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  A lesson learned on how to go Dutch

BENJ GALLANDER and BEN STADELMANN

Thursday, September 4, 2008

In November 2004, we wrote about Franklin Covey, a company that describes itself as "the global consulting and training leader in the areas of strategy execution, customer loyalty, leadership and individual effectiveness."

At that point, the stock was stuck at the $1.75 (U.S.) level, a scant 20 cents above our purchase price. In April 2006, the share price thrust forward, allowing us to eject one-third of our position at $8.84.

Since then, the value has done a whole lot of backing and forthing, though ultimately not much at all. Recently, things got more exciting, as the company orchestrated a Dutch auction using about $28 million of the $32 million received from the sale of its Consumer Solutions business unit.

The Dutch auction was introduced for stock markets in 1981. It was based on the system used by Dutch tulip farmers in the 17th century, many of whom participated in one of the biggest monetary frenzies in history, the Dutch Tulip Mania, which lasted from 1634 to 1637. Then the market imploded and the crash became synonymous with extreme market folly. More famous for the younger generation, perhaps, is when Google rolled out its shares in 2004 using this methodology.

A Dutch auction specifies a price range at which the shares will be purchased; in the case of Franklin, the bottom end was $9 and the top end $10.50, with shareholders allowed to offer their shares in 25-cent increments. Stakeholders knew that if they offered their stock at $9, at least some of their holdings would be bought. However, there was no guarantee that all would be picked off, for if more shares were tendered than the dollars available, the money would be paid out on a pro rata basis, leaving many people with odd lots of stock. Shareholders who offered above the price where the sale settled would not sell any shares.

Figuring out at what price to offer shares is a fascinating example of game theory in action, and unfortunately, a challenge that was new to us. As rookies, we looked to those more experienced for guidance, but that was sadly lacking. So we began as logically as possible for neophytes in a new arena.

First was the question of whether it was even worthwhile to participate, given that the maximum possible sale price, $10.50, trailed our target price for the stock of $11.24.

The price Franklin was trading at before the offer came along, which was in the $7.50 range, also was key; immediately after the auction was announced, the stock price jumped to about $8.75, indicating that perhaps the value was artificially inflated. One could surmise that, after the auction occurred, the stock price would perhaps return to the pre-offer range, driven not only by the old supply-demand equation, but also by those people who did not sell wanting to cash in their chips. People who ended up with dribs and drabs also might want to dump.

In a development that further clouded our dilemma of what to do, Franklin hired Georgeson Shareholder Communications to actively solicit shareholders to tender to the deal. If more shares were tendered, a lower price would be the likely end result.

Adding to the possibility of a diminished valuation was that a default factor came into play — if people offered their shares without stating a price, they would automatically go into the $9 group. On the upside, management had stated that it would not sell any shares, an indication that the price was low.

Based on an examination of the company fundamentals, selling Franklin seemed reasonable. The turnaround had run its course after moving from losses to improving profitability, and the company had taken a step backwards, losing money in the most recent quarter amidst falling sales. The deal to sell the retail operations would lower future revenues, and with a recession in the air, outfits that purchase Franklin's corporate courses might decide that the expenditure was not necessary, or could be delayed.

All of this led to uncertainty at our end. Ultimately, we decided to tender at $10, knowing full well that it was unlikely our shares would be picked up. However, we were not willing to settle for less.

In the end, the deal transpired at $9.25 a share, meaning about 3 million, or about 15.4 percent, of the common shares were purchased. It will be interesting to see what happens to the share price, which currently remains cradled above $9 less than two weeks after the transaction transpired.

As with most first-time events, this has been a learning experience for us. If and when such a situation arises again, we will certainly be prepared with additional understanding and knowledge. It is unfortunate that comprehension is not instantaneous and one has to play a game, sometimes numerous times, before achieving an optimal level.


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