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By rfnf2933
September 20, 2001

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Angello Asks:

Can a more experienced investor explain to me what a company like GX in a precarious position is doing paying dividends? How can one acquire Convertible Preferred Stock? Is this some sort of scheme (such as options) to enhance insiders salaries at the expense of common shareholders?

Angello,

I will give it a quick shot as to your questions. Maybe if someone on the board has experience in this area they can enlighten us further.

First of all, as a poster on one of the boards indicated, the fact that GX is paying the preferred dividends in CASH instead of by issuing additional shares is a big positive. If GX thought they were in an imminent cash crunch, they would have exercised the option to pay the dividend requirement in additional shares. So I think that was good news. (Note to Smartguy0-I will save you the trouble of a post-yes, I do like the lemonade I am drinking.)

As to the logic behind preferred shares, a company really has multiple ways of "capitalizing" (provide money to run the business) the company:

1) Selling common stock to raise cash
2) Issuing debt to raise cash
3) Selling non-convertible preferred shares to raise cash
4) Selling convertible preferred shares to raise cash
5) Some combination of the previous options.

Each of the options have pros and cons, and it really depends either on the specific company situation or the specific alternatives that are available to a company as to which approach they choose. Many companies use a number of those approaches, sometimes all of them.

In GX's case, they have issued "convertible" preferred shares. Convertible means that the owners of the shares have the option, at defined prices and time intervals, to convert their preferred shares to common shares. From the owner's standpoint, preferred shares are preferable to common shares because they stand in line sooner to get dividends and return of capital ahead of the common owners. Further, it is an advantage to the preferred owners in that they typically get a much higher dividend percentage than a common shareowner. The advantage of owning common shares over preferred shares (disadvantage to the preferred share owner) is typically if the company does well, the common shares will return more than the preferred shares. The "common share" owners are "paid for their additional risk they have assumed" by taking on a lower dividend (or often no dividend as in GX's case) and being the last person in line to get paid (after preferred share owners and debt holders) if the company is liquidated. The benefit to GX of issuing preferred shares can depend upon a number of unique circumstances that are often specific to the company and the situation. However, generally an advantage to the company issuing preferred shares instead of debt is that it usually is much cheaper. The interest payments on debt are much higher than the interest (dividend) payments on preferred. Although GX will suffer dilution of ownership when issuing preferred versus debt (since the preferreds are convertible to common and the debt is not), the cost of this approach to raise capital for the company is typically much cheaper.

The previous examples and explanations are being given at the Macro level. The specific pros and cons of the different approaches will vary depending upon the specific company circumstances and financial markets at the time.

As to whether dividends are another way to getting money to the insiders, very doubtful. The dividends are paid directly to the owners of record for the preferred shares, so unless the insiders actually own the preferred shares, they do not get the dividends. I do not know who owns the preferred shares, but I think it is highly unlikely that insiders own them. The likely owners are mutual funds, venture capitalists, and the like.
Hope this helps. If any specific questions, please advise and I will try to expand on the above.

Bob

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