When Duke Energy (NYSE: DUK) and Progress Energy announced their merger agreement in January 2011, the Carolina companies assured Wall Street that the merger would close by the end of 2011. Well, it didn’t work out that way because in December 2011 FERC rejected the companies’ “virtual divestiture” plan for the Carolina wholesale power market and made them go back to the drawing board.

The merger finally closed on July 3, 2012, seven months later than planned, but the bad feelings caused by the merger delay claimed a prominent victim: Duke Energy CEO Bill Johnson, the former CEO of Progress Energy, whose term as CEO lasted only 24 hours. Bad feelings toward Johnson may also be related to two disclosures Progress made shortly after the merger agreement with Duke was announced: (1) Progress’ Crystal River nuclear power plant in Florida needed $1 billion worth of repairs; and (2) Progress’ planned construction of a new nuclear power plant in Levy County, Florida would cost $22 billion rather than $5 billion.

But Jim Rogers, former Duke CEO who was supposed to be the Chairman of the Board under the merged company and has now returned to the CEO position, doesn’t have clean hands either, having been responsible for a $1.3 billion cost overrun at the Edwardsport, Indiana coal gasification power plant, not to mention an influence-peddling scandal aimed at recovering these cost overruns from Indiana ratepayers in exchange for offering a job to an Indiana Utility Regulatory Commission official.

So why punish Johnson but reward Rogers when they have both proven to be incompetent? It may have something to do with the fact that the merged company’s 18-member board of directors is composed of 11 Duke Energy representatives compared to only seven from Progress. The known devil is better than the less well-known one.

The July 3^rd press release announcing the merger’s completion stated:

The newly constituted board of directors has appointed Jim Rogers as president and chief executive officer of the combined company, effective immediately. Rogers will also maintain his responsibilities as chairman of the company’s board. Bill Johnson has resigned as president and chief executive officer of the combined company, by mutual agreement. Bill Johnson has been instrumental in helping us close the merger with Progress Energy, and we wish him well in his future endeavors

Please note: the phrase “mutual agreement” means Johnson was fired.

North Carolina Regulators Feel Duke Energy Deceived Them

Johnson signed his three-year employment contract to act as CEO of Duke Energy on June 27^th, effective July 2^nd. His “Separation and Settlement Agreement” became effective at 12:01 AM on July 3^rd. Do you mean to tell me that the board changed its mind about Johnson in the six days between June 27^th and July 3^rd? Preposterous. Rogers testified on Tuesday (July 10th) before North Carolina regulators that the board didn’t decide to fire Johnson until July 2nd, even though Rogers had been approached by the board of directors on June 23rd about their negative views regarding Johnson. Why did the company offer Johnson an employment contract on June 27th if its board members were voicing concerns on June 23rd? According to Rogers, the merger agreement required the company to appoint Johnson as CEO and so they did. In my mind, the decision to remove Johnson as CEO must have occurred much earlier than June 23rd — especially given Rogers own admission that the Progress nuclear power plants were part of the reason for Johnson’s dismissal — but the company kept it quiet (i.e., a cover up) in order to achieve regulatory approval without further delays and inconvenient questions.

Even if I’m wrong, and Rogers is telling the truth about June 23rd, Duke Energy had a responsibility to tell regulators that the June 27th employment agreement was a sham intended merely to satisfy the letter of the merger agreement and that Johnson was on the way out. The approval process for a hostile utility merger is quite different from the approval process for a friendly utility merger and the Duke/Progress merger had clearly become hostile by June 23rd. Furthermore, Standard & Poor’s has put Duke Energy on “creditwatch with negative implications” because of the management chaos. A lower credit rating would increase the utility’s debt costs, which could harm ratepayers through higher cost-recovery requirements. According to Standard & Poor’s:

The sudden shift in management raises concerns about effective corporate governance, successful handling of the anticipated merger integration, and the ongoing effective management of pending challenges that face the combined entity.

Utility regulators were hoodwinked by Duke Energy and they understandably don’t like it. The North Carolina Utilities Commission has initiated an investigation of Johnson’s ouster and summoned new CEO Jim Rogers to testify on the reasons for Johnson’s ouster on Tuesday July 10th. Besides the problems with Progress Energy’s nuclear power plants, Rogers testified that the board didn’t like Johnson’s “autocratic” management style. My translation: Johnson was willing to disagree with Rogers, and Rogers loyalists didn’t like Johnson’s independence.

Like North Carolina regulators, the former Progress Energy directors who approved the merger also feel betrayed. John Mullin, former lead director at Progress, wrote a letter to the Wall Street Journal on July 5^th in which he called Johnson ouster a betrayal:

In my opinion this can only be described as an incredible act of bad faith with regard to the undertakings of the merger agreement. This was a critical element in the merger deliberations of our Board because we had confidence that Bill would successfully lead the combined companies to achieve the potential synergistic benefits of the combination. I do not believe that a single director of Progress would have voted for this transaction as structured with the knowledge that the CEO of Duke, Jim Rogers, would remain as the CEO of the combined company.

This is the most blatant example of corporate deceit that I have witnessed during a long career on Wall Street and as a director of ten publicly traded companies and as a former Trustee of Putnam’s numerous mutual funds. I find myself without a constituency and without an ability to mount a challenge to what I believe is one of the greatest corporate hijackings in US business history.

Johnson can’t explain what happened because of a non-disparagement clause in his termination agreement which prohibits him from “making any public statement regarding Executive’s termination of employment that is materially inconsistent with such press release whether true or false.” In return for this gag order, Johnson was paid $1.5 million on top of the $40-plus million in other severance he received. To be fair, Johnson would have received almost this entire $40-plus million under his prior employment contract with Progress, so all of the sensationalistic headlines saying that Johnson was paid $44 million for one day’s work as Duke Energy CEO are misleading.

Co-CEOs Can Be a Blessing or a Curse

Don’t get me wrong; I’m not arguing that boards of directors lack the discretion to remove CEOs. In fact, supervising the CEO and removing an underperforming one is a key aspect of a board’s duties. Co-CEOs are especially tricky to manage. Granted Jim Rogers was officially the Chairman and not a co-CEO, but Rogers was not willing to let Johnson run the show alone. A similarly-precarious situation involving a former CEO as chairman of the board exists over at Avon Products (NYSE: AVP) with Andrea Jung. In the Russell 3000, less than 100 companies have a co-CEO structure, including:

• Chipotle Mexican Grill (NYSE: CMG)
• Whole Foods Market (NYSE: WFM)
• Primerica (NYSE: PRI)
• SAP AG (NYSE: SAP)

Academic studies have concluded that co-CEOs can be successful (or not), depending on the personalities involved and whether clear understandings of each person’s duties are in place at the beginning of the corporate marriage. When it works, one plus one equals three. When it doesn’t work, you’ve created “an unequally yoked two-headed monster” that ends up devouring one of its heads. Since Johnson and Rogers are both strong personalities that “can suck the oxygen out of a room just by entering,” this co-CEO structure was doomed to fail. This is especially true in merger situations. Several examples exist of CEOs being removed soon after a merger, including:

• 1998 – Hugh McCall of NationsBank ousted David Coulter of BankAmerica
• 2000 – Sandy Weill of Travelers ousted John Reed of Citibank
• 2009 – Ken Lewis of Bank of America ousted John Thain of Merrill Lynch

Other companies that have tried and discarded the co-CEO model include Research in Motion (NasdaqGS: RIMM), J.M. Smucker (NYSE: SJM), Martha Stewart Omnimedia (NYSE: MSO), and Wipro (NYSE: WIT).

How can anyone claim that Johnson underperformed as Duke Energy CEO when he had been in the job less than one day? It appears that Johnson wasn’t ousted for cause, but was the victim of a power grab by Jim Roger loyalists in the boardroom. Maybe I’m wrong, but Rogers’ testimony today before the North Carolina Utilities Commission was unpersuasive and obviously biased. Furthermore, when a company that has made the decision to remove a CEO fails to disclose that material fact – or worse fraudulently asserts that the CEO is in good standing and provides a regulatory agency with a recently-signed employment contract as proof – something is seriously wrong.

Analysts believe the boardroom coup has subjected Duke Energy to a 6-12 month “legal and regulatory quagmire” that will be distracting at best. Furthermore, with Jim Rogers’ advanced age of 64, he faces mandatory retirement from the CEO position in two years when he hits 66, so the company will have another distracting CEO search soon. One reason Bill Johnson was initially given the CEO reigns is because at 58 he is six years younger than Rogers and his tenure ensured managerial continuity for the next eight years. Duke Energy’s stock has fallen about 7% — from $71 to $66 — since news of the boardroom coup became public on July 3^rd and I’m not sure the public-relations damage has run its course yet.

Reverse Stock Splits are a Short-Term Negative

Also hurting the stock may be the company’s decision to do a 1-for-3 reverse stock split. The company said it was doing the reverse split because the merger caused the number of shares outstanding to increase to more than 2 billion which is “a very large amount,” exceeds the number of shares authorized without a shareholder vote, and more than any of its utility peers. That is true, but none of these reasons explains why the company felt a need to reverse split 1-for-3 rather than only 1-for-2 or even 1-for-1.5. The fact remains that more than 25 U.S. companies have more than 2 billion shares outstanding and are doing just fine. Furthermore, as I wrote in Avoid Leveraged ETFs that Undergo Reverse Stock Splits, a 2005 paper by professors at City University of New York (CUNY) concluded that “reverse stock splits tend to be strong indicators of poor performance afterward.” Maximum underperformance occurs on average on the 50^th trading day (10 calendar weeks) after the reverse split, which for Duke Energy would hit around September 11^th.  A more recent 2011 study finds maximum underperformance occurs only 10 days after the reverse split and there are no long-term negative effects. A 2012 study concludes that low-priced stocks that undergo a reverse split actually enhance value since it removes the institutional constraint against buying stocks priced under $5 per share, but this doesn’t apply to Duke which was trading above $20 per share at the time of the reverse split. 

Theoretically, reverse splits should have no bearing on stock performance because changing the number of shares does not affect business performance or cash flows. And lower shares outstanding can actually reduce administrative costs because fewer shareholders need to be catered to, as well as fewer stock certificates and dividend checks. Still, some investors mindlessly sell stocks that have undergone reverse splits because they erroneously think the stock has gone up in value and they want to lock in a huge profit. Higher-priced stocks are easier and more attractive to short (e.g., they have further to fall), so short sellers may increase their trading volume on reverse-split stocks they don’t like, which can also temporarily put downward pressure on the stock’s price.

Investing Daily utility expert Roger Conrad recently wrote that he wouldn’t buy Duke Energy unless the stock fell another 10% down to $60. This cautionary note from an investing legend sounds very wise to me.

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