The Surprise Dividend

This is just a “what if” piece. If one of my readers knows better than me, leave a comment, or email me. Thanks.

The Surprise Dividend

Imagine one day in 2019 that your favorite dividend-paying stock made the following announcement:

Dear Shareholder,

As you may know, we currently pay a dividend of $2/year to holders of our common stock for each share they hold.  In this current climate where there is uncertainty over whether dividends will be cut at some companies, we would like to guarantee the current payout, and give you more.

We are replacing the current dividend and declaring a special payout today — an unsecured perpetual junior subordinated bond that will pay 80 cents quarterly per current share, payable to all current shareholders as of June 1st, 2019.  It will be eligible to trade separately under the ticker [TICKER].  You are free to sell this income stream for a current gain, or you can continue to receive this income in perpetuity, as will any future holder of this bond.

Why are we doing this?  The Total Revenue And Safe Harbor Act of 2018 repealed special treatment of dividends, but interest is still tax-deductible to us as a corporation.  Much as we like the flexibility of dividends, our cash flow is more than sufficient, and can handle a higher payout.  This higher payout is possible partially because this is an interest payment, and we get to deduct the payment from taxable income.  With our current corporate tax rate of 35%, the effective cost of the new dividend to the corporation is $2.08 per current share.

Many of our shareholders are not taxable, or have taxes deferred.  Still others are retirees who are in lower personal tax brackets.  We expect that some current shareholders in higher tax brackets will choose to sell their bonds.  We would not be surprised to find life insurance companies as willing buyers, given our high credit rating, and their need for long bonds as investments.

Though in the near-term, we will not pay a dividend, that does not mean we will never pay a dividend again.  We will review our payout policy regularly, and make changes as we see best.  It is also possible that future shareholders could see further issuance of these securities if our reliable excess cash flow grows.

As always, we welcome your inquiries to our Investor Relations Department.  Please be aware that this does not constitute tax advice, nor will we provide that to you.  Please give your tax questions to your own personal tax adviser.

Many thanks for being one of our shareholders.  We hope you prosper in 2019 and beyond.

I left aside the argument that now shareholders could choose their own income preference, and also that the income from a junior subordinated bond could survive bankruptcy (though unlikely), and could control the company post-bankruptcy (also unlikely).  Mentions of bankruptcy don’t travel well, even in vague terms.

I also did not mention that the package of the junior bond and the post-dividend stock would likely trade at a higher price post-event.  Might some activist investors try some more severe proposals of this sort?

Your thoughts on this proposal are welcome.  I can’t think of any firm that has done something like this in the past.  Might they do it in the future?