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BAY APARTMENT COMMUNITIES, INC.
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(Name of Registrant as Specified In Its Charter)
BAY APARTMENT COMMUNITIES, INC.
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[LETTERHEAD OF BAY APARTMENT COMMUNITIES APPEARS HERE]
June 2, 1998
Re: Bay Apartment Communities, Inc.
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Dear Fellow Stockholder:
Bay Apartment Communities, Inc. will hold its 1998 Annual Meeting of
Stockholders on Thursday, June 4, 1998 at which time our stockholders will vote
to, among other things, approve the merger between Bay and Avalon Properties,
Inc. We are extremely excited about the future prospects of Bay following the
merger. We believe the merger will result in improved long-term earnings
growth, greater financial strength and flexibility, geographic diversification,
a strengthened management team, greater total market capitalization and
liquidity, and substantially increased dividends to our stockholders.
As you know, Institutional Shareholder Services recommended that Bay's
stockholders vote against the merger at the annual meeting. The ISS report
states that the merger is an attractive proposal that has economic merit, both
in terms of pricing and strategic fit. The ISS report also points out that
there will be an immediate 21% increase in Bay's annual distributions to
stockholders. However, ISS recommended against the merger because of its
concerns regarding certain corporate governance provisions that will be in Bay's
charter after the merger. These charter provisions relate to three issues: the
directors' ability to expand the size of the board of directors, the
stockholders' inability to remove directors without cause, and the number of
authorized shares of common stock.
Following the merger Bay will add six new directors (all of whom are
currently Avalon directors), which will result in a twelve member board. After
the merger, Bay's charter will permit the directors to expand the size of the
board as necessary. We feel that the ability of the directors to expand the
board will allow Bay to take advantage of opportunities to add new expertise
through additional directors. For example, when Bay acquires asset portfolios
or enters new markets it can be very beneficial to have the expertise of
individuals who are more familiar with the particular properties or markets.
Although Bay could seek shareholder approval every time a new director is added,
we believe that holding a special meeting each time would be disproportionately
expensive for our stockholders relative to the benefit stockholders would
obtain. Because all of Bay's directors are subject to re-election each year,
stockholders will always have the ability to replace any newly appointed
director in a relatively short time period.
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Although we have no intention of doing so, ISS has pointed out that the
ability to expand the board and fill vacancies could enable the existing
directors to "pack the board" in the event of a hostile takeover attempt. Since
Bay does not have a staggered board of directors, we believe it is highly
unlikely that packing the board would be an effective defensive mechanism for
Bay.
The second concern raised by ISS is the charter provision that only allows
directors to be removed "for cause" by a 75% vote of the stockholders. As
discussed above, because Bay chose not to adopt a staggered board all directors
are subject to re-election annually. Therefore, stockholders may, in effect,
remove directors with or without cause at least once per year by simply not re-
electing them. However, even though all directors are subject to removal
annually we view continuity on the board between annual stockholder meetings as
an important element in pursing Bay's long-term strategic goals.
We believe that Bay's immediate and future growth and profitability are
dependant upon its long-term strategic goals. One important factor in the
successful implementation of long-term goals is to ensure continuity in the
individuals responsible for adopting and monitoring the achievement of those
goals. Many companies try to obtain this continuity by adopting a staggered
board and a "for cause" removal provision, which are designed to ensure that
each director serves for at least three years. We feel that in light of our
decision not to adopt a staggered board, a "for cause" provision designed to
provide continuity between annual stockholder meetings is an appropriate
compromise between the stockholders' desire for long-term profitability and
their need to hold directors accountable through frequent elections.
The final concern raised by ISS relates to the number of shares of common
stock that will be authorized in the charter after the merger. Currently, Bay's
charter provides for 40 million authorized shares of common stock. After
completing the merger, Bay's charter will provide for 300 million authorized
shares of common stock. Approximately 70 million out of the total 300 million
shares of common stock will be outstanding or reserved for issuance immediately
after the merger.
We believe that our proposed increase in the number of authorized shares of
common stock is advisable for several reasons. First, unlike other companies,
REITs are required to distribute 95% of their taxable income to their
stockholders annually. As a result, REITs must frequently raise additional
capital to fund their growth through acquisitions and development or
redevelopment of properties.
Bay, like many other REITs, also is finding more and more opportunities to
acquire properties by issuing securities to property sellers. In fact, because
of the tax advantages that can be realized by the sellers, this structure is
often a prerequisite to the sale. These transactions involve the issuance of
limited partnership interests in exchange for the properties. The partnership
interests are then convertible into shares of common stock to provide future
liquidity for the property sellers. This structure enables Bay to make
accretive property acquisitions without incurring the costs associated with
raising capital to acquire properties for cash.
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In addition, during the period since Bay's initial public offering at $20
per share in 1994, we have experienced rapid growth and have seen our common
stock trade at more than $40 per share. In order to continue to encourage
retail ownership of Bay's stock, we may determine in the future that it is
appropriate to declare a stock split. Although a stock split would be made to
all shareholders pro rata without any dilutive impact, it would require the
issuance of a very large portion of the authorized and unissued shares of common
stock.
In considering the appropriate number of shares of common stock to
authorize, we considered many factors, including the issues outlined above. We
also surveyed the charters of other REITs and we consulted informally with ISS
regarding its general policies relating to proposed increases in the number of
authorized shares. Though our consultations with ISS were on a confidential
basis, and ISS had not yet reviewed the proposed charter, we sought and followed
its informal guidance in an attempt to provide for an appropriate increase in
the authorized common stock of Bay.
After reviewing the proposed charter and upon further consideration, ISS
now appears concerned that additional shares could be issued in circumstances
when it would be dilutive for existing stockholders. Based on its guidelines,
ISS recommends substantially reducing the number of authorized shares of common
stock. However, we feel that for the reasons mentioned above traditional
guidelines used to determine appropriate share increases for companies other
than REITs should not be applied to Bay. You should also note that Bay has a
history of issuing common stock at prices that are not dilutive to existing
holders. As substantial holders of common stock, Bay's directors and management
are very aware of the need to avoid dilutive stock issuances.
The practical limitations on issuing common stock are also supplemented by
New York Stock Exchange stockholder voting rules. NYSE rules limit the ability
of listed companies, such as Bay, to issue large amounts of common stock (any
amount representing 20% or more of the voting power or outstanding number of
shares of common stock immediately prior to the issuance) in certain
transactions without prior stockholder approval. Bay intends to continue to
list its shares of common stock on the NYSE and therefore will remain subject to
those stockholder approval requirements.
I hope this letter helps you to better understand our position with respect
to the issues raised by ISS. Bay's board of directors and management
enthusiastically support the merger with Avalon and recommend a vote for the
merger. If I can be of any further assistance please do not hesitate to call
me.
Sincerely,
/s/ Gilbert M. Meyer
Gilbert M. Meyer
CEO & President
