Who Lives and Who Dies? The Moral Hazard of COVID-19 Bailouts

Finance

Synopsis

COVID-19 will require a comprehensive US government bailout for many affected businesses. However, many recipients of this government relief, particularly large publicly traded companies, have engaged in a widely popular form of “shareholder friendliness” over the past 10 years in the form of large-scale dividends and stock buybacks. These “shareholder friendly” actions have often been at the expense of reducing indebtedness or investing for the future. In the coming weeks and months, the Trump Administration has a difficult task of deciding who lives and who dies, and will they address “shareholder friendliness” in the next round of bailouts?

We will cover four specific examples of large publicly traded companies across sectors to help folks quantify “shareholder friendly” behavior over the past decade. If you want to do the math yourself, I’d encourage you to check out the corresponding Apteo workspaces to visualize the data:

- Boeing: click HERE for workspace
- Macy’s:
click HERE for workspace
- Southwest Airlines:
click HERE for workspace
- Royal Caribbean: click HERE for workspace

Introduction

Large US government bailouts are coming. COVID-19, with little warning, has created a demand shock that is rippling across every sector of the US economy. US airlines, hotels, restaurants, cruises, casinos, and service-oriented sectors will be especially hard hit. Given the sheer employment of these sectors (30 million people in the US) and their strategic importance in many cases (e.g., domestic air travel), it does not seem plausible to allow mass bankruptcies. The US government should, and will, step-in to help companies navigate the impacts of COVID-19, especially when many of these businesses were forced to close for the greater good of public health.

Stock Buybacks, Dividends, and Ballooning Corporate Debt

But one of the big challenges facing the Trump Administration is deciding who lives and who dies: how do you bailout Boeing and its 161,000 employees but not extend that same relief to some of the 30 million small businesses in the country?

This will be a difficult task, further complicated by the fact that many large publicly traded bailout recipients, like Boeing and others, have exhibited a common pattern of behavior over the last 10 years. This behavior often labeled as “shareholder friendliness”, has become widely accepted practice mutually developed between stock and bond market investors, C-suite management teams, Boards across Corporate America, bankers, and rating agencies. In its simplest form, being “shareholder friendly” after the 2008 – 2009 financial crisis has come in two forms, cash dividends and stock buybacks. Often, these actions have come at the expense of reducing a company’s debt burden on its balance sheet, investing in capital expenditures and R&D, or both. And in many cases, companies “took advantage” of low interest rates to issue debt to facilitate dividends and stock buybacks. This last dynamic largely explains why US corporate debt has ballooned to $10 trillion, or about 50% of US GDP. While everyone sees the daily volatility in stock markets, the real ticking time bomb seems to be in US corporate credit.

Four Examples Over The Past Decade

In the following analysis, I will look at four (4) US companies across four (4) non-energy sub-sectors (aerospace, retail, airlines, cruises) that will likely need some form of US government aid to navigate the impacts of COVID-19. The goal is to examine the moral hazard we face during the next round of bailouts: are we rewarding 10 years of bad behavior?


Boeing (ticker: BA) - see workspace
Number of employees – 161,100

Over the last 10 years (2010 - 2019), Boeing has generated cumulative Cash Flow from Operations of $78 billion, and as the chart below shows, 88% of this cash flow ($68 billion) was deployed to pay dividends to shareholders or engage in share buybacks over this 10-year period.

In fact, over the past 10 years, Boeing has paid more in cumulative dividends ($25 billion) to shareholders than the cumulative amount spent on capex ($20 billion) by a magnitude of 1.5x. However, both of these figures are dwarfed by the amount spent by Boeing on stock buybacks ($43 billion) and with Boeing stock at a 7-year low, most of these purchases were done at materially higher stock prices.


Macy’s (ticker: M) - see workspace
Number of employees – 130,000

Over the last 10 years (2010 - 2019), Macy’s has generated cumulative Cash Flow from Operations of $20 billion, and as the chart below shows, 54% of this cash flow ($12 billion) was deployed to pay dividends to shareholders or engage in share buybacks over this 10-year period.

In fact, over the past 10 years, Macy’s has spent about the same amount of money on stock buybacks as the cumulative amount spent on capex ($8 billion). Note: Macy’s stock currently sits near an all-time low so most of these repurchases were done at much higher stock prices.


Southwest Airlines (ticker: LUV) - see workspace
Number of employees – 60,800

Over the last 10 years (2010 - 2019), Southwest Airlines has generated cumulative Cash Flow from Operations of $31 billion, and as the chart below shows, 40% of this cash flow ($17 billion) was deployed to pay dividends to shareholders or engage in share buybacks over this 10-year period.

Royal Caribbean Cruises (ticker: RCL) - see workspace
Number of employees – 85,400

Over the last 10 years (2010 - 2019), Royal Caribbean has generated cumulative Cash Flow from Operations of $22 billion, and as the chart below shows, 19% of this cash flow ($4 billion) was deployed to pay dividends to shareholders or engage in share buybacks over this 10-year period.

What Will Likely Happen

We are facing an unprecedented challenge, and the US government should deploy every monetary and fiscal tool at its disposal to help businesses and individuals navigate the impacts of COVID-19. It is yet to be determined the form, substance, and how these bailouts will transpire by sector. However, I suspect the US government will have to guarantee credit lines for particularly hard-hit sectors, provide cash directly to many companies to help meet payroll, and the Federal Reserve will broaden the types of assets it purchases to include corporate debt (like that of Boeing, Macy’s, Southwest Airlines, and Royal Caribbean). In fact, the past two Fed Chairs Ben Bernanke and Janet Yellen wrote an op-ed yesterday urging Fed Chair Jay Powell to pursue this route.

In the near-term, the Administration likely allows companies to opt-in for US government assistance, but potentially on terms that create some sense of culpability to the American taxpayer. These are the types of ideas that I suspect that are floating around the Department of Treasury, but whether they are pursued by the Trump Administration is to be determined:

   - No buybacks or dividends for the next [5] years, or until US government relief paid back in full

    - No executive bonuses or Board of Directors fees until US government relief paid back in full

    - No executive bonuses or Board of Directors fees if workforce size shrinks over last 12 months or median wages decline. A creative mechanism for narrowing wage gaps would be the goal

    - Executive compensation targets must include (a) target debt ratings/ratios, and (b) de-emphasize easily manipulated metrics like Earnings Per Share (EPS) that are buoyed by buybacks

Closing Thoughts

I want to caution that not all stock buybacks and dividend policies are bad. They are capital allocation decisions, and like any decision, some are good, and some are bad. But I suspect most folks will look at the last decade of Corporate America’s “shareholder friendliness” as a parallel to the pattern of behavior leading up to the US subprime mortgage crisis in the mid-to-late 2000s.

The hard lessons of the 2008 – 2009 financial crisis made our banks stronger. In that vein, we can only hope this event represents a learning opportunity for the way Corporate America approaches capital allocation (leverage, dividends, buybacks). Unlike the 30+ million small businesses where the concept of dividend programs and stock buybacks is foreign, the American taxpayer should no longer be on the hook for large public companies that push the limits of this behavior with little consequence.

Manan Shah is the co-founder & COO of Apteo. Prior to Apteo, Manan spent over a decade as an investor across public equity, private equity,  and distressed credit markets. Most recently, he was a Portfolio Manager at Point72 Asset Management, where he oversaw a U.S. focused equities portfolio. Prior to Point72, Manan spent time in public market investing as a Research Analyst at Coatue Management, and private market investing as a Principal & Associate at Centerbridge Partners.

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