Interesting Slate article on why cash-rich companies (e.g., Dell) won't pay dividends, regardless of tax changes... it's the options, stupid.
slate.msn.com
Dell last fiscal year spent $3 billion on stock buybacks and paid no dividend.
Conventional wisdom holds that buying back shares is good for shareholders. Many investors regard buyback announcements as signs of confidence, like chefs paying to eat at their own restaurants. The practice makes particular sense when shares seem beaten down for reasons unrelated to underlying performance. (Philip Morris has long been a major buyer of its own controversial stock.) Buybacks increase demand for stock, driving up prices. And by taking shares out of the public's hands, buybacks make earnings-per-share look better, since there are fewer shares among which to divide profits.
But for many companies, purchasing their own shares is less a magnanimous gesture than a defensive one. They don't buy back loads of shares each year simply because they want to, they eat the home cooking because they must—to compensate for all the options they give out. Regardless of what Washington decides about Bush's tax plan, shareholders of Intel, Microsoft, Dell, and other cash-rich technology companies shouldn't sit by their mailboxes waiting for fat dividend envelopes. The tax proposal may alter the incentives—the people who receive cash in buybacks will pay capital-gains taxes on the value realized, while dividend recipients won't. But it won't change the underlying dynamic that favors stock buybacks over dividend payouts.
An option gives its holder the right to convert it into a common share, subject to certain price and time constraints. Every option that a company issues to executives and employees is therefore a potential share, which, when exercised, adds to the total number of shares outstanding. Since the same earnings must be spread over a larger number of shares, any value realized by employees converting options into shares comes directly out of the value of existing shareholders. It's a zero-sum game.
As options have morphed over the years from occasional incentives into a widespread form of compensation, many companies—not just startups like Amazon.com, but mature blue-chips like IBM—now find themselves with vast options overhangs. Dell has about 2.6 billion shares outstanding, but options exist on another 360 million shares—or 14 percent of the company.
To forestall the inevitable dilution caused by options, company boards authorize officials to buy back shares regularly. But if you've got lots of options outstanding, you can spend billions annually on your own stock and still not dent the total number of shares outstanding. It's running in place. In the five-year period from 1998-2002, Dell spent $9.8 billion to buy back 940 million shares. But the number of shares outstanding fell by only 29 million.
I do question why MD still needs more options...
Anyway, the dividend tax cut is so irrelevant to all bar the wealthiest, it would be laughable - if it weren't so expensive and potentially damaging... |
