Some investing stories are timeless and thought provoking, worth recollecting time and again. The infamous Northern Pipeline affair, which brought an investment legend to the spotlight, would fall into such a category.
Standard Oil was an American oil producing, transporting, refining and marketing company, and also the largest oil refiner in the world at that time. John Rockefeller was a founder, chairman and major shareholder.
Viewed as a monopoly, under the Sherman Antitrust Act, the U.S. government split Standard Oil into smaller independent entities. Wall Street didn’t pay much attention to them. Little was known about their finances since they did not provide detailed balance sheets. Frankly, no one seemed to care. Except one young man.
As Benjamin Graham was looking through information provided by the Interstate Commerce Commission, a regulatory body that oversaw the railroads, he came across some statistics furnished by the pipeline companies accompanied by a note that read “taken from their annual report to the Commission”.
Curious to learn more, Graham took a train to Washington with the aim of examining the company’s full-length filings in the commission’s record room.
He discovered that all the pipeline companies owned huge amounts of the finest railroad bonds. He also discovered that they were doing a comparatively small gross business, with a large profit margin, carried no inventory and had no need whatever for these bond investments.
He narrowed down on Northern Pipeline because it had the greatest amount of securities per share relative to its market price. The company, responsible for transporting crude oil to Standard’s refineries, was trading at $65 per share. Meanwhile the company held $95 per share in railroad bonds and other liquid assets, nearly all of which it could distribute to its stockholders without the slightest inconvenience to its operations.
Graham began to pick up the stock. When he acquired a 5% stake in Northern Pipeline, he met with the company’s President and General Counsel with the intention of requesting them to distribute the excess cash. They declined because the par value of the stock was too high.
Graham suggested that they reduce the par value and treat the distribution as a return of capital. They said that they needed the capital because the investments were a depreciation reserve.
Graham asked them when they would replace the pipeline. They couldn’t say.
With their patience exhausted, they belittled Graham and sent him packing.
Their next interaction was at the annual shareholders’ meeting where Graham rose to read his report on the company’s financial position. He was asked to put his request in the form of a motion. He did. No one seconded the motion. The meeting adjourned. An embarrassed Graham was sent packing again.
He then decided to mount an offensive via proxies. Shareholders not attending a company's annual meeting may choose to vote their shares by proxy, which means allowing someone else to cast votes on their behalf. Graham hired a law firm and got to work soliciting proxies.
Naturally, one of his first visits was to the Rockefeller Foundation. He told the foundation’s financial adviser that he had no interest in Northern Pipeline’s operations just its surplus assets. The proper use of those assets was the concern of the shareholders not the management. Once again, he was sent packing.
In January 1928, on the eve of Northern Pipeline’s annual meeting, Graham and his lawyers met with the other side since the two opposing groups agreed to count the proxies the night before. The Graham group had obtained proxies for roughly 37.50% of the company’s shares. The Rockefeller Foundation gave their proxies to the company management with a message: distribute as much cash as the business can spare.
Northern Pipeline was forced to distribute $50 in cash and promised $20 more would follow. Eventually, investors in Northern Pipeline would receive more than $110 in distributions for each share held as of that January.
However, the battle did not end there. Northern Pipe Line’s management would not easily loosen their hold on the excess treasure. In fact, management intended to thwart Graham’s request to distribute $90 of the company’s $95 per-share surplus of liquid assets, even though the company was generating annual revenue of $300,000 while carrying $3.6 million in railroad bonds that were unrelated to its normal course of business. So, distributing most of these assets to the shareholders made eminent sense.
Graham took his argument directly to the shareholders during the annual shareholder meeting. Since he had failed to bring someone to “second” his motion, it was denied.
Once again Graham rounded up proxies. Within a year, he had proxies for almost 40% of the company’s shares. Management was compelled to accept Graham’s election to the board and, shortly thereafter, distributed $70 per-share of excess liquid assets to its shareholders.
John Rockefeller was so impressed that he met up with Graham and reached out to the former Standard Oil affiliates with excess liquid assets on the books. This ripple effect throughout several Rockefeller-associated entities is one reason why Graham’s triumph, known as the “Northern Pipeline Affair,” helped cement his reputation as both an exceptional analyst and a highly effective shareholder activist.
(The entire and detailed narration can be read on Bloomberg, written by Joe Carlen, author of The Einstein of Money: The Life and Timeless Financial Wisdom of Benjamin Graham.)
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