At the Ira Sohn Conference, David Einhorn explained why Greenlight likes to buy preferred stock in many case over common equity. Below is a summary followed by the full presentation with examples of some equity holdings in an excel document.
There are many great companies with great balance sheets that suffer from low valuation multiples in the current environment, when market participants have enormous appetite to pay for yield, but little appetite to pay for earnings. The traditional advice to such companies is to offer a dividend, but dividends often don’t work. A stock with a low P/E multiple often just becomes a stock with a low P/E and an attractive dividend.
Rather than enduring low multiples, companies can create value for shareholders by taking advantage of the situation by creating a new type of preferred security and distributing it to shareholders. This new security, which we call Greenlight Opportunistic Use of Preferreds, or GO-UPs, would be perpetual preferred stock distributed directly to shareholders, so that shareholders would own and could separately trade both the GO-UP and the common stock.
The “liquidation preference” of the GO-UP would represent a meaningful percentage of the existing market capitalization, and would carry the following terms, allowing it to trade at or near par:
- 4-6% dividend rate, which would be taxed at preferential rates.
- Quarterly cash payments, which would be cumulative and subject to Board approval.
- Customary protective provisions for similar securities. For example, Board representation in the event of two consecutive missed dividends.
GO-UPs would have many benefits to issuers:
- Since the liquidation preference only needs to be satisfied upon a sale or wind-down of the business, there is no immediate use of cash, no maturity or refinancing risk, and no default risk.
- The GO-UP would be displayed as a component of equity on the balance sheet and not as debt. Should times turn tough, the board could defer dividend payments.
- The company would maintain all its current resources to pursue its business strategy.
- These would be very high quality credits, as each company holds several years of dividend payments in idle cash on their balance sheet. The GO-UP would trade to reflect long-term interest rate expectations.
- The GO-UPs would be bought or sold as needed to suit investment goals. Some people will keep them and some can sell.
This idea should be appealing to management teams, because it allows employees to achieve personal liquidity without needing to sell common stock. GO-UPs unlock value by converting low multiple net income into low yielding preferred stock. The value arbitrage is very large and the potential value unlock is remarkable as we show in the model below.
Some may object that there is no precedent for this idea. That is because this is a new idea.
Below is Einhorn’s presentation on preferreds and an excel spreed on some companies he owns:
Sohn-einhorn
Excel-spreed-sheet
