From the November 2009 issue of Treasury & Risk magazine

Dividends Pay Off

When EnergySolutions, a nuclear waste management company in Salt Lake City, went public in November 2007, it did something not that many newly listed companies do: It announced plans to issue a dividend.

"We knew we had a pretty stable business with stable cash flow," says CFO Philip Strawbridge. "With two-thirds of our income coming from life-of-plan arrangements with utilities that operate nuclear plants, and most of our other contracts being with the U.S. and U.K. governments, we felt we had the predictability to pay out $10 million a year in dividends and still leave us with $60 million of true free cash for investment."

Meanwhile, there was the advantage that, at a time when the IPO market was starting to close down, "we could open ourselves to funds that require that their investments pay dividends--such as teachers union pension funds and the like--investors that have the advantage of being more stable and long-term."

It wasn't that far back--really just a little over a year ago, before the financial market turmoil really hit--that corporate managers, especially at high-growth companies, didn't think much about paying dividends. Investors, after all, were after appreciation, not dividends, and managers wanted their cash to be available for investment purposes. For the most part, paying dividends was something that established blue chips did, not happening companies.

Today, that attitude may be changing a bit. Paying a dividend can be more than just another way of returning shareholder value. It can be a way to attract new investors, a way of telegraphing that the company is confident about its long-term cash and earnings prospects--even a way for management to apply a bit of self-discipline.

Over the last year and a half, more than 30 companies listed on the New York Stock Exchange, ranging from little Vanguard Natural Gas and Ducommun to giants like KBR and Philip Morris, have begun issuing dividends. Their reasons for doing so have been as varied as the industries they're in.

Global engineering, construction and services firm KBR was spun off by Halliburton as an IPO in April 2007 and began paying a dividend in its first year out as an independent company. "We had $1.9 billion in cash on our balance sheet at the end of our first year, and the obvious question after saying 'Wow!' was 'What do we do with this?'" recalls CFO and senior vice president Kevin DeNicola. "We instituted a 20 cents a share dividend--not a lot with shares at $24. We also put in a 5% stock buyback, and we did $160 million in acquisitions."

Of the dividend, DeNicola says, "It's not a lot of money, but it's a little discipline for us, without being a burden. And it does matter to some of our shareholders that we pay it."

"The market does penalize companies that cut dividends," notes Narayanan Subramanian, a senior manager at Cornerstone Research, a consultancy in Boston, "so paying a dividend is a kind of commitment to continue to do so." Subramanian, who has written about dividend-paying companies with colleague Laarni Bulan, an assistant professor of finance at Brandeis University, suggests that it provides something of a counterweight to the pressure on companies with a lot of cash "to try and make acquisitions that don't make real sense."

"Acquisitions have always been a key part of our growth strategy," says Cindy Lucchese, CFO of coffin manufacturer Hillenbrand. But last year the firm began paying a dividend of 18.5 cents a share.

Partly it was tradition. Hillenbrand's parent firm, Hillenbrand Industries (now Hill-Rom Holdings), from which the company was spun off a year ago, had been paying a dividend for almost 40 years, raising it every year. "We will continue to make acquisitions, but paying that dividend is a sacred priority for us too," Lucchese says. "You can't say never, but I can't see us suspending it, and it does make you focus on cash."

"Typically, companies start contemplating issuing a dividend when they have clear visibility about free cash flow they'll have on a going-forward basis," says Qwest Communications CFO Joe Euteneuer. Qwest, ironically, made that decision to start paying a dividend back in early 2008. "A the time, we thought we had visibility going forward," he says ruefully, "but of course Sept. 15, 2008, rocked everyone's world, ours included."

While maintaining the dividend this past year, when visibility was in short supply, has been a challenge, Euteneuer says it has nonetheless been worth the effort. "Without a doubt, paying a dividend adds a layer of discipline on management, because it's not a one-time thing," he explains. "Clearly, when you go through the evaluations about where to invest, you are thinking, 'What are the trade-offs versus the dividend for the shareholders?'"

Lowell Miller, president of Miller/Howard Investments, a Woodstock, N.Y., investment management company that focuses on dividend-paying stocks, says, "There is ample evidence that dividend introducers and dividend increasers outperform their peers, and that their stocks are less volatile."

Miller, who has also written a book, The Single Best Investment: Creating Wealth with Dividend Growth, suggests that one reason could be that by attracting longer-term investors, managers of dividend-paying firms may feel less pressure to focus on boosting quarterly earnings, allowing them to think longer term.

"A dividend--especially if it is a significant dividend in line with debt yields--can help make sure management is working in the interest of the company's owners, and not just to enhance management compensation," Miller adds.

"It's not so much that it makes managers think more long term, but a dividend is a long-term commitment," Euteneuer says. "And so as I look ahead, I do feel that I have this certain need going forward for cash to pay that dividend."

That's not to say that dividends, once paid, can never be cut. Subramanian notes that when Florida Power & Light wanted to implement a major modernization program in 1994, it explained its plans to shareholders and said that it would be cutting its dividend to help finance the program. "The company's shares dipped briefly," he says, "but then they rose."

Of course, that was 1994. "Over the past nine months, investors have been pretty leery of managements who cancel a dividend saying they're investing in growth," says EnergySolutions' Strawbridge, "but I think in a period of general economic growth, that argument would be easier to make." Meanwhile, though, Strawbridge says paying a dividend makes the investor relations part of his job easier. "As you know, these days investors and analysts are much more concerned about your cash, and with a dividend, they know we've got the cash."


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