A major investor in one of South Carolina's largest technology businesses is demanding that the struggling company explore strategic alternatives, including a sale, pointing to years of losses and a growing dissatisfaction with the board of directors.
Indaba Capital Management has amassed a nearly 10 percent of Charleston-based Benefitfocus Inc. since last fall. It vowed to take a hands-on approach and bring about changes when it disclosed its stake in December.
At that time, the San Francisco hedge fund said it was talking with management and board members, among others, to seek out "ways to narrow the gap" between the languishing stock price and what it viewed as the software company's untapped value.
The gloves came off Feb. 11.
Indaba said recent "incremental" and "half-measure" actions indicate the directors of the Daniel Island firm are "uninterested in implementing the meaningful changes required to turn around Benefitfocus and realize its standalone potential."
"The board appears to be more interested in maintaining the status quo that has already given shareholders years of dismal governance, problematic related-party transactions, poor oversight and weak strategic execution," Indaba partners Derek Schrier and Alex Lerner wrote in a seven-page letter.
They said a top concern is the company's opposition to adding more independent shareholder representatives as directors and establishing a special committee to review a "good faith sales process" and other alternatives.
"This is clearly the best path forward for Benefitfocus and its shareholders," said Schrier and Lerner, whose firm also controls some of the company's debt.
In a written response, Benefitfocus said it is committed to "building a truly great company" and "to generating substantial value for shareholders, and we remain open to constructive input and suggestions that may help us achieve this goal."
"While it is a general company policy not to comment on specific shareholder interactions, members of the Benefitfocus board of directors and senior management team have had numerous discussions over the past two months with representatives of Indaba Capital to better understand their ideas and suggestions and incorporate them into the board’s decision-making process. We attempted to reach an amicable resolution with Indaba, but have been unable to achieve a reasonable compromise. The board has consistently communicated its desire to engage in constructive discussions with Indaba," according to the statement.
The hedge fund said the relationship soured on Jan. 26, when the Benefitfocus "abruptly undermined" the private talks by publicly announcing "certain basic, long-overdue corporate governance improvements that Indaba was advocating for."
The changes included declassifying the board, meaning all directors will stand for election by shareholders annually rather than serve staggered terms.
"While it was a small step in the right direction, the announced changes fell woefully short of what is needed," Schrier and Lerner said. "They suggest only a wink to cleaning up the mess, with no real commitment to value-enhancing change."
Indaba also criticized how the company is handling the recently announced resignation of its executive chairman later this year, saying company's co-founder Mason Holland — and one of its largest individual shareholders — will remain on the payroll as an adviser and be allowed to sit in on board meetings after he steps down.
"This suggests that his influence over the board has not been significantly diminished," Schrier and Lerner said. "The board must recognize that it will not be lost on shareholders that Mr. Holland’s recent track record includes leading Benefitfocus down a path of considerable value destruction, including negative returns over the past one-, three- and five-year periods."
At the same time, they said, it was their view that Holland has "participated in multiple problematic related-party transactions." It was a reference to his dual role as a top executive and a co-owner of the company's Daniel Island campus through private entities that received a $4 million advance last year to cover future rent payments, according to Schrier and Lerner.
Indaba calculated that Holland and former Benefitfocus CEO Shawn Jenkins, who is a partner in the real estate ventures, stand to receive $186 million over the life of the building leases.
"We question the inherent conflicts and misalignment of incentives in these related party transactions," Schrier and Lerner wrote. "Is the company able to negotiate market rents with its landlord and extract competitive terms as its needs change when the company’s landlord is also its chairman of the board?"
Indaba said it also is troubled by "the unusually favorable economics" that another investment firm negotiated in exchange for providing $80 million to Benefitfocus in June, even though it didn't appear a fresh capital injection was necessary. The terms of the deal with BuildGroup, which is led by longtime Benefitfocus board member Lanham Napier, included an 8 percent return and the option to convert its debt into shares equal to 13 percent of the total.
"We seriously question these capital allocation decisions," Schrier and Lerner said.
Holland and Jenkins founded Benefitfocus in Mount Pleasant about 20 years ago. It's the developer of a software platform that workers can access to enroll in and manage their health plans and other benefits. Employers pay a subscription fee to use it.
The company hasn't turned a net profit since Goldman Sachs took the business public in 2013 at $26.50 a share. The cumulative losses since have surpassed $400 million over the past decade.
The stock has suffered. It hit a peak of about $77 in early 2014. Last March, it dropped under $7 after COVID-19 upended the U.S. economy, down from $21 at the start of the 2020. Shares of the company jumped 10 percent to close at $17.24 Thursday.
The virus crisis has forced the company to rein in its spending. In April, Benefitfocus announced a $23 million cost-cutting plan that eliminated 250 jobs, or 16 percent of the work force. It also has warned of a $50 million to $60 million sales hit for 2020 from the drop-off in subscription revenue.
About two months after the BuildGroup debt deal was announced, CEO Ray August was replaced by finance chief Steve Swad, adding to the growing list of high-level executive departures at Benefitfocus.
Indaba said on its website that it seeks out "companies we believe are experiencing a dislocation in value due to complex, misunderstood events and situations which can be researched and analyzed."
The hedge fund was familiar with Benefitfocus before it started buying shares last fall. In addition to its stock holdings, Indaba controls about $51 million of debt the company issued in 2018.
It remains a believer in the underlying business, according to Schrier and Lerner.
"Simply put, Benefitfocus is a quality asset in a growing industry and there is a plentiful value creation opportunity under the right stewardship," they wrote. "We believe having a refreshed board pursue a sales process would be in the best interests of shareholders, including the many long-suffering investors forced to endure the incumbent directors’ self-dealing and value-destructive blunders."