May 16 2024
Dear fellow shareholders
I am writing to you in connection with the forthcoming Annual General Meeting (AGM) of the shareholders of TECO Electric & Machinery Co Ltd (TECO, or The Company), to be held on 24 May 2024.
My name is Eugene Huang. I am the leader of FutureTECO, a group of concerned TECO shareholders who have put forward a vision for modernisation of TECO’s strategy and sustainable performance, and are proposing a slate of 8 candidates for election at the Company’s AGM next week.
We have previously distributed our detailed pitch deck directly to shareholders and made it available on our campaign website, which for ease of reference is accessible here.
As a subscriber to ISS proxy voting research, you will have just received a report containing recommendations AGAINST election of the FutureTECO candidates and in favour of the candidates proposed by the incumbent Board. I expect that you will now be in the process of weighing ISS’s recommendations against your own stewardship policies, along with any engagement you may have had with TECO’s management regarding the AGM proposals.
I am writing to you to request your urgent and careful consideration of FutureTECO’s case, and why I believe you should support our candidates notwithstanding ISS’s recommendations.
Rationale for ISS voting recommendations
In their research analysis of the competing director slates of FutureTECO and incumbent directors, ISS makes a number of significant concessions to key elements of FutureTECO’s campaign, including:
• TECO’s failure to deliver promised financial returns and strategic goals promised in the last activism campaign in 2021;
• The company’s lagging commercial progress and performance relative to both domestic and international peers;
• The sprawling and haphazard nature of TECOs growth into a conglomerate structure that has drifted away from its core competencies in world-class machinery manufacture; and
• The company’s failure to recognise and adapt to the profound disruption being caused by artificial intelligence (AI) and other transformative technologies in the global motion industry.
Nevertheless, ISS concludes that they believe FutureTECO has ‘failed to make a compelling case that a board refresh is needed’. The essential rationale for this conclusion is that they believe the high ‘burden of proof’ they require from activist investors in contested voting situations has not been met in this case.
Why you should look beyond the default guideline-driven ISS recommendation
We understand why, from a default guideline perspective, ISS would generally err on the side of supporting incumbent directors in typical contested election situations. We appreciate and respect
the general principle that incumbent directors as elected fiduciaries should generally have the benefit of doubt absent sound reasons to recommend against their judgment.
However, in the present case, I believe those sound reasons do clearly exist, and I urge to you re-consider exactly how high the ‘burden of proof’ from a dissident group in fact needs to be in practice to displace the default ISS position.
This is especially so in relation to the current profile of TECO’s share register, whereby many major subscribers to ISS’s research are not short-term driven active holders but long-term, inter-generational focused investors, who are inextricably exposed to the long-term financial sustainability and competitiveness of the company. This is against a backdrop of virtually all actively-managed international investors having ‘voted with their feet’ by exiting the stock over the past three years, leaving indexed and quantitative investors as the most significant holders among global institutional investors (as detailed in Slides 38-42 of our pitch deck).
I urge you to consider Future TECO’s case for fundamental reform of TECO’s business model and strategy, from the perspective of a long-term or permanent portfolio investor.
I believe that in this light, the case to set aside ISS’s recommendations and vote in support of the Future TECO campaign is manifestly clear.
4. Key reasons why we believe ISS’s recommendations are wrong
- Company structural issues
• The detailed analysis in the body of ISS’s report includes a side-by-side comparison of both sides’ cases regarding the four main business segments (Motors, Energy Intelligence, Air & Intelligence life, Electric Vehicles).
• The framing of these business segments favours the status quo business structure, which FutureTECO is strongly critical of, and therefore misses the point of our campaign. It fails to address the underlying point we are making that the company has become a sprawling conglomerate of disconnected businesses, a dangerous distraction from TECO’s core areas of sustainable advantage in an increasingly competitive, constantly evolving global market.
• For example, why is there a construction business, undertaking highly risks projects such as construction of a new airport in Taipei, hidden in a division called ‘Energy Intelligence’? Infact, why is there a construction business at all, given construction is a high-risk, low margin activity that is not a core skill of the company? (refer pp. 21-22 of our deck).
• Similarly, why is TECO doubling down on light commercial vehicles and buses in its EV strategy through major capex commitments in Mexico and India – in an already-saturated market dominated by Chinese companies – while turning a blind eye to the much more accessible and business-aligned opportunities in electric cars and drones? (pp. 23-24)
2.Mistaking commercial competitor comparisons for market cap peers
• ISS’s report does provide some supportive comments on FutureTECO’s arguments about TECO’s lack of AI integration – for example their comment on p.21 of their report that ‘We do not disagree with the dissident’s concerns over the lack of AI integration into TECO’s manufacturing process’.
• However, they then go on to question the validity of our use of ABB and WEG as peer comparators, citing the much larger market cap of those companies as a rationale for them not being comparable peers.
• This rejection of our peer group selection does not make sense. Those same companies are also invoked by TECO’s management themselves in their public disclosures (for example 2022 Annual Report, Section 5.1.2). ISS’s questioning of our use of these peer comparisons highlights poor due diligence in ISS’s research process.
• Another point we are making, and that ISS overlooks, is that ABB and WEG are the primary commercial competitors to TECO in the eyes of TECO’s customers. This is not the same thing as an abstract comparison that investors sometimes like to make based on capital market data points such as market capitalisation.
• So, for example, if you are an oil and gas producer who is in the market for a large-scale industrial motor or turbine, then those companies (ABB and WEG) will generally be on your shortlist.
• Put simply, TECO will lose the competitive race if it fails to keep pace with these larger foreign competitors in design, technical innovation and efficiency.
• Our fundamental argument is that current management is too distracted by forays into non-core, disconnected business lines to address this foundational issue which is a key to TECO’s survival, at whatever market capitalisation it has (and hopefully continues to have in the future).
3. Flawed performance analysis relative to agreed peers
• Moving on from the fallacious representation of commercial competitors like ABB and WEG, I will now point out that FutureTECO has in fact provided detailed investment performance analysis against relevant domestic and market-cap market peers (Tatung, Fortune Electric, Chun-Hsin) elsewhere in its campaign material.
• This peer group selection is broadly accepted by ISS and is the same peer group that ISS go on to tabulate on pp. 22-23 of their report, using three broad metrics (Revenue, Return on Equity (RoE), and Return on Assets (RoA)) of the past five years (pp. 23-23 of ISS Report).
• But what we then see is a highly flawed set of conclusions being drawn from this data.
• According to ISS’s analysis, TECO’s ROE is the lowest among its peers, TWII index and Electrical Equipment (Sector). Similarly, it has the second lowest ROA, which lags the TWII and Electrical Equipment sector.
• While acknowledging the ‘weak ROE and ROA’, ISS still gives management the benefit of doubt for achieving a ‘steady growth trajectory’.
• The board is the steward of shareholder capital. It needs to maximize ROE and ROA. If we were to follow ISS’s argument, a company can put all its cash in the bank, generate a steady interest income and call it a day. It’s a nonsensical argument.
• Bridging back to my earlier comments, the low ROE and ROA are pretty much entirely due to the current Board’s focus on the low margin, highly risky construction business. ISS’s research team has completely failed to connect the dots on this.
4.TECO’s lack of transparency
• The ISS research makes a number of references to TECO Management’s ‘pitch book’ but does not say that this material was only sent to investors/proxy advisers and was not shared
publicly or with FutureTECO.
• Giving ISS the benefit of the doubt, they may have assumed that this information was in the public domain, shared with FutureTECO, and accessible by all investors. It wasn’t.
• This lack of transparency by TECO stands in stark contrast with FutureTECO, whose equivalent information is fully in the public domain.4
• This information asymmetry has effectively meant that FutureTECO has been ‘shadow boxing’ without having been given the courtesy of being copied on the management material, and clearly demonstrates the current Board’s lack of commitment to open and free discussion of all the issues.
Summary
In substance, ISS’s report was not a categorical rejection of FutureTECO’s campaign, but more in the nature of a lineball call, driven by their standard policy guidelines for contested voting situations,
which tend to favour incumbent boards. We recognise that this is ISS’s typical benchmark policy approach, but urge you, as an important investor in TECO, to carefully consider your reliance on this recommendation based on the points we raise above, together with:
• your own status as a fiduciary investor responsible for sustainable, long-term / inter-generational investment on behalf of your own clients and beneficiaries,
• your assessment of the actual long-term value drivers of the company compared to the priorities current being pursued by management ,
• the substantive case for change we have put forward in our presentation slide deck; and
• the demonstrable failure of the company to deliver on the financial performance and strategic they promised in 2021.
Overall, we believe that ISS’s analysis is too favourable to the incumbent board, who have had a number of years to lift TECO’s performance to the level of their key peers yet have demonstrably failed to do so.
Your vote is important
In conclusion, I strongly urge you to overturn ISS’s voting recommendation and vote FOR the FutureTECO candidates. For ease of reference, the relevant individuals and ballot items numbers are included below:
3.8 Li-Chong Huang – Executive Director
3.9 Chih-Yuan Hou – Executive Director
3.10 Song-Ren Fang – Executive Director
3.11 Liang-Chien Chen – Executive Director
3.16 Yu-Hsuan Wu – Independent Director
3.17 Ming-Shiuan Lee – Independent Director
3.18 Chao-Ching Huang – Independent Director
3.19 Po-Min Yang – Independent Director
If under your internal proxy voting guidelines you are not prepared to support the entire slate of FutureTECO candidates, I recognise that it is open to you to vote for a blended combination of FutureTECO and management candidates, utilising the cumulative voting framework that applies to Taiwanese listed companies.
Whilst we would of course like to see all eight of our candidates elected, there is no need for you as investors to necessarily adopt an ‘all or nothing’ voting approach if you believe there can be an appropriate balance between the competing factors in play.
If you are exploring options along these lines, I would urge you to consider the overall board skills matrix criteria discussed in Slides 57-64 of our presentation. I would also encourage you to consider the Board diversity factors in play – in particular the age diversity of the respective candidates spelt out on Slide 65 of our deck, in addition to broader gender diversity, educational and professional experience factors.
Engagement Outreach
I appreciate that, with ISS’s report being published very late into the notice of meeting period, you need to finalise your voting decision within the next few days in order to meet very tight custodian and registry vote cut-off deadlines.
To this end, aside from asking you to consider the points raised in this letter, I would very much appreciate the opportunity to engage with you directly between now and the vote cut-off date of next Tuesday 21 May. I will actively prioritise this engagement request and do my best to fit in with whichever timing and format best suits you.
Please contact my solicitation advisers Georgeson: Savoy Lee (savoy.lee@georgeson.com) to make the necessary arrangements.
I very much look forward to your favourable consideration of this letter and the opportunity todiscuss with you directly.
Yours sincerely,
Eugene Huang