TPL - A Boring Look At Texas Pacific Land Litigation Against Horizon Kinetics

2023-05-23 04:06:12 ET

Summary

• The proposal to increase the number of TPL shares outstanding was defeated at the May 18 shareholder meeting, but that could change depending upon the Delaware court's eventual decision.
• If the court rules that Horizon Kinetics has to vote according to the board's recommendation the proposal would then pass with 53.25% of the vote.
• A key issue is if the proposal to increase the number of shares is considered "routine" or "non-routine'.
• This litigation and the potential for future litigation are having a negative impact on TPL's stock price.

Most articles about Texas Pacific Land Corp. ( TPL ) focus on future production and oil/gas prices, but this article will focus mostly on an issue that has had a very significant impact on TPL stock price over the last eight months - a lawsuit. The company is suing their largest shareholders. Texas Pacific Land Corp. v Kinetics Horizon LLC (2022-1066-JYL) was heard on April 17 in Delaware and is a battle over increasing the number of authorized TPL shares outstanding. At the May 18 reconvened shareholder meeting the proposal was defeated, but that could change based on the court's decision. Because of the uncertainty of this and potential future litigation I rate TPL neutral/hold.

Details on Proxy Voting

Since I read a number of incorrect comments about voting by shareholders I am going to start with some basic information. The board sets a shareholder of record date that determines who can vote. Already there is problem because if an investor is a shareholder on the record date that shareholder can still vote even if they sell the stock after the record date, and the buyer does not get the right to vote. (There are ways the voting right could be transferred but that is beyond the scope of this article.)

Shareholders that directly own a stock are called "registered" shareholders and get information, such as proxies, sent directly to them. Most shareholders hold their shares at their broker in "street name". The broker/clearing firm is the actual shareholder, and their customer is the "beneficial" owner. There are basically two types of beneficial owners. Non-Objecting Beneficial Owners - NOBOs and Objecting Beneficial Owners - OBOs. Almost all retail investors have NOBO accounts, and the company is able to see who the specific NOBO shareholders are. The company, via a retained proxy solicitor, often tries to contact the NOBO shareholders to vote on critical issues. OBO account holders are often large investors or institutions. The company does not get their names so they can't directly solicit them for their proxy votes.

The actual vote requirement needed for approval of a proposal depends on state law where the corporation was incorporated, by-laws of that specific corporation, SEC regulations, and NYSE/NASD regulations. For some proposals a majority of shares actually voted is needed and other cases a majority of shares outstanding/entitled to vote is needed. There are even a few cases where approval of 2/3 of shares outstanding is needed.

On most items shareholders can change their votes by submitting a new signed/dated proxy. The last signed/dated proxy received is the one that is counted. During proxy fights, proxy solicitors often try to get shareholders to change their already submitted proxies.

This brings us to proposal #4 on TPL's proxy increasing the number of authorized shares from 7,756,156 to 46,536,936, which "requires the affirmative vote of the majority of voting power of the outstanding shares of Common Stock entitled to vote on the matter". This is because Texas Pacific Land is incorporated in Delaware and is governed by Delaware's Title 8 Chapter 1 subchapter Vlll .

TPL's proxy solicitor, Mackenzie Partners, most likely received the list of registered shareholders and the list of brokers with the number of shares at each broker held in street name. They also most likely got the list of names/addresses of NOBO holders, but not OBO holders. In addition, most proxy solicitors use a data bank of all the institutional SEC filings of TPL ownership.

Usually, the higher the percentage of NOBOs compared to registered holders is an indication that a routine proposal recommended by the board will get approved since all the NOBO proxies will be voted - by the shareholders or the brokers. Of course, some of the NOBO shareholders might vote against the recommendation. The level of registered shareholder participation varies from company to company and the matter being voted on. OBOs, however, are very likely to vote because they are almost always very sophisticated investors, but you can't generalize if they will or will not follow board recommendations.

Many institutions use outside proxy advisors that make recommendations on voting. Glass Lewis and Institutional Shareholder Services are two major ones that give institutions their recommendations and a summary of the issues involved. Many institutions follow these recommendations or at least use them in their decision process on how to vote their proxies. Glass Lewis on May 9 changed their recommendation from "for" to "against" on #4. This recommendation change may have impacted the final results. As of May 9 , "for" votes were 2,701,435, but that total decreased to 2,518,781 (32.67%) on May 18.

TPL Lawsuit Against Horizon Kinetics

Texas Pacific Land Corp. filed a lawsuit against Horizon Kinetics asserting under the terms of their Stockholder Agreement ( text of the agreement ) that the group of investors led by HK is required to vote "for" #4. HK asserted in responding to the lawsuit that they are not required to vote "for" #4. HK also asserts this item should be considered "non-routine", which would then mean brokers can't vote non-votes.

Looking first at the routine versus non-routine. TPL asserts this is routine under NYSE 452 Regulation that governs this issue. HK counters that there is case law and Delaware Law that supports their claim that it is non-routine.

The lawsuit ( April 13 Pre-Trial Brief text ) brought by TPL is based on the Stockholder Agreement and TPL asserts that the Agreement requires HK "to vote all shares of Common Stock beneficially owned by such Stockholder…in accordance with the Board's recommendations". Since the board recommended supporting #4, HK is required to vote "for" #4 according to TPL.

HK counter claims the exceptions in the Agreement states "Stockholders ((HK)) shall not be required, to vote in accordance with the Board Recommendation for any proposals (i) related to an Extraordinary Transaction or (ii) related to governance, environmental or social matters." The definition of "Extraordinary Transaction" is THE key point of this entire matter. "Extraordinary Transaction" are defined as "any tender offer, exchange offer, share exchange, merger, consolidation, acquisition, business combination, sale, recapitalization, restructuring, or other matters involving a corporate transaction that require a stockholder vote". The problem for HK is that change, either increase or decrease, in the number of authorized shares outstanding is not included in this list. HK asserts that it would have never agreed to a settlement that did not effectively include the right to vote against an increase in the number of TPL shares because HK has always been against increasing the number.

Broker Non-Vote Impact on Voting Results

There is an issue that actually might be more important than the lawsuit by TPL asserting that HK must vote according to the board's recommendations -that is broker non-votes. If a broker's customer does not actually vote on the proxy proposals, the brokerage firm has discretionary authority to vote the customer's proxy for routine items. The brokers almost always vote following the board of director's recommendations. This almost always results in "0" broker non-votes on routine items. With brokers voting for a proposal, it is much easier to get a majority - either a majority of those actually voting or a majority of shares outstanding. If there is a proxy fight over electing members of the board of directors, brokers can't vote non-voted proxies.

To illustrate the importance of the broker non-vote issue, I suggest readers look at what happened to Bed Bath & Beyond (BBBYQ). Their preliminary proxy stated that a proposed reverse stock split item was considered "routine". which would mean that brokers "will have discretionary authority to vote your shares held in street name on this matter". BBBY wanted a reverse stock split that would indirectly greatly increase the authorized number of shares outstanding and allow them to raise much needed cash via an ATM stock offer. (I covered the details of this issue in a March 31 article .) The final proxy , however, asserted that the vote on the reverse stock split was "non-routine", which meant that brokers "will not have discretionary authority to vote your shares held in street name on this matter... in the absence of your voting instructions, your broker...may not vote your shares on the proposals". The BBBY reverse stock split proposal needed a majority of shares outstanding to be approved. Since there was considerable stockholder disapproval of the reverse stock split and because so many shareholders, especially retail investors, don't vote, it was almost certain the proposal would not be approved. Without the ability to sell more shares to raise cash BBBY filed for Ch.11 bankruptcy. (BBBY is incorporated in New York - not Delaware.)

With brokers allowed to vote non-voted shares, I expect the final vote tally on #4 of 2,518,781 "for" as of the May 18 reconvened shareholder meeting included a significant number of broker voted proxies. There were "0" broker non-votes. The "against" were 4,158,907 and "abstain" 34,090, which has the same effect as a vote "against". On November 18 the reported voting results on other proposals that did not allow brokers to vote non-votes totaled 971,156 (broker non-votes). If one subtracts 971,156 from the November 18 total "for" number of 2,718,734 on #4 you get 1,747,156 or only 22.66% - far short of 50%+1 needed. (The non-vote number may be lower now because some shareholders may have eventually instructed their brokers to vote after the November shareholder meeting on #4.)

Assume for the sake of discussion that the Delaware court decides that HK has to vote "for", the new "for" total would be 2,518,781+1,587,902 (HK votes) = 4,106,683 or 53.25% - #4 is approved. That total would imply if 251,217 shares were to switch from "for" to "against"/"abstain", it would be defeated. That is a very small margin. If the court decides that a completely new vote is needed with a new record date/new proxy material, there is a very real potential that the new voting would defeat the proposal even if HK has for "for" #4.

Still using the 4,106,683 total, if the court decides that the matter is actually non-routine that means the broker votes would be deducted from the "for" total. If the November 18 broker non-votes total of 971,156 is an indication of how many "for" votes were cast by brokers, it is very possible that #4 would be defeated even if the court decides the HK must vote "for". Subtracting 971,156 from 4,106,683 = 3,135,527 or 40.66%. Actually, it is not as simple as just deducting the broker votes. An amended proxy statement would have to filed with SEC and sent to shareholders amending the statement that #4 is actually non-routine and that brokers can't vote non-votes. Some shareholders who support #4 may not have bothered to vote before assuming that their broker would vote "for" so they did not vote, but now would vote "for".

Trial Results

There was an April 17 trial in Delaware on this lawsuit. The final decision is still pending. I am always reluctant to guess what a court decides, but this April 21 letter by the Vice Chancellor to the various lawyers might give investors a "feel" for the direction the court is headed. The actual results of the May 18 shareholder meeting on #4 will be determined by the court. (The shareholder meeting was held on May 18 and was not adjourned.)

Dear Counsel:

The court has considered the parties' submissions regarding the 2022 annual meeting and its stale record date. The court sees no need for the Company to adjourn the meeting further and perceives no basis for doing so without setting a new record date and conducting a new solicitation. As demonstrated by the authorities that the defendants have cited, a stockholder can seek relief if a company attempts to adjourn a stockholder meeting inequitably. Were such an application made in connection with the 2022 annual meeting, the Chancellor of course would have discretion over the assignment of the case, and she could view it as related matter that warranted consideration by the same judicial officer presiding over this action. Were the case assigned to me, I would address the application promptly. In the meantime, the parties should plan on a four-brief sequence with not more than two weeks between each brief.

Sincerely yours, /s/ J. Travis Laster J. Travis Laster Vice Chancellor

My Opinion on the Impact on TPL Investors

I am not a fan of either TPL insiders or those associated with HK, which is why I currently have no TPL positions. I am just sitting in the bleachers eating popcorn and drinking my Coke watching the drama. Investors seem more focused on this power struggle between current management and HK than actual operations such as oil/gas production, which is a major negative for TPL stock price.

I agree that the stock should be split. The current intent is a 3 for 1 split. I actually would prefer a 20 for 1 split to make the stock price more affordable to a broader range of retail investors. HK worries about potential dilution because of the increase in the authorized number of shares outstanding, but I think much of that worry is associated with them having less influence on TPL as their percent of ownership decreases as additional shares are issued either via stock offerings and/or acquisitions using equity. The reality is that this happens when a company expands - they are not a trust anymore and can now buy new assets. Management wants to potentially make acquisitions using equity and/or debt. I agree, but I don't want any of the current management to make those decisions.

TPL is authorized by the board to repurchase $250 million shares. I assume some of that will be used for a management incentive plan. Because they can't currently increase the number of TPL shares to be used for a management incentive plan they have to repurchase TPL shares. I worry that they are "buying high" and "selling low" by paying for shares and then using the same shares to issue at some later date at a lower price via a management incentive plan. It might be more beneficial if they were allowed to issue more shares and some of those shares for a management incentive plan.

The first advantage of changing from a trust to a corporation I stated in my March 16, 2021 article was that TPL can hedge future energy prices. I was shocked to see they did not hedge when energy prices were high last year, and management indicated in their recent conference call that they are not planning to do any hedging in the future. This reinforced my already low opinion of current management.

This entire sordid affair has had a very negative impact on TPL stock price, in my opinion. Even if there is some resolution on the #4 proposal, I expect that at some point in the future there will be a nasty proxy fight over board of director seats or other issues. This soap opera could play for many more years and continue to impact TPL stock price.

Conclusion

The reason that I covered a large number of issues associated with proxy voting is that I expect that there will be future proxy fights at Texas Pacific Land Corp. between insiders and those associated with Horizon Kinetics. I have read a number of incorrect comments by investors about proxy issues and I wanted to clarify this complicated issue. The reality is that TPL stock price may depend more on the proxy battles instead of actual asset values and income.

I personally don't want anything to do with either the current TPL insiders or those associated with Horizon Kinetics. I don't think either are out for my best interests - only their own. The stock has dropped almost 20% since I sold my last TPL shares in June 2022. Because of the potential for continued proxy fights and future litigation that has a negative impact on TPL, I rate TPL neutral/hold.

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