Hundreds of US companies are throwing away millions in shareholders’ money every quarter; corporate leaders are desperate to bury the profligacy once and for all; and investors are lining up to eulogize the soon-to-be-extinct practice. ‘Problem is,’ muses the Vanguard Group’s Douglas Roman, ‘no company wants to be the first one to do it.’
This hollow-eyed zombie teetering toward oblivion is the dividend. The bullish stock market has so outstripped weakening payouts that investing for dividends is as passe as beheadings. Dividend yield (payout divided by stock price) for the S&P 500, sinking past 1.5 percent, has never been lower. ‘If the dividend yield is less than two percent, what’s the big deal if a company cuts it?’ demands one public pension plan fund manager.
‘Dividends have shrunk in both availability and importance as a proportion of total return to investors,’ confirms Richard Wines, Georgeson’s capital markets visionary. ‘The next question is why bother?’
Because they’re taxed more than capital gains, dividends have never really made sense – even for the group of investors that remains most attached to them. ‘In fact individual investors ought to be begging companies not to pay them taxable dividends, instead to reinvest the cash in either buy-backs or growing the business,’ says Wines.
As for institutional investors, theory says they should be neutral on the dividend debate, and surveys by Georgeson have borne this out. ‘The vast majority don’t care,’ says Wines. ‘They’re interested in total returns, and don’t care if a company pays a dividend, uses the funds to buy back stock, or invests the money in growing the business.’
‘Whether we get it in the form of a dividend or a buy-back doesn’t matter,’ says Jim Fleischman, senior managing director at pension fund TIAA-Cref. ‘And if a company thinks it can do better by making investments in plant or equipment, then we’re in favor of that – we’re always in favor of maximizing shareholder return.’
According to the data, only a tiny, two percent slice of institutional assets are in portfolios that demand dividends, with most of the rest only slightly to moderately sensitive. That’s strong evidence that most institutions are generally indifferent to dividend policy. But what of individual investors who, contrary to common sense, still flock to high dividend-paying stocks? And can companies afford to alienate even the small audience of institutions that are more or less dividend-sensitive? According to Wines, they can’t afford not to.
‘There are certainly investors who prefer dividends – even fat dividends,’ he concedes. ‘But if you get them to buy your stock, does it make any difference? They’re usually unlikely to buy growth stories or willing to pay very high multiples. The investors most sensitive to dividends are also the least likely to support a company’s valuation,’ says Wines.
Take a dividend-paying company with good growth prospects of 15 percent a year – as a result trading at a decent multiple. Chances are its current institutional shareholder base doesn’t care much about the dividend; investors who do care aren’t appropriate for the stock; and even if the company could attract them, they wouldn’t support valuation. Why not just eliminate the dividend altogether and save $10-50 mn or more per quarter?
Amazingly, when Georgeson searched for an example of a company with a modest dividend that eliminated it when not under financial pressure, they didn’t turn up a single one: ‘We couldn’t find any healthy company of significant size with a dividend yield of less than 1.5 percent that eliminated its dividend.’
Let the tumbrels roll
All reason points to giving dividends the final coup de grace. But here’s a hitch: most institutional investors, while agreeing the days of dividends are numbered, worry they still make a difference to other investors. ‘The times may have changed, but terminating the dividend is still seen as a negative and a company would have to go through a whole lot of explanation as to why they’re doing it,’ says Roman, a senior investment analyst at Vanguard. ‘I know there are logical reasons, but the initial announcement might cause the stock to get hit.’
‘Dividends are becoming a non-issue,’ agrees a senior equities portfolio manager at Travelers Insurance. ‘However the psychology of eliminating dividends is still such that it implies there’s something wrong: the company is circling the wagons and needs to preserve cash. But that’s a process issue, not necessarily a fundamental issue. It’s an investor relations issue.’
Matthew Yanni, an equity analyst in PNC Bank’s asset management group, also seems to fear the psychological backlash. ‘Generally the market does not react positively to a dividend cut, let alone a dividend extinction,’ he comments. ‘In many cases, dividend yield is a factor in attracting a certain class of investor. Depending on how frequent and how high dividends are, eliminating them may have different psychological effects on investors.’
IR to the fore
‘The gut reaction of people when they hear of a dividend cut is what’s wrong?’ says Michael Del Balso, portfolio manager at Jennison Associates, a division of Prudential Insurance. ‘Companies have to be very careful about how they announce the termination of dividends. If companies like McDonald’s and Coke made such announcements, I think other companies would follow.’
As companies and investors alike wait for the first pioneers to take the plunge and eliminate dividends, it’s up to investor relations professionals to respond to the vocabulary of dividend extinction.
‘We like to see opportunities for acceleration of top line and earnings growth,’ asserts Pamela Carlton, director of equity research at Chase Asset Management. ‘Therefore, it could be a positive for a company to cut, or not increase, its dividend in favor of reinvesting excess cash in growth businesses. It depends, case by case, on a company’s growth opportunities versus other ways to increase shareholder value. A repurchase program can also have a positive impact, but such programs are by their nature short-lived.’
‘I’d have to look at it on a company-by-company basis,’ agrees William Van Arnum of the treasurer’s office at the University of California. ‘Just cutting the dividend and reinvesting in the company is not, by itself, going to create shareholder value; they’ve got to invest in areas where the returns are in excess of the company’s cost of capital. I get the feeling that some of these companies thinking about cutting their dividend don’t necessarily have good projects to reinvest in.’
Buy-backs, for their part, also meet with a measure of skepticism nowadays. ‘I would be in favor of a company eliminating its dividend to reinvest in growth areas or to do a share repurchase,’ says Marc Lowe of Citibank Global Asset Management. ‘However, many companies have huge buy-back programs that only off-set the dilution from handing out too many stock options. It’s unfortunate when you read some of these proxies, with chief executive officers making $200 mn over 5-10 years. That’s just not equitable. I’m not talking about a stock that goes from $2 to $100, but making that kind of money for a stock that provides only average returns is wrong.’
The message from investors is clear: dividend termination would have to be explained very carefully. One, it’s no crisis. Two, the cash is going toward shareholder value. ‘There’s a big mental barrier that you have to get across,’ concludes Georgeson’s Wines. ‘Make sure you understand your current shareholder base and identify any institutions that might need special hand-holding. Also make sure the announcement is properly explained and bracketed – ideally coupled with nothing but positive news.’ spin-off of ‘new’ Marriott International proved a difficult pill to swallow for shareholders; and a significant number insisted they would vote against it as a package deal. The ‘super-stock’ proposal would, company officials say, beef up the new company’s anti-takeover defenses while creating a new class of voting stock with ten times the power of the existing common stock.
Not so fast, said shareholders. On March 12, the powerful California Public Employees Retirement System said it would fight what it termed a ‘package of governance provisions’ tied to Marriott’s proposed restructuring. Calpers, which owned more than 569,000 shares of Marriott at the time (or around $40 mn in value), viewed the vote as ‘an all-or-nothing deal’ and called on all Marriott shareholders to oppose it. ‘Marriott was forcing our hand and that of all its owners to accept provisions that not only fail to promote good governance but threaten the future viability of the company,’ says James Burton, chief executive of Calpers. ‘We strongly urged Marriott to unbundle these provisions and allow shareholders their right to vote on them separately.’
Specifically, Calpers had a beef with the spin-off’s ‘dual class’ stock structure, which carries unequal voting rights and contradicts the fair and fundamental principle of a ‘one-share, one-vote’ system, explains Brad Pacheco, a spokesperson for Calpers. ‘We had no problem with the Sodexho merger – we felt that was economically viable – but the anti-governance stipulations in the dual class offer of the new Marriott made us vote against it,’ he says. Pacheco adds that the super-stock structure would also deprive shareholders of an opportunity to sell their shares at a premium over prevailing market prices and make it difficult to change control of the company’s board and management.
Calpers officials also took a dim view of the proposed staggered board structure proposed by Marriott in the new stock deal, which would allow shareholders to vote on one-third of the directors at any given time, thus insulating the board from attack. ‘A staggered board structure shields directors from those to whom they are accountable – their shareholders,’ says Burton. The company’s poison pill provision, which would have cut the trigger level of outstanding shares from 20 to 15 percent, fared little better in Calpers’ eyes. The provision would ‘strengthen the new Marriott board’s veto power over a takeover bid even in the event that such a bid is in the best interests of shareowners,’ Burton adds.
Calpers was not alone in its defiance of the Marriott board’s wishes. Proxy advisors Institutional Shareholder Services and Proxy Monitor advised their clients to issue a thumbs-down on the Marriott stock deal as well. ‘Although the terms of the Sodexho deal are favorable and its strategic vision ambitious, ISS objected to the myriad anti-takeover and entrenchment devices bundled into the deal,’ says a spokesperson for ISS.
The Washington, DC-based Hotel Employees and Restaurant Employees International Union also got into the act, launching its own campaign on behalf of Marriott employees to persuade the Marriott board to unbundle the popular spin-off from the controversial dual-class share structure.
May day
Cornered by both shareholders and employees, and needing two-thirds of the company’s outstanding shares, Marriott officials pulled the plug on the dual voting classes on March 17, settling instead for the spin-off and merger vote which was approved four days later. It postponed the new stock deal vote until its May annual meeting. It also agreed not to lower the triggering levels of its poison pill. ‘In the process of soliciting proxies for the special meeting, stockholders told us that they strongly support the spin-off and merger transactions,’ Marriott said. ‘At the same time, we are responding to their desire to vote on the dual class share provision separately.’
Unless a majority of shareholders votes against the dual class deal at the annual meeting, Marriott officials have said they will immediately convert the two stock classes into a single class of common stock, and thereafter take all steps necessary to remove the dual class provisions from the new Marriott’s charter.
Investors are happy that the company separated the two votes, although some thought it was being heavy-handed in switching the voting date to the annual meeting, where the numbers are more in management’s favor. Some shareholders weren’t much happier when Michael Stein, Marriott’s CFO, told the Wall Street Journal in March that the company could offer the dual class shares no matter what shareholders thought. ‘To be technical, we didn’t need a vote on dual class at all,’ said Stein.
Hardly the stuff of public relations legend. Thus, after having achieved one half of its restructuring goal by securing shareholder approval for the spin-off of the new Marriott Sodexho merger, company officials are, at the time of writing, bracing for their annual meeting on May 20 and a vote on the proposed new class of stock. They remain cautiously confident of the results. ‘I don’t think that shareholders were dissatisfied with the way the dual class stock vote was structured,’ ventures Tom Marder, a spokesperson for Marriott International. ‘We did, after all, structure the Sodexho merger tax-free to shareholders which was a big benefit to them. I think Marriott has always had the best interests of shareholders on its mind.’
One thing’s for sure. After the proxy process runs its course, Marriott will know what its shareholders have on their mind.
