Is that a special dividend, or a dividend recap? It's hard to tell the difference these days.
By now you've probably heard about Costco's whopping $3-billion (U.S.) special dividend, paid for by a $3.5-billion debt issue. But it turns out that the bulk retailer wasn't the first company with enough brass to try this trick. A day earlier, Murphy Oil sold $1.5-million of debt to pay its own special dividend. And it wouldn't be surprising if more are on the way.
Such is the reality of the pending fiscal cliff. If U.S. lawmakers can't agree on a solution to the dilemma before year-end, dividends will be taxed at the highest income tax rate, 39.6 per cent, and the highest income earners will have to pay a 3.8 per cent surcharge to help pay for the Affordable Care Act.
Though this may not happen if a deal is hashed out, companies have been trying all sorts of things to save their shareholders some money. Wal-Mart, for instance, moved up the date of its next dividend payment to December, from January, so that at least that distribution would be paid under the current rules.
Of course, public companies have used dividend recapitalizations before. But when they do, they'll often buy back stock to boost future earnings per share. In these cases, debt investors are simply lunging at new offerings even though the special dividends won't even benefit them. All they're left with is new debt on the balance sheet. Plus, the coupon they're getting isn't anything special. In the Costco offering, all three tranches had coupons of 1.7 per cent or less. At least private equity deals often offer attractive yields. (Of note, dividend recaps are back to pre-crisis levels in the private equity world.)
Clearly, there are many factors at play. In Costco's case, the new deal was the company's first debt offering in five years, so fixed-income investors were probably happy to get exposure to the name. But you have to ask, at what price?
Going forward, expect to see more special dividends – regardless whether they're paid for with new debt. Barron's calculated on Thursday that 174 U.S. companies announced special dividends in November, much higher than the average of 74 that announced in the previous eight Novembers, proving that companies of all sectors and sizes are jumping at the chance to help their shareholders.