Category Archives: Dividends

spinoffs: sometimes toxic, sometimes hidden gold

March 15, 2013 By in Dividends, spinoffs Tags: , , , , , 1 Comment

The March 12th edition of the New York Times’ excellent Dealbook section has an article written by Buckeye professor Steven Davidoff, titled “In Spinoffs, a Chance to Jettison Liabilities.”  It’s well worth reading.

spinoffs

In it, Mr. Davidoff documents how in a spinoff ( which is when publicly listed companies separate out a large chunk of themselves into a separate legal entity, whose shares they then distribute to existing shareholders) the parent companies sometimes have ulterior motives.  (…shocking!)

being left behind on an ice floe

Many times, such “spinoffs” are businesses the parent wants to sell but can’t find buyers for.  They often are loaded up with a disproportionately large amount of the company’s debt.  Sometimes the spinoff is even forced to take out new loans and turn the proceeds over to the parent before it’s launched.  Davidoff gives lots of examples.

One of my favorites is the case of Monsanto, which spun off its industrial chemicals and fiber operations as Solutia, to get rid of liabilities relating to its production of PCBs.  It later spun off its agricultural businesses as the “new” Monsanto, retaining its pharmaceutical businesses in the parent, which was renamed Pharmacia.  Spinoff Monsanto was forced to agree to compensate Pharmacia for any losses it might suffer from Solutia-related litigation.  Sort of like a belt and suspenders.

three points

–None of this spinoff-unfriendly activity takes place completely in secret.  Somewhere in the SEC filings all of the potential bad stuff is disclosed.  Don’t expect it to be to be highlighted in LARGE print and a bold typeface.

There is a quick and dirty way to help focus your attention, though.  See where the current CEO is going end up.  There’ll never be potentially toxic liabilities there.  Look at the other parts of the deal.

–Not all spinoffs are disasters waiting to happen.  There’s a legitimate case to be made against conglomerates.  If a company has, say, two unrelated businesses, one which generates tons of cash flow but has few growth prospects, and a second that has huge growth opportunities, it may make sense to separate the two.  Income investors will bid up the price of the first, growth investors the second.  The sum of the two parts can be worth much more than the original conglomerate.

Sometimes, too, a small growth business can be lost in a much larger entity and starved of capital.  Spinoff will allow it to flower.

Two things to look for:  in my experience, it’s a good sign if the spinoff is relatively small and doesn’t “fit” with the rest of  the firm (think:  Sara Lee and Coach).  Also, it’s a plus if the parent retains an interest in the spinoff.

–There’s a perverse, human nature aspect to the spinoff game.

A captain, dying to get his own ship–even if it is rapidly taking on water–may be unduly optimistic in talking about his new command.

On the other hand, if you’re a shrewd businessman, once you learn your division is going to be spun off–usually at least a year, maybe two, in advance–you know there’s no sense in shining up the business any more until it’s its own public entity.  Improving your business pre-spinoff only makes your post-spinoff job harder!!  Best just to go on vacation for a while.  The result:  a “good” spinoff can be shockingly good in the first few years.

returns: capital changes vs. total return

December 31, 2012 By in Basic Concepts, Current Market Thoughts, Dividends, ETFs Vs. Mutual Funds, Portfolio management, Recent Market Action, Strategy, yearly distributions Tags: , , , , , , , Leave a comment

Happy New Year!!

Like a stock that’s gone ex-dividend, my mind has gone ex-thoughts on the final day of the year.  My family might contend that this is not as unusual as I want to make it out to be.  Whatever the case, I can always hope that, like dividends, my absent thoughts will show up in my account as credits in a day or two.

Anyway, this is the best I can come up with on a sleepy New Year’s Eve.

Through last Friday, the S&P 500 was up 14.07% for 2012, year to date, on a total return basis.  The index was up 12.52% on a capital changes basis.

The difference?

Total return includes dividend payments as part of the return.  Capital changes doesn’t.

In figuring out your performance against the index, the total return figure is the one to use.  Looking at standard reference sources, like your broker’s website or the financial news, however, the figure that gets the most prominence is the capital changes one.

There are two historical reasons for this:

–from the mid-1980s until very recently, US Baby Boomers, who have been a major force in the domestic stock market, have been pretty much exclusively interested in capital gains, not in dividend income. So they paid the highest prices for growth companies.   Firms risked being typecast as dowdy and unimaginative if they paid large dividends, so they didn’t.  The result is that the dividend yield on the S&P has been small, and easily ignored.  No longer, though.

–keeping track on a daily basis of inflows and outflows of funds, account by account, is necessary for an accurate total return performance calculation.  This was beyond the computer capabilities of the custodian banks I knew for a considerable portion of my professional career.  Easier to ignore than to spend the time and money to upgrade staff and computer systems–especially when the calculation didn’t make that much difference.

2012 (and beyond): a different story

Dividends are again a significant component of the total return on US stocks.

2012 has seen a significant number of companies declare large special dividends, making the difference between their stocks’ capital changes and total returns especially large.  Take WYNN, which I own, as an example:

Through last Friday, WYNN is just about unchanged, year to date, meaning a capital changes return of 0.  The company has paid out dividends of $10, an $8 special dividend + four quarterly $.50 dividends.  On a total return basis, then, the stock is up a bit over 9%.  Yes, still an underperformer–but not by the margin that just looking at the figures Yahoo or Google offer would suggest.

I’m not sure that 2013 will be a year to write home about as far as capital change in the S&P 500 is concerned (more about this when I post my strategy for 2013).  Despite the absence of a spate of special payouts, I think dividends will be at least as important to next year’s total returns as they have been in 2012.

See you next year!

 

special dividends and (in)efficient markets

December 20, 2012 By in "carrying" the dividend, Current Market Thoughts, Dividend Discount Model, Dividends, double taxation, Recent Market Action Tags: , , , , , , , Leave a comment

As I’ve already blogged about, many US companies are paying large special dividends to shareholders before December 31st. Either that or they’ve accelerated payouts planned for 2013, distributing them this year instead.  The idea is to avoid the presumably much higher taxes the IRS will be levying on dividends next year.  Some companies, like COST, appear even to be borrowing money to fund distributions.

The after-tax value of a dividend payment in 2012 to a taxable shareholder is likely greater than one made in 2013.  In addition, it may be possible to manufacture a tax loss from the transaction as well–something that would add another bit of extra value.  So it’s not surprising that stocks paying special dividends should be strong performers in advance of the day they start trading ex dividend.

I’ve been noticing another feature they seem to have, however, that I hadn’t anticipated.  The stocks appear to be “carrying” a large part–and in one case I’m aware of, all–the special dividend.  Here’s what I mean:

If a company’s stock is trading at $100 a share the day before it goes ex a $10/share dividend, then in a flat market you’d expect the stock to drop to $90 when ex trading commences the next day.  But the current crop of special dividend stocks aren’t acting true to form.  They’re trading at $93 or $95 or higher instead.

What could be causing this behavior?

I haven’t seen any cases where important news breaks on the day the stock goes ex.  The only thing that I can see is that a buyer is no longer entitled to the special dividend.

I have only one explanation, and a semi-crazy one at that.  I’ve concluded that buyers don’t know that the stock has paid out a large dividend.  Buyers think instead that the stock has just made a large downward random fluctuation that makes it an attractive purchase.

I have two thoughts:

–what I’ve just described could never happen in an efficient market, which tells you something about how much attention Wall Street is currently paying to stocks; and

–I wish I’d thought of this possibility before companies started paying special dividends, rather than when they’re finishing up.

Intel (INTC)’s $6 billion bond offering

December 6, 2012 By in Dividends, double taxation, Stock ideas Tags: , , , , , , , , Leave a comment

INTC has just filed a prospectus with the SEC for a proposed $6 billion bond offering.  The securities it intends to sell are as follows:

Title of Each Class of
Securities To Be Registered		 Amount To Be
Registered		 Proposed Maximum
Offering Price
Per Unit		 Proposed Maximum
Aggregate
Offering Price
1.350% Notes due 2017 $3,000,000,000 99.894% $2,996,820,000
2.700% Notes due 2022 $1,500,000,000 99.573% $1,493,595,000
4.000% Notes due 2032 $750,000,000 99.115% $743,362,500
4.250% Notes due 2042 $750,000,000 99.747% $748,102,500

Several aspects of this offering are interesting:

1.  INTC says it will use the proceeds for general corporate purposes (this is the boilerplate answer to the use question) and to buy back stock.

The dividend yield on INTC shares at a price of $20 each is 4.5%.  Total interest expense for the offering, ignoring accretion of discount, will likely be $142.875 million, meaning INTC is paying a blended interest rate of 2.38% for the money it will receive.

Unlike dividends, interest payments are a deductible expense for income tax.  After tax, the interest rate is 1.55%.  So for every share of stock INTC buys it will pay out $.31 in annual interest but save $.90 in dividend payments.  So the issue makes INTC’s cash flow go up. A $1 billion buyback at current stock prices would add about $30 million to annual cash flow.

2.  Why an offering now?

A short while ago, INTC boosted its quarterly per share payout to $.225, even though the company knew its new product spending would remain very high through this year.  Companies typically don’t raise the dividend based on future earnings potential;  they do so based on the idea that they have plenty of extra cash, come what may.  In other words, INTC thought it had lots of money to spare.

What’s changed?

–for one thing, the stock price is a lot lower than I would have expected, and the dividend yield is very high.  The chance to buy INTC assets for less than management thinks they’re worth + being paid through dividend savings to do so, the opportunity may have been too good to pass up.  I think this is the main reason for the fundraising.

–INTC’s operations generated over $5 billion in cash during a (relatively weak) 3Q12 alone.  The company also has about $11 billion in cash and short-term investments on the balance sheet.  So why borrow?   …presumably because the bulk of that money is located outside the US.

3.  My initial reaction on seeing the announcement was that problems had developed with planned cash flow in the US.  I don’t think that’s correct, though.  The US has been weak for a while.  It’s emerging markets that have been surprisingly bad for INTC recently.  And those profits presumably remain overseas.

In other words, I don’t think the offering comes as a result of adverse internal cash flow developments.

4.  INTC may be figuring that current low rates won’t last very long.  To me it’s striking that the company is raising 20-year and 30-year money.  Why else do that today?

my conclusion:  I’ve written about confirmation bias recently, partly with INTC in mind.  If I’m suffering from it, INTC’s board is, too.  In any event, the company’s indicated intention to buy back a significant amount of its shares appears to be what’s behind the stock’s current strength.  My guess is that this strength will continue for a while more.

 

large one-time dividends in 2012: why they drive stock prices up

November 28, 2012 By in Current Market Thoughts, Dividends, Recent Market Action, Stock ideas Tags: , , , , , 2 Comments

big payouts

A significant number of publicly traded companies in the US are declaring large special (i.e., one-time) dividends to be paid before yearend.  In every instance I’ve seen–the latest being LVS and COST–the stock has gone up significantly on the announcement the company is taking this action.

two tax reasons

There are two reasons for this, the first of which relates to the current income tax preference for dividend income (a maximum 15% federal tax rate) versus “ordinary” or “earned” income (a maximum of around 40%).  They are:

1.  The reasonable supposition that the income tax on dividends will go up in January, either as part of a political deal to avoid the “fiscal cliff” or in a subsequent, more general reform of the tax code whose provisions are made retroactive to January 1st.

A dollar in dividend income today nets the taxable recipient $.85.  In January, it may only have an after-tax value of $.40.

Let’s say, to make the numbers easy, a stock is trading at $100 a share.  It has $8 a share in excess cash.  It has no sure-fire investment projects that have the potential to make large future gains, so that $8 will remain $8 in present-value terms.  For a taxable investor, that $8 a share inside the company is worth $4.80 if it will be paid out after December 31st.

If, however, the entire $8 is paid out in 2012, it is worth $6.80 after-tax–a $2 difference.  So the taxable investor is $2 better off because of the dividend payment.

That’s not the whole story, either.

2.  When this stock goes ex-dividend, its price will presumably drop by about $8, simply because the ex-dividend buyer isn’t entitled to the $8 dividend.   In a very simple world, the $100 price falls to $92.

For the taxable investor who buys the stock for $100 right after the dividend announcement, the fact of going ex-dividend “manufactures” a short-term tax loss of $8.  This loss can be used to shield  otherwise taxable income at the holder’s highest marginal tax bracket.

If that rate is 40%, then the tax loss is worth $3.20.  (For what it’s worth, the part of T. Boone Pickens’ reputation that doesn’t come from relentless self-promotion is based on creating dividend situations like this on a massive scale.  There was also a one time a type of investment vehicle, called a dividend capture fund, whose main purpose was to capture the tax benefits of dividend-paying stocks going ex. )

#1 and #2 together make $5.20.  So the declaration of the $8 dividend has made the stock 5%+ more valuable to taxable investors than before.  In theory, the stock should rise on the dividend announcement until that “extra” value disappears.  That’s also what’s actually happening.

Of course, to use the short-term loss the holder has to sell the stock, creating downward pressure on the price once it goes ex-dividend. But at the same time, non-taxable investors, for whom there are no tax benefits, may be attracted to the issue and lend support because of the substantially lower price.

worth looking for?

For highly specialized professionals, yes.  For the rest of us, no.  One of the first lessons I learned as a portfolio manager is that you should focus all your time trying to find the 30% gains, and the 50%s and the 100%s.  If you see a 5% on the ground in front of you, pick it up.  Otherwise, the gain is too small to spend time on.

So, while it’s nice to understand why a stock is going up, these aren’t worth chasing.  Nor, in my view, is searching for stocks where a large potential special dividend payment is the major attraction worth the time and effort.

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