Ford's Value Enhancement Plan Analysis
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Ford's Value Enhancement Plan aims to align the interests of various shareholders by offering them different options - the choice of $20 in cash, additional new common shares or a combination of cash and new share. Based on the following analysis, Ford should go ahead with Value Enhancement Plan.
Characteristic of VEP
The Value Enhancement Plan has the feature of stock split and share repurchase. Exchanging existing shares for new shares on a one-for-one basis, shareholders are also offered the option to reinvest $20 to receive additional new Ford common shares. In this sense, share price would decrease while the number of shares outstanding is going to increase. According to Ford's announcement mentioned in the case, shareholders choosing the share option would receive 0.748 new Ford common shares in lieu of $20 cash. So, the effect is similar to 1.748 for 1 stock split. However, not all the shareholders prefer share option. For those who elect cash option, they would receive $20 as though they sell part of their shares, which reflects the feature of share repurchase.
Advantages of VEP
With the combined feature of stock split and share repurchase, VEP has its strength.
In terms of cash option, since there is no good things to do with the massive cash reserve, returning the excessive cash allows shareholders to make profitable investment by themselves. Unlike cash dividend, returned cash is taxed as capital gains, so it generates tax efficiency for shareholders. In addition, though the price of new Ford shares would decrease, shareholders will not bear any loss, because the reduced price is offset by the cash they receive. But from the company's point of view, they can reduce dividend payment. Companies tend to keep dividend payout ratio constant, so dividend for each new Ford share will decrease because share price falls. For those who choose to receive $20 in cash, they keep the same amount of shares before VEP is introduced, therefore, the total dividend payment is going to reduce and to some extent, the pressure for increasing dividend level can be relieved a bit. Moreover, the effect of cash option is similar to that of share buyback, the number of new shares outstanding will reduce; thus, earnings per share will increase and it can increase the overall demand for Ford's share, which will benefit share price in the long run.
If shareholders elect stock option, they can increase voting power and exercise more control over the company. Also, as we discussed in the cash option, share price will increase, so, shareholders will benefit a lot from holding more new Ford shares.
As for the combination of cash and new shares, shareholders can take part of their money out of the stock to make other profitable investment, and they can also maintain their interest in the company. On the one hand, they can enjoy tax efficiency by paying tax of capital gains for cash received, on the other hand, they can enjoy the profit when share price increases and they can have a say in the firm.
VEP is better than cash dividend in terms of tax effect, and compared with share repurchase, it meets shareholders' need to remain or increase control of the company. Therefore, based on the analysis, Ford should go ahead with VEP.
Possible Choices of Different Shareholders
Ford family member will choose stock option because they want to expand their control in the firm. By supporting VEP, their 40% voting power remains unchanged but their equity in the firm decreases from 5% to 3.6%. If they elect stock option, they hold more common shares, and their voting power is beyond 40%.
Institutional investors, such as TIAA-Cref and the Calpers would choose combination of cash and shares. It's obvious that VEP favors Ford family members and dilutes institutional investors' voting power, so it's hard for them to compete with Ford family members in terms of control even if they reinvest all the $20 cash to buy new Common shares. In this sense, combination of cash and new share is a better choice for them. They can get part of their investment out of Ford stock for good opportunities somewhere else; meanwhile, they can remain interest in Ford.
A regular outsider shareholder doesn't care about voting power. The purpose of their investment is profit. So, if I was one of them, I would go for cash option, because I would think Ford can't find profitable projects and there are few growth opportunities. By getting money back, I can make good use of it by myself.
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