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Since we are following the Foolish Four strategy very strictly in the demonstration portfolio below, and since my only GM shares are the ones in that portfolio, deciding whether to keep the GM shares or trade them in for GM-Hughes was very easy. I just looked to the past.
Our backtest was constructed and run assuming that offers such as this would not be accepted. Sticking with the parent stock is the easy, low-maintenance way to invest so that was perfectly in line without Foolish Four philosophy, and it's as good a guideline as we have. We didn't test the results of accepting versus not accepting such offers, though, so I have no idea what our database would tell us about which might be the best course. We just know that the strategy worked well sticking with the parent stocks. It's an investment you can ignore while you sail around the world in a dingy or spend a year in an African village with the Peace Corp. I like that idea.
(FYI -- in the case of spin-offs where stock in an additional company is issued automatically, the spun off shares were held until the end of the year, at which time they were sold. GM's spin-off of Delphi Automotive Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DPH)") else Response.Write("(NYSE: DPH)") end if %> last year was a perfect example. Again, the situation required no active investor input.)
I confess, though, if I weren't committed to being a strict constructionist about this particular portfolio, I would find this tax-free exchange offer very tempting. Hughes is the cool, high tech arm of GM and getting a chance to grab some of that stock at a possible premium is appealing. Wait a minute, though. I have lots of high tech companies in the rest of my portfolio. I almost forgot that the Foolish Four is my ballast, my insurance against the specter of a tech stock meltdown. Flash the prospect of a little glamor at me and I'm ready to abandon my plan. Not good.
OK, I'm over that. But what if I didn't have a bunch of high tech stocks? What if I weren't trying to set such a good example? Then I would have to make a decision about this exchange, and the choice wouldn't be easy.
On the one hand, we have a venerable, old line company paying a fat dividend with the prospect of a higher dividend after the new Hughes shares are issued. After the deal is done, GM will have fewer shares outstanding and a smaller pension plan contribution burden, which means both earnings per share and dividends should go up. On the other hand we have Direct TV. How much cooler can you get?
Technically, GM owns all of Hughes, since GMH is a tracking stock. Right now, 38% of Hughes' earnings are allocated to Hughes and 62% of Hughes' earnings are allocated to GM's bottom line. After the new tracking shares are released, Hughes shareholders will have an "economic interest" in 73% of Hughes' earnings, while GM will only retain a 27% interest.
Hughes doesn't technically have earnings at the moment. Earnings for the first quarter of 2000 showed a net loss of $81.9 million compared to a profit of $73 million in the first quarter of 1999. But that doesn't tell the full story. The loss was mostly a result of increases in depreciation and amortization and some one time charges.
The impressive part of its quarterly statement was an increase in revenues of 85% compared to the first quarter of 1999. This is a company with pretty hot prospects -- and an equally impressive set of risks, including competition from some other pretty hot companies, the risks associated with fast growth, a potential lawsuit for violating export controls, and the risk of satellite failure.
At the moment, there is an interesting economic premium that rewards GM shareholders for making the exchange, however, there is no guarantee that the premium will last. If you look at the relative prices of GMH and GM, you see that if you were to have sold 1000 shares of GM today, you would only be able to buy about 958 shares of GMH with the proceeds of that sale, but if you tender your 1000 GM shares in the exchange, you would expect to receive 1065 shares of GMH. (If you tender less than 1000 shares, or an odd number of shares, you won't receive any fractional shares of GMH. The value of any fractional share will be paid in cash.)
Well, that looks pretty good. It's about a 10% premium, however, the premium was up around 17% when the offer was first extended, so it's shrinking, and one would expect it to continue to shrink until the tender actually takes place. In theory, anyone who wants to buy Hughes would do better by buying GM shares now and exchanging them. That course carries risks, too, though. The premium could shrink to nothing by the time the offer closes, and if too many exchanges are requested, the number of shares exchanged will be prorated. You might ask to exchange 100 shares and only have 80 accepted.
Small shareholders get a break in this situation. Anyone holding less than 100 shares can tender them all and not be subject to proration.
I've looked and looked, but I can't find any compelling argument on either side. What it comes down to is this: If you like the Hughes business better than the General Motors business, and you're not committed to strictly following the Foolish Four, take the exchange. I'm not suggesting that you will come out ahead, but at the moment, the deal looks good.
On Monday, we'll attempt to deconstruct the AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> and AT&T Wireless <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AWE)") else Response.Write("(NYSE: AWE)") end if %> deal.
Fool on and prosper!
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