When a Tax-Dodging Special Dividend Isn’t So Smart
Some dividends are just a little bit more special than others, and Brown-Forman Corp. (BF.B) announced one of those earlier this week when it declared a hefty $4 a share one-time payout on December 27 to shareholders of record December 12. The problem? The $800 million or so that the beverages company will be distributing to its shareholders actually exceeds the amount of cash it has sitting on its balance sheet. It’s enough to make you wonder whether the company’s board was quaffing too much of its signature brand, Jack Daniel’s whiskey, while it pondered its decision.
In the current low interest rate environment, that’s far from being a major problem. Indeed, within hours of the dividend announcement, the company had laid out its plans to finance the payout by raising about $750 million in debt, via a sale of 5-year, 10-year and 30-year bonds, with coupons ranging from a low of only 1% to an absurdly low “high” of 3.76%. At those prices, it might seem downright foolish not to raise debt, and what better use to put it to than returning it to shareholders? In making a special dividend, or moving up the payout on a regular dividend, Brown-Forman joins Wal-Mart (WMT), Costco (COST) and Las Vegas Sands (LVS).
Except of course, that Brown-Forman has managed to get the theory backwards. The idea behind special dividends is that they are great when a company has a bunch of idle cash cluttering up its balance sheet for which it can’t find a way to deploy it that would generate a higher return than the cost of capital. With rates as low as they are, that’s a pretty low threshold, so it’s unlikely that many companies – unless they are as cash-rich as, say, Apple (AAPL), are wary of rushing into an ill-considered merger, or are in a slow-growth business – can truly believe that paying out cash is better than looking for a way to deploy it themselves. Especially when they are pondering paying out cash that they don’t even have, and committing themselves to paying interest on debt for years to come.
The new debt will more than double the amount of long-term debt on Brown-Forman’s balance sheet. True, the company’s balance sheet has been healthy, as measured by its current ratio and debt/equity ratio, and its cash flow from operations is relatively robust, if not as much so as it has been. There is no serious question about the company’s ability to finance that debt given the miniscule coupons and the strength of the demand (especially in overseas markets) for Brown-Forman’s roster of alcoholic beverages, which also include Finlandia vodka.
Still, it weakens – on the margins – the company’s financial strength. As Standard & Poor’s pointed out when it downgraded the ratings on Brown-Forman’s debt to A minus, it is a smaller player in the competitive global beverages business and while its brands are well recognized, it has a smaller portfolio than many of its rivals. S&P voiced concern that it may not be able to improve its cash flow metrics until after the fiscal year that will end April 2014. Goldman Sachs (GS) seemed to agree with this assessment, cutting its rating on the stock to “sell” from “neutral” in the wake of the special dividend announcement.
Brown-Forman may be in one of the most recession-resistant industries that exists, but weakening the company’s credit profile even slightly simply in order to pay out a special dividend in anticipation of what could prove to be higher tax rates in 2013 is giving shareholders a boon today that they may well pay for in some way other than higher taxes in the coming years. Should Brown-Forman want to invest in its business in a year’s time, its financial flexibility will have been limited by the decision to fund a special dividend using debt, and debt markets may prove less open at that time. This may not be a reason to sell the stock – at least, not until you have collected that special dividend – but it might be a reason to ponder the judgment of the company’s management team.
Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at email@example.com.
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