Selling Off A Competitive Business Advantage

One of the reasons why dividends can improve corporate governance is because they encourage restraint. If you are running the show at Procter & Gamble, and you know that the corporation has raised the dividend every year since 1963 and already has a commitment to paying out half of its profits to shareholders, then you feel some baked-in pressure from shareholders to do something intelligent with the retained earnings to make sure that the streak doesn’t end on your watch (e.g. CEO Jeff Immelt said cutting the GE dividend was the worst moment of his professional career.)

But that shareholder pressure can also apply in reverse. Especially in cyclical industries, there can be a shareholder pressure to keep the dividend high even if it means borrowing debt at high rates or selling off attractive pieces of the business. The consequences of this decision aren’t felt for at least five to ten years into the future, while the continuation of a dividend payment is a gratification that is instantly felt. It is easy to see how the incentives can be misaligned to choose short-term appeasement of shareholders over their long-term best interest.

This possibility was on my mind when I saw that Total SA was selling its specialty-chemical business, Atotech BV, to the Carlyle Group for $3.2 billion. That is unwise to me–Total SA just gave up a stable source of $250-$300 million in annual profits to shore up its balance sheet so that it can maintain a high dividend payout to shareholders.

If you look at the past three years, you will see that Total SA weathered low oil better than just about any other company that has adopted the integrated business model. It made $12 billion in 2014 profits, $5 billion in 2015 profits, and an expected $8 billion in 2016 profits. Its highest profits ever were $19 billion in mid 2007 through mid 2008. Other than for about six months last year, the profits at Total SA were higher than the pre-existing dividend commitments.

It was precisely because of business lines like Atotech BV that Total SA has been able to ride out the slumps in the oil sector and still remain a powerhouse.

But because Total SA wants to keep its dividend payout high now, it is selling off some of its stabilizing assets like Atotech BV that provide support during the lean times. The reason why Total SA survived so well during the 1986s, 1998-2000s, 2008-2009s, and 2014-2016s is because it always had other subsidiaries that didn’t crash alongside oil which could pump out reliable profits. Total SA wasn’t quite so desperate to borrow or raise capital during moments of weakness when the borrowing costs were high.

If you are someone you plans to hold Total SA stock in your portfolio for the rest of your life, you should lament moves like these. It is worse than when Conoco spins off Phillips 66 because you don’t get to own both sides of the fence–here, Atotech BV goes to a private equity firm, and Total SA gets cash which will be used to pay out shareholder dividends and invest in their core competency which is subject to severe highs and lows.

Don’t get me wrong, this individual move to sell Atotech BV isn’t a big deal by itself. Total SA has $22 billion in cash and a profit engine of $3 billion to $4.5 billion remaining outside of the traditional oil sector. But if oil gets lower while the dividend remains high, and Total SA repeats this move three or four more times, it will be problematic for shareholders. These speciality chemical and other businesses are critical for shoring up the vulnerability points of core businesses that directly respond to commodity prices, and they should not be regularly discarded because they represent such a competitive advantage when the times get tough. Total SA has enough remaining great assets to absorb the ill effects of this decision, but that doesn’t you should bless the moments when short-term popularity is chosen over the long-term best interest.