Context and presentation often matter more than substance, at least in the short term. Many public companies have elevated this notion to a perverse art form - announcing news that is actually quite bad for shareholders, but spinning it in a way that makes it sounds as though shareholders should be grateful to have such far-sighted leadership. Being able to separate the real good news from puffery and double-talk is a valuable skill, and investors should be on the lookout for some of these examples of good news that really is not good news. (For more, check out Can Good News Be A Signal To Sell?)
Tutorial: Stock Picking

Given the end of the Great Recession and the recovery in the economy, it seems more likely that companies will be in a mood to hire and expand rather than restructure and retrench. Eventually, though, there will be another wave of corporate restructuring among public companies. Though analysts and institutions often cheer these moves, savvy investors should be skeptical.

Sometimes restructuring makes all the sense in the world; particularly when a company hires a new management team to improve or turn around a business that has been lagging and underperforming. But what about cases where the management team doing the firing is the same team that did the hiring? Barring a public mea culpa (and perhaps the surrender of some bonuses or salary), why should an investor trust a CEO who is basically saying "I confess … they did it!"

Restructurings can be very bad for morale, and they eat away at the loyalty between employees and employers. Worse still, the roster of companies that have fired their way to prosperity is rather short. When a shareholder sees one of his or her portfolio companies announcing a restructuring, they should carefully examine whether the moves are aimed at long-term success (rather than a short-term earnings boost) and whether current management really has the skill set to build long-term shareholder value and compete effectively in the market. (To learn more, see Cashing In On Corporate Restructuring.)

There has long been a notion in academia that there is a "right" capital structure for each company; the perfect balance of debt and equity financing to maximize earnings and returns and minimize risk and volatility. As readers may suspect, the professors advancing these theories have almost universally never run a company, nor held a position of high responsibility within one.

What a recapitalization often means is this - a company that has had a reasonably good record of cash flow generation and little debt will often go to the market and issue significant amounts of debt. This essentially shifts the company's capitalization from an equity-heavy/debt-light ratio to the opposite.

Why would a company do such a thing? To a certain extent, debt is cheap money. Creditworthy companies often find that the coupon rate on debt is lower than their cost of equity and the interest on debt is tax-deductible (equity dividends are not). Sometimes firms will use this sort of maneuver to raise cash for use in acquisitions, particularly in cases where the stock might be illiquid or otherwise unattractive as deal currency.

In many other cases, though, companies use the cash generated by the debt sales to fund a large one-time special dividend. That is great for long-term investors who get the cash payout and leave, but it creates a radically different company for those who remain invested or buy in after the recapitalization.

Unfortunately, many companies recapitalize themselves during periods of peak cash flow and struggle to survive under the heavy weight of debt payments as economic conditions worsen. Consequently, a recapitalization is only good news for investors willing to take the special dividend and run, or in those cases where it is prelude to a deal that is actually worthy of the debt load and the risks its brings. (To learn more, see Evaluating A Company's Capital Structure.)

Special Dividends
With the popularity (and flexibility) of stock buybacks, special dividends have become less common, but they still do occur. A special dividend is basically what it sounds like - the company makes a one-time payment of cash to shareholders with no particular expectation of making a similar payment again in the near future.

While special dividends funded by debt are dangerous in their own right, there is a problem even with dividends funded by a non-strategic asset sale or cash accumulation. The biggest problem with special dividends is the not-so-subtle message that goes with them - management is basically out of ideas and better options for the company's capital.

Is it better for a company to write a check to its shareholders instead of wasting the money on a stupid acquisition or a new expansion project that cannot earn its cost of capital? Of course. But it would be better still for management to have a plan and strategy in place to continue growing and reinvesting capital at an attractive rate. Though management teams willing to acknowledge that a company has grown as large as it practically can should be applauded for their candor, investors should not overlook the message that a special dividend sends and should adjust their future growth expectations accordingly. (To learn more, see Dividend Facts You May Not Know.)

Poison Pills
What happens when a board of directors is afraid that a company will expose their shareholders to the truth that they could reap a premium by selling their shares in a buyout and management does not want to sell? They initiate a poison pill, or as companies prefer to call them, a "shareholder rights" plan. Poison pills are designed to make unfriendly acquisitions prohibitively expensive for the acquirer, often allowing underperforming management to keep their jobs and their salaries.

In essence, a company sets a trigger whereby if any shareholder acquires more than that amount of the company, every other shareholder except the triggering shareholder has the right to buy new shares at a major discount. This effectively dilutes the triggering shareholder and significantly increases the cost of a deal.

What's really unfortunate about these deals is the embedded paternalism. Management and the board of directors are telling its own shareholders "look, you're not smart enough to decide whether this is a good deal, so we'll decide for you". In other cases, it's simply a conflict of interests - the management or board owns a big slug of stock and just isn't ready to sell yet.

It is true that some studies have shown that companies with poison pills get higher bids (and takeover premiums) than those that do not. The problem is that there is relatively little beyond the threat of lawsuits that shareholders can do to ensure that a board of directors upholds their fiduciary duty to shareholders. If a majority of shareholders wish to sell the company at a given price, a poison pill and management's opinion of the valuation should not be allowed to stand in the way.

The Bottom Line
News always carries a certain amount of nuance with it. None of the actions listed here are universally or automatically "bad" or "wrong" for a company and its shareholders. The problem is that too often dishonest and self-serving managers try to fool their shareholders into believing that quick fixes are a long-term strategy. Investors should foster a healthy sense of skepticism and make sure that "good new" is really as good as management wants you to believe. (For more, see Evaluating A Company's Management.)

Related Articles
  1. Investing

    Asset Manager Ethics: Acting With Competence and Diligence

    Managers must make investment decisions based on their personal investment process, which in turn should be based on solid research and due diligence.
  2. Forex Education

    Understanding The Income Statement

    Learn how to use revenue and expenses, among other factors, to break down and analyze a company.
  3. Investing

    Wal-Mart's Share Repurchase Isn't All Good

    Wal-Mart announced huge internal investments along with an aggressive share repurchase program that isn't as good as it initially sounds.
  4. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  5. Economics

    Investing Opportunities as Central Banks Diverge

    After the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
  6. Stock Analysis

    The Biggest Risks of Investing in Pfizer Stock

    Learn the biggest potential risks that may affect the price of Pfizer's stock, complete with a fundamental analysis and review of other external factors.
  7. Markets

    PEG Ratio Nails Down Value Stocks

    Learn how this simple calculation can help you determine a stock's earnings potential.
  8. Investing

    What’s the Difference Between Duration & Maturity?

    We look at the meaning of two terms that often get confused, duration and maturity, to set the record straight.
  9. Fundamental Analysis

    Buy Penny Stocks Using the Wisdom of Peter Lynch

    Are penny stocks any better than playing penny slots in Vegas? What if you used the fundamental analysis principles of Peter Lynch to pick penny stocks?
  10. Fundamental Analysis

    Are Amazon Profits Here to Stay?

    Amazon is starting to look like a steadily profitable company. Is this really the case? Should investors even be hoping for profitability?
  1. What do states do with unclaimed property?

    Unclaimed property refers to personal accounts in financial institutions or companies that have had no activity and whose ... Read Full Answer >>
  2. How do financial advisors execute trades?

    Today, almost every investor invests through online brokerage accounts. Investors often believe that their trades are directly ... Read Full Answer >>
  3. What are ComputerShare's escheatment services?

    Escheatment is the process by which ownership of abandoned property is transferred to the state. Escheated property can include ... Read Full Answer >>
  4. How does escheatment affect a company's shareholders?

    Escheated property in the United States is a designation for personal property such as bank accounts, shares, insurance proceeds, ... Read Full Answer >>
  5. What does low working capital say about a company's financial prospects?

    When a company has low working capital, it can mean one of two things. In most cases, low working capital means the business ... Read Full Answer >>
  6. Do nonprofit organizations have working capital?

    Nonprofit organizations continuously face debate over how much money they bring in that is kept in reserve. These financial ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Cyber Monday

    An expression used in online retailing to describe the Monday following U.S. Thanksgiving weekend. Cyber Monday is generally ...
  2. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  3. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  4. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  5. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  6. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
Trading Center