed delivery, as of the original April 19 deadline, according to a statement.
Shepard, in a short phone conversation, declined to answer questions for this story. Donegal Senior Vice President and Chief Financial Officer Jeffrey Miller said in an email that the company cannot comment beyond the official statements it has released.
The tender offer is Shepard's latest attempt to force Donegal Group's management to consider a sale or merger. He submitted stockholder resolutions to that effect for consideration at Donegal Group's 2012 and 2013 annual meetings; in both cases, the SEC allowed Donegal Group to omit Shepard's proposal from the agenda.
Donegal Group's corporate structure makes Shepard's quest challenging, Hussey said.
Donegal Group Inc. is a "downstream holding company," formed by Donegal Mutual Insurance Co. Donegal Mutual owns three-quarters of Donegal Group's 5.6 million Class B shares and 65.9 percent of the voting stock overall, which includes both Class A and Class B securities. Class A shares have one-tenth of a vote per share; Class B, one vote per share.
There are certainly investors, such as Shepard, who look for companies that are undervalued and seek to guide them in a new direction, but generally not when the company has a majority shareholder, Hussey said.
Bloomberg Businessweek lists Shepard, 56, as chairman and president of American Union Insurance Co., based in Bloomington, Ill. His SEC filings describe him as a Florida resident.
In 2000, Shepard and his brother Tracy made an unsuccessful $65 million tender offer to acquire control of Illinois-based Meridian Insurance Group, according to news reports at the time.
In 2003, Columbus, Ohio-based State Auto Financial Corp. advised its shareholders to reject a Shepard tender offer — like Donegal, calling the offer "illusory," and for the same reason. State Auto, like Donegal Group, is a downstream holding company, two-thirds owned by State Automobile Mutual Insurance Co.
Shepard sued State Auto's board, and a federal judge dismissed the suit, according to a company news release.
Managers of public firms have to treat all shareholders fairly, Hussey said. If Shepard can show that Donegal's management is ignoring or discounting the interests of outside shareholders, that could offer some leverage, he suggested.
Donegal's Class B share prices show the effect of Shepard's actions. The stock shot up by a third on Shepard's offer, from $21.07 on March 19 to $28.10 on March 20, then gradually ebbed. It eased from $20.66 on April 16 to $19.50 on April 17, the day of Donegal Group's first-quarter earnings announcement, but it climbed anew after Shepard's April 22 extension of his tender offer, reaching $26.06 on April 25.
Henock Louis, a Penn State Smeal College of Business accounting professor, said he hasn't tried to calculate a value for Donegal Group, but it's reasonable to assume Shepard has the knowledge to make a "sensible assessment."
"Given that he is willing to offer a 42-percent premium, I am inclined to believe that the firm is currently operating below its full potential," Louis said via email.
Like Hussey, Louis does not think Shepard's offer will go through.
"The major blockholders will not tender their shares," he said. "However, this cannot be the end of it. They cannot simply reject a 42 percent premium and expect (other) shareholders to stay quiet."
Donegal continues to forcefully rebut Shepard's views.
"We believe we have a solid long-term business strategy to grow profitably and effectively compete with national property and casualty insurance companies," the company said in its April 3 letter to shareholders. "Our current corporate structure, with Donegal Mutual as our controlling stockholder, has proven its effectiveness and success."
Louis put it this way: "These guys are fighting for control."