New, Improved Stocks? They Don’t Wash
The curious thing about money is that people treat it so respectfully. When Colgate or Procter & Gamble bring out a wash day miracle--new, improved Fab or Tide--it is seen for what it is, a marketing gimmick to wake up customers. But when Wall Street comes up with a new scheme for its brokers to wake up customers, it’s treated as a great financial innovation. That’s the way it was last week with unbundled stock units, the latest gimmick dreamed up by Shearson Lehman Hutton. Shearson, the $10-billion (revenues) investment firm that is 60% owned by American Express, was hailed as an innovator for a scheme to split common shares into three separate securities and for getting four major companies to adopt it.
Early in the new year, Dow Chemical, Pfizer the drug maker, Sara Lee the cake maker and American Express will ask holders of 20% of their stock to swap their shares for new three-part securities: (1) a bond that will pay interest equal to what the stock has been paying in dividends and for which the company promises to pay a higher price 30 years from now; (2) a preferred stock that will pay any dividend increases the company makes over the next 30 years, and (3) an “equity appreciation certificate” that allows an investor to buy a common share 30 years from now at a price that reflects a gain of about 3.5% per year--which may, or may not, be a bargain in 2019.
Uncommon Shares
Put more simply, the companies are asking shareholders to trade their stock--which is a share of company ownership--for a bond with an interest rate under 4%; a preferred stock with no specified or required dividend, and a piece of paper that must be held for 30 years before it can be turned into common stock, at a price reflecting a lower rate of appreciation than stocks have shown historically.
We’re not making this up!
The Shearson people, not surprisingly, see it differently. They say the bond gives investors income and capital gains, that the preferred stock allows investors to enjoy rising dividends and that the equity certificate allows investors to cash in if the stock is a better-than-average performer.
So what should you do if you own stock in American Express, Dow Chemical, Pfizer or Sara Lee? Nothing. Aside from capital gains taxes that you’d have to pay at swap time as if you were selling the stock--the unbundled unit offers you no more dividends or appreciation potential than you already have through stock ownership. To be sure, the bond portion promises to pay you more in 30 years--for example, $123 a unit on Sara Lee, compared to today’s stock price of about $45 a share. But so what? That capital gain of 3.4% per year, on top of less than 4% bond interest, is less than the nearly 9% you can earn today on a safer, 30-year U.S. government bond.
‘Snare and Delusion’
“There’s nothing there for individual investors,” says Earl Fisher, of Stern Fisher Edwards, a small Los Angeles brokerage firm.
OK, but is it a good deal for non-taxable pension-fund investors? An emphatic no, says Chairman Robert G. Kirby of Capital Guardian Trust, a major pension management firm. “It’s a snare and a delusion,” says Kirby. “If investment bankers came to me with a presentation on this, I’d get two burly guys to throw them down the stairs.”
“It takes away the voting right and may not even be prudent for fiduciary investors,” says Robert A. G. Monks, head of a firm that advises pension fund managers and former administrator of pension fund matters at the Labor Department.
So who’s this stuff good for? For corporate managements. First, trading bonds for stock in theory strengthens management against takeover raids because a greater share of ownership will be in friendly hands.
Second, reducing shares outstanding by 20% boosts reported earnings per share, and thus, in theory, the price of the remaining shares. Anthony Marchese, of Weatherly Capital, a New York investment firm, notes that companies could achieve the same result with less complexity if they repurchased their own shares. But that would mean paying real cash, which is expensive, while using unbundled units involves low-interest, 30-year IOUs.
Third, unbundled units reduce the corporate tax bill because paying interest on bonds is deductible, while the income that pays dividends on stock is taxable to the corporation. Note: Investors, who pay tax on interest and dividends, get no tax break--only the companies.
But when all is said, the real reason for the new scheme is to make fees for Wall Streeters. Shearson will make more than $100 million on the four stock swaps proposed so far. It’s a case once again of the stockbrokers’ yachts--as in the old story of the visitor to a Wall Street firm who is shown impressive yachts at anchor in New York harbor. “That’s Mr. Morgan’s yacht,” says the brokerage partner, “and over there is Mr. Merrill’s yacht. . . . “
“But, where,” asks the visitor, “are the customers’ yachts?”
