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If you're Steve Jobs, the CEO of Apple Computer, you might spring for a $40 million private Gulfstream Jet similar to one he received recently as bonus compensation. Or if you're Microsoft's Bill Gates, you could build a $53 million techno-mansion. Maybe you've been eyeing that cute little golf course called Pebble Beach. A group that included actor Clint Eastwood bought it for $820 million last year. Even if you purchased all three, you'd have made barely a dent in a $10 billion checking account.
For Jacques Nasser, president and CEO of Ford Motor Company <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>, the question is more than hypothetical. Ford's bank account is registering about $23 billion in cash, according to its last quarterly report. The company earned $2.1 billion in its last quarter. That's about $23 million a day, including Sundays. The green stuff is piling up so fast, it's hard to find a place to stash it.
Ford's board of directors can't find many good things to do with all this cash. If the auto company did business in a rapidly expanding "new economy" sector like e-tailing or wireless networking, there would be all kinds of young, growing start-ups to buy. But Ford's business is pretty mature now. Unlike these start-ups, right now the company is a cash-generating machine -- a cash machine whose stock price is in the dumps.
Last week we discussed Ford's plight, and focused on the first part of the company's strategy to bring back shareholder value -- the Visteon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: VC)") else Response.Write("(NYSE: VC)") end if %> spin-off that was completed today. Now we'll concentrate on the second part of the strategy, the so-called "Value Enhancement Plan" that includes just such a $10 billion distribution. Many investors in the Beating the S&P strategy own Ford and might be confused by the implications of this plan.
Here's how the Value Enhancement Plan will work, assuming it's approved by Ford shareholders later this summer:
For every share of Ford Common or Class B stock held, the shareholder will receive a share of newly issued Ford stock plus a $20 bonus. This bonus can be taken as either cash, or the $20 can be automatically reinvested in the newly created shares of Ford stock. To make the numbers work, immediately after the distribution, the price of the new Ford shares will be $20 less than that of the old shares. The number of shares outstanding will increase, but since the action is like a stock split, that increase is meaningless. We will refer to the post-bonus shares as "new" shares in an attempt to avoid confusion.
Here's an example given at the Ford's April press conference. If the old Ford shares are trading at $60, for each share held, shareholders will be given a choice of either taking $20 cash plus a share of new Ford stock worth $40, or they can choose to use the $20 cash dividend to automatically purchase a half share of the new Ford shares. Financially, the choice is a wash at the time of the transaction, because the $20 spent for the new share is offset by the lower price of the new shares. Like the Visteon spin-off described last week, there's still no free lunch, darn it!
Not to complicate the matter too much, but there are actually two additional options that shareholders have, as explained in last week's press release. The company will also give you cash for all your Ford shares, or you can use part of your cash distribution to buy new Ford shares, and keep the remainder in cash.
Ford has placed a limit of $10 billion on the amount of cash it can distribute through this Value Enhancement Plan. So, if too many shareholders elect the cash instead of the new stock, the deal will have to be prorated, and not everyone will be able to get the full cash back.
As with everything in life, the Value Enhancement Plan has tax consequences. Those shareholders electing to receive the new shares of Ford instead of the 20-buck bonus will not be directly affected by the tax man. The new shares are considered a tax-free exchange, with the holding period of the new shares considered the same as when the original Ford stock was purchased.
Those shareholders choosing to collect the $20 cash per share will have to pay capital gains tax on the cash distribution just as though they have sold part of their shares. This can be either considered a short-term or long-term capital gain, depending on when your original Ford shares were purchased. Long-term gains (held more than a year) are taxed at lower rates than the usual dividends, a comfort to those wishing to take the distribution in cash. Of course, if your shares are held in a tax-deferred retirement plan, you can blissfully ignore these pesky details.
How does this plan affect quarterly dividends, those distributions held dear to the hearts of Foolish Four and BSP investors? Ford intends to make the plan yield-neutral. Although the yield won't change, the dividend of the new Ford shares will be adjusted so that shareholders using their cash bonus to purchase new shares will receive the same total dividend as before the transaction occurred.
Since the new shares will sell for less than the old shares, the dividend on the new Ford shares will be lowered by the same proportion that the stock price drops. (Recall that dividend yield is simply the annualized dividend divided by a company's current stock price. Since the dividend will drop in direct proportion to the drop in the stock price, the dividend yield won't change.)
Here's another example of how these dividends will work, using different (and more recent) numbers. Ford shares are now priced at about $41 and pay an annual dividend of $2 per share, for a yield of about 4.9%. After a cash payout of $20 a share, the new Ford shares will be worth about $21 each. To make the transaction revenue-neutral, the $20 cash distribution per share can buy about 0.95 (20/21) new shares of Ford for each of the old shares owned.
Before the transaction, an owner of 100 Ford shares would receive $200 annually in dividends, or $2 per share. After the transaction, if this shareholder chooses to purchase new shares with the $20 distribution, he would now own 195 shares of new Ford stock. To keep the total dividend payout the same, the new shares of Ford would have to pay out an annual dividend of about $1.03 per share (195 shares times $1.03 per share equals the original $200 in annual dividends).
Those who decided to take the $20 cash distribution and run with it would own 100 shares of the new stock (worth $2,100), instead of 195 shares (worth $4,100). Since their total investment in Ford has dropped, their new shares would only pay $103 per year in dividends instead of $200, even though the yield is the same. The yield on the original investment would be cut almost in half. (Of course, they can always put their $2,000 cash bonus in some other dividend-paying investment.)
We've just run some numbers, but what's actually going on here? Is Ford really giving out $10 billion to its stockholders? Is this the largest rebate in automotive history? Is value being enhanced, like the plan's title suggests?
Yes... and no. The company isn't actually giving away $10 billion to shareholders. Those shareholders deciding to take the cash option will see the value of their remaining Ford stock drop by exactly that amount, at least initially. And such a shareholder will be left with a capital gains bill at tax time.
Those choosing to reinvest their $20 per share dividend back into the company will have more shares, but at a commensurably lower price. In that sense, this is a type of stock split, almost two to one assuming the price of Ford's stock doesn't change dramatically over the next few months.
The $10 billion is really being used to pay some shareholders to get out of the stock, reducing the number of new shares outstanding. In that sense, it's a type of stock buyback program. Since the total market capitalization for Ford after the Visteon spin-off will be about $49 billion, this plan is potentially a huge buyback program.
Fools have learned that stock splits are meaningless but stock buyback programs are good. A stock split does nothing to either enhance nor detract from the inherent value in a stock. It's mere window dressing.
Stock buyback programs, on the other hand, do create value. With fewer new shares outstanding, earnings per share increase, and there's an improvement in the supply-demand ratio for the stock. All these factors tend to increase share price in the long run.
What should current Ford shareholders do? As I see it, Ford is simply giving shareholders a chance to sell some of their shares for the market price that's current on the day of the plan execution. If you already own Ford stock, presumably you've invested because you like the prospects of the company, either on an analytical basis, or because of its status as a BSP portfolio stock. I don't see any specific benefits of taking the cash just because it's offered as part of this plan.
Shareholders electing to use the $20 bonus to purchase new shares might well benefit in the long run -- mostly because of the benefits of the buyback nature of the plan mentioned above. Certainly if you've invested in Ford as part of a mechanical system, the $20 bonus should be plowed back into the new stock.
What will the new Ford company look like after the Value Enhancement Plan is completed?
Presumably it will have $10 billion less on the books, with sufficient cash left over for rainy day expenses during the next (inevitable) industry downturn. The stock price will be almost halved, but the dividend yield should remain the same. Depending on how much of the $10 billion bonus is taken in cash, there will be fewer new shares outstanding because of the buyback feature. And those stockholders that still own the shares (like I will), will have done so through a conscious decision that they want to own the stock, shaking out any of the marginal investors -- probably good for the stock price in the long run.
As with any buyback program, the effective earnings per share should increase, the P/E ratio should decrease, and the stock should appear to be a better value. Again, this will depend on the number of people electing to take their bonus in cash or to sell other shares back to the company. Finally, the RP ratio for the stock will increase, since RP is calculated based on dividend yield divided by the square root of the stock price.
Will the Value Enhancement Program turn around Ford's stock price woes? In the long run the stock price will be determined by the prospects for the company, not by plans such as these. The price of the entire automotive sector has been in a swoon the last few years. But Ford's fundamental numbers should look a little better, which should benefit the stock price. And as value investors, Foolish Four and BSP investors know it's often better to strike when the iron's cold rather than red-hot.
Beating the S&P year-to-date returns
Compound Annual Growth Rate from 1-2-87:
Beating the S&P +23.1%
S&P 500 +17.2%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $162,700
S&P 500 $84,400
(as of 06-27-00):
Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %> -8.3%
PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %> +24.0%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> -17.4%
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> -4.4%
Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %> -9.0%
Beating the S&P -3.1%
Standard & Poor's 500 Index -1.3%