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. Stock Analysis

    Corvex Management: An Activist Investor Analysis

    Read about activist hedge fund Corvex Management and its founder, Keith Meister, who is a sometimes abrasive and emotional, but effective, leader.
  2. Stock Analysis

    Analyzing Microsoft's Return on Equity (ROE) (MSFT)

    Discover a detailed analysis of Microsoft's historical return on equity, and learn how its ROE stacks up to its competitors in the tech industry.
  3. Stock Analysis

    ValueAct Capital: An Activist Investor Analysis

    Read an in-depth review of activist hedge fund ValueAct Capital, which saw nearly all of its 2015 gains eliminated in a matter of weeks during Q3 2015.
  4. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  5. Investing

    Don't Freak Out Over Black Swans; Be Prepared

    Could 2016 be a big year for black swans? Who knows? Here's what black swans are, how they can devastate the unprepared, and how the prepared can emerge unscathed.
  6. Stock Analysis

    Analyzing Sirius XM's Return on Equity (ROE) (SIRI)

    Learn more about the Sirius XM's overall 2015 performance, return on equity performance and future predictions for the company's ROE in 2016 and beyond.
  7. Stock Analysis

    Will Virtusa Corporation's Stock Keep Chugging in 2016? (VRTU)

    Read a thorough review and analysis of Virtusa Corporation's stock looking to project how well the stock is likely to perform for investors in 2016.
  8. Stock Analysis

    Analyzing Porter's Five Forces on JPMorgan Chase (JPM)

    Examine the major money-center bank holding firm, JPMorgan Chase & Company, from the perspective of Porter's five forces model for industry analysis.
  9. Stock Analysis

    Analyzing Dish Network's Return on Equity (ROE) (DISH, TWC)

    Analyze Dish Network's return on equity (ROE), understand why it has vacillated so greatly in recent years and learn what factors are influencing it.
  10. Stock Analysis

    Forest Laboratories: An Activist Investment Analysis

    Find out how patience and perseverance paid off big-time for billionaire activist Carl Icahn during his four-year fight with Forest Laboratories.
  1. When does a growth stock turn into a value opportunity?

    A growth stock turns into a value opportunity when it trades at a reasonable multiple of the company's earnings per share ... Read Full Answer >>
  2. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  3. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  4. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  5. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  6. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
Hot Definitions
  1. Short Selling

    Short selling is the sale of a security that is not owned by the seller, or that the seller has borrowed. Short selling is ...
  2. Harry Potter Stock Index

    A collection of stocks from companies related to the "Harry Potter" series franchise. Created by StockPickr, this index seeks ...
  3. Liquidation Margin

    Liquidation margin refers to the value of all of the equity positions in a margin account. If an investor or trader holds ...
  4. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  5. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  6. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
Trading Center