Why Orient-Express is no easy meat

Orient-Express Hotels, the Bermuda-based owner of luxury hotels, has received an unsolicited offer to be acquired by Indian Hotels Company, a subsidiary of Tata Group. In surveying the potential battle for control, I am certain of one thing: It’s good to be a director of Orient-Express – and it’s likely to stay that way.

It’s not because Orient-Express’ chairman gets to stay at the hotels for free, or that other directors get a 75 per cent discount. Or that these directors have largely served without consequence despite Orient-Express’ poor performance.

Rather, it is because these directors can elect themselves, a unique characteristic among companies worldwide. Shareholders have no real say in the selection of Orient-Express directors.

Orient-Express shares are divided into Class A and Class B shares, with Class B shares controlling 64 per cent of the votes. Who owns the Class B shares?

Actually, Orient-Express itself. The shares are owned by a subsidiary and voted by the four directors of the subsidiary, two of whom are also directors of Orient-Express.

The reason this structure exists is because of a unique Bermuda law. In 2000, Orient-Express was slowly spun out of Sea Containers, a now-defunct shipping company. Sea Containers sold off its shares.

But the executives of the shipping company apparently wanted to ensure that even if Sea Containers stake went below 50 per cent, the company would be safe from a hostile bid.

They accomplished this by placing majority voting control with this subsidiary. And because two of the four directors on this subsidiary are also directors of Orient-Express, they are necessary for any action with respect to these shares.

The other two directors, by the way, are lawyers at Orient-Express’ law firm, Appleby Global.

It’s a structure that wouldn’t be allowed under Delaware law, but one that effectively gives the directors control over the company. This wouldn’t be so bad, except Orient-Express has a history of poor performance.

In 2007, the Jumeirah Group of Dubai made a $60-a-share bid for the company. Indian Hotels also expressed interest.

Both bids were vigorously rebuffed by the chief executive at the time, Paul White, and his board. Orient-Express’ strategy was clear. Because it controlled the shares, it didn’t even need to engage with these bidders.

At that time, Taj Hotels, the Tata subsidiary with an interest in Orient-Express, wrote that “the Taj Hotels and Dubai Holdings, the two largest public shareholders of OEH, have been unable to enter into any meaningful dialogue with the OEH Board”.

By 2008, Orient-Express was still under siege, this time by two hedge funds, D E  Shaw and C R Intrinsic, a division of Steven A Cohen’s SAC Capital.

The two funds proposed at an October 2008 shareholder meeting that the Class B shares be treated as treasury shares with no voting rights. The proposal was defeated with the company’s Class B shares voting against it, despite the approval of over 90 per cent of the Class A shares.

The funds then sued in a Bermuda court to have the structure ruled invalid. But in a June 1, 2010, decision the Bermuda court upheld this structure under Bermuda law. Basically, the court stated that the petitioners could not challenge the voting structure as “per se” illegal under Bermuda law without a showing that the directors were acting against the company’s best interest.

Orient-Express’s directors have continued to do a less-than-stellar job. The company’s stock has plummeted almost 85 per cent from its high, and in November 2008, Orient-Express undertook a $55 million dilutive capital raise.

In July 2011, White resigned. Since then, the company has been largely rudderless. Board chairman J Robert Lovejoy took over for a time. In May, Philip Mengel, another director, was named interim head.

Ta Ta to the offer

In October, the Tata Group, which owns 7.63 per cent of Orient-Express, made another offer to acquire the company. With the stock at $9 a share, the $60-a-share offer of a few years ago was now an impossible dream.

Tata and its co-bidders are offering $12.43 a share, a roughly 45 per cent premium. Notably, White has reemerged as part of the bidding group.

Orient-Express has responded with a two-pronged strategy. First, it has made the usual complaint that Tata’s bid is severely underpriced, an effort to acquire the company at a low point in the economic cycle.

When rejecting Tata’s offer, Orient-Express’s board stated that “the current macroeconomic environment, conditions in the luxury hotel business and factors unique to Orient-Express would make this a highly disadvantageous time to sell the company to realise its true value.”

Second, Orient-Express has finally hired a permanent chief, John M Scott III, who did a decent turnaround job at Rosewood Hotels Resorts, a group of 17 ultra-luxury hotels, eventually selling the company in 2011 for $229.5 million. There has also been some turnover at the board, with four new directors added in the last few years.

But Orient-Express is once again refusing to meet with Tata to discuss this offer. In doing so, it would seem the Orient-Express board is unwilling to sell at any price.

Still, Tata’s bid is merely the opening price. A report by Citigroup puts the share price north of $15, while one from Barclays gives a higher estimate at $18 a share.

The Barclays valuation analysis is done on a per-key or price-per-room basis and seems to be in ballpark. Barclays assigns Orient-Express’ two premium hotels, the Cipriani and Splendido, a $3 million per-key valuation.

That amounts to a total of roughly $285 million and $240 million, respectively. This appears comparable with the recent offer of $2.4 million per room made on the Four Seasons in New York.

There may be a Russian oligarch willing to pay more, and that is what Orient-Express will argue. But it is hard to see how value can go higher without a change in the direction of Orient-Express.

Orient-Express seems to be putting all their valuation eggs in the basket of one chief executive, a man who has done well with a small private company. It may well be that Scott can create value beyond what these hotels are worth through branding and expansion. But this is a risky bet, and one that shareholders do not seem to want to take. Who can blame them, given past performance?

Of course, none of this really matters, because the directors hold all the cards. Tata could sue to challenge this share structure again, arguing that directors are breaching their fiduciary duties by keeping themselves in office despite a fairly priced offer. But the directors could say they need yet more time to allow this chief executive to implement his plan, whatever it may be.

Dual-class share structures are not uncommon. But there are none that I know of where directors rather than shareholders can vote their stock. Shareholders have the duty only to themselves in deciding not to sell. But directors have duties to all shareholders, and this would be the basis of such a challenge.

Still, don’t count on a lawsuit. Tata seems intent on appearing friendly. And such a suit has only a small likelihood of success because the board will again hide behind its new chief executive and his plans. While it’s easy to point fingers at the board here, the shareholders also need to take some of the blame for buying into this structure.

The directors appear poised to wait it out, perhaps in the Cipriani, where I hear the cocktails are nice. And there is nothing to stop these board members from doing so, given their position and stated beliefs.

(The author, DealBook columnist of NYT is professor at the Michael E Moritz College of Law at Ohio State University)