Breaking up may be hard to do, but some kinds of splits can be good news for investors. Walmart (NYSE:WMT), Netflix (NASDAQ:NFLX), and Sears (NASDAQ:SHLD) are all currently involved in splitting, of one form or another, and even our usual consumer goods team of Shen and O'Reilly has (temporarily) split up.
Are any of these splits cause for concern? Tune in to learn more about the Walton family's divestment and what not to believe about the reasoning behind it; Netflix's big talk on a potential stock split and what it means to current shareholders; and why Sears' REIT spinoff may be a last-ditch effort to save the company, but could still be good news for investors.
A full transcript follows the video.
Dylan Lewis: This week's theme in CG is "splitting." Netflix announces a stock split, Sears is spinning off real estate holdings into a REIT, and CG Industry Focus duo of Shen/O'Reilly is on a one-week hiatus.
I'm Dylan Lewis, subbing in for Vincent Shen, and I'm joined by Sean O'Reilly to talk CG today.
Sean O'Reilly: How's it going, Dylan?
Lewis: Doing all right. I feel like I've got some big shoes to fill, here in the chair.
O'Reilly: You do, thank you. We're sorry we lost Vincent. He's currently on vacation.
Lewis: Yeah real tough, being in Colorado!
O'Reilly: I was a little sore, but oh well! What are we talking about first here? Waltons are up to some shenanigans?
Lewis: Yes, why don't we talk Waltons first?
O'Reilly: The Walton family. Of course, the patriarch and founder of the Walmart stores, Sam Walton, has passed away, but there are five of them; his wife and his kids and everything, and they are the richest family in the world.
Walmart is such a good business, such an effective retailer, that one of the things they do to return capital to shareholders is buy back shares. The family hasn't sold too many shares up until now, so their ownership stake has slowly been approaching 50%, and that's making them nervous.
Lewis: It's just creeping up, creeping up.
O'Reilly: Slowly but surely.
Lewis: Why is that making them nervous, Sean?
O'Reilly: Well, ask the IRS and they will tell you that if their ownership were to go over 50%, Walmart would then be classified as a personal holding company, which involves five or fewer individuals, and WalMart, as a corporation, would then be taxed at the personal income tax rate for these multi-billionaires.
O'Reilly: That would be expensive.
Lewis: The tax considerations of the rich and the famous.
O'Reilly: Yes. The long and short of it is that there are five or six of these people ... his kids are worth $20 billion each. Talk about winning the lottery there.
What they're doing is, they formed a separate entity from Walton Enterprises LLC, which owns half of Walmart, and they formed another charitable trust, they gave 6% of their shares to this trust, and they're going to just start giving it away.
Alice Walton, his daughter, started -- it's actually the nicest museum in the world, or one of them -- a beautiful art museum in Arkansas. They'll keep doing that. Little things people do to avoid taxes. That's what's going on.
Lewis: So there's some benevolence to it.
O'Reilly: There is, yes. I did want to bring up, though, this is nothing compared to what I'm not sure our listeners are aware of -- and this isn't 100% CG, but I just thought I'd talk about it -- which is Bill Gates' current, we'll call it "tax planning" or "retirement planning" or something.
As long as I can remember, I remember going to the library and flipping through the Value Line Investment Survey, and in their index section one of the things they show is big insider sales and purchases by major corporations.
Gosh, the last 15-20 years, Bill Gates every quarter sells 20 million shares of Microsoft (NASDAQ:MSFT), just like clockwork.
Lewis: Scheduled, right?
O'Reilly: Yes, it's completely scheduled. Also, a little fun fact, he would be worth $170 billion had he kept all those shares. But he had to diversify, so there you go.
Lewis: I don't think he minds.
O'Reilly: No. No, no, no. This is nothing compared to that, but it's still just a little thing that people do to save money.
Lewis: So there's not really much for Walmart investors to read into this?
O'Reilly: No. I saw a few articles in the cybersphere, in the tubes and all that stuff, and people were saying, "They're cashing in because they don't like Wal-Mart's $1.5 billion costs that they're going to incur by paying their workers $10 an hour," and all this stuff.
That's not the case. If they said, "We're going to sell half of our stake right now, and we're going to just start buying other companies," I would agree with that -- but they're not.
Lewis: All right, so not too much to worry about there, if someone were invested.
O'Reilly: No, not at all.
Lewis: Why don't we pivot over to Netflix, then, and talk a little bit about the announcement they made.
O'Reilly: They're pulling an Apple (NASDAQ:AAPL)!
Lewis: Pulling an Apple? I don't know, that seems like a pretty good model to follow.
O'Reilly: You could do worse than what is arguably going to be the world's first $1 trillion corporation.
On what was it, Friday? They put forth the docket for what the Netflix shareholders are going to vote on in June at the annual shareholders' meeting. One of the items is increasing the number of shares allowed under Netflix's charter, from just 170 million to a whopping 5 billion shares.
That's a lot of shares outstanding.
They actually bluntly say in the filing, "If this proposal is approved by stockholders, management expects it will recommend to the board that they go forward with the stock split."
Lewis: Yes. That multiple is, what, 30 times?
Lewis: You're used to seeing a stock split in the 2:1, 3:2 kind of range. Are we expecting something?
O'Reilly: Even Apple was 7:1. That's a lot.I don't think they'll do that much, I really don't.
Lewis: While the headline number is that 30:1, I don't think that's what we should be expecting.
O'Reilly: Right. I would assume 10 or less. Netflix is currently trading, at this moment, at $477.40. Even if they did 10:1, it would be a $47 stock. I think that would be reasonable, so anywhere from 5:1 to 10:1, I would imagine. But don't quote me!
Lewis: Why don't we get into some of the motivations for companies to split? I think this is something that always trips up investors: Why is a company looking to do this? What are they getting out of it? What's the plan here?
Lewis: Yes, I might have to save up for a bit!
O'Reilly: Even the Class B, man! It's crazy.
You go in and out. It doesn't do anything economic. Do you feel richer with a $10 bill or two $5 bills?
On the one hand, having a super-high stock split -- and this is the reason Mr. Buffett has never split a share of Berkshire Hathaway -- is lower volume/higher share price keeps people in longer. It has a longer-term mentality. It has more of a partnership mentality, as opposed to the hyperactive trading mentality.
Lewis: Yes, you're getting people to commit to the buy and hold.
Lewis: On the flipside, what are some of the advantages of a stock split?
O'Reilly: It's kind of nuanced, but it's more like, "We want the average Joe investor to have access to a share of Apple." What would it be? It would be over $1,000 right now? If it's $120, that's times seven ... just under $1,000 a share. The average Joe investor, do they want to pay $10 for one share in a trade to buy that?
Lewis: It goes back to that early investing fallacy of, "This is a $5 stock. It's very cheap."
O'Reilly: I remember talking to this guy one time. He was like, "I got into Coke (NYSE: KO) before the stock split." I was like, "You feel good about that?"
Lewis: It's the same valuation.
O'Reilly: It doesn't matter!
Lewis: But it definitely makes it a little bit more appealing to small investors. They feel like they can get in and get a more meaningful share count.
O'Reilly: It makes it more accessible. There are also other reasons, like for stock grant reasons. More volume/lower share price makes it easier for insiders to cash out part of -- actually, often a large part -- of their compensation, which is granted stock options.
Just a couple little nuanced reasons. It doesn't add any economic value whatsoever. This, long-term, does not matter but there are a couple of reasons why they might want to do it.
Lewis: Yes. At the end of the day, it's just increasing liquidity.
Lewis: If you want to look at the historical example, Apple went 7:1 in June, and went on like a 35% run since then. Granted, they had the benefit of having ...
O'Reilly: "That was because of the Apple Watch, we swear!"
Lewis: ... an absolutely killer iPhone sales season, and the promise of a new product coming out -- so no historical forbearance there, necessarily. But some people take it as a bullish sign. Others, it's kind of neutral.
Lewis: Anything to think about with this, ahead of their announcement for earnings?
O'Reilly: I think it means they think that they're here to stay. As I said, it doesn't add any economic value. It shows confidence on the part of the management. The stock actually rose on Monday; this is one of the two reasons. The other reason was they had a bullish note by a brokerage. It is what it is.
Lewis: It was UBS (NYSE:UBS), right?
O'Reilly: Yes. I didn't know if we wanted to plug them or not!
Lewis: Well, it's always nice to be able to point to the research so people can find it.
O'Reilly: Facts are facts.
Lewis: Check our facts! Great. Why don't we wrap up by talking about Sears?
O'Reilly: Last but not least. Oh boy, this takes me back. This was back in 2004, there was an edition of Business Week, and it had Sears CEO Eddie Lampert on the cover. It was right after he took over Kmart, but before he merged it with Sears.
Oh, man. It was actually brilliant. He bought the bonds of Kmart, when it went into Chapter 11 bankruptcy, for like 10-20 cents on the dollar, converted that to equity, wiped out all previous Kmart shareholders, and had a completely debt-free retailer, a couple billion dollars in cash in the bank. It was awesome.
He had actually just sold a bunch of stores to Sears and Home Depot (NYSE:HD) for like $800 million. He was sitting pretty, he was called the next Warren Buffett, all this stuff.
Then he merged it with Sears. Oh, gosh!
Lewis: Yes. I referenced that video you showed me, the Family Guy video, when Lois and Peter go to Sears.
O'Reilly: Post-apocalyptic civilization.
Lewis: Yes. It's a man with a baby, on a horse, talking in grunts and bartering in leaves! When you walk into a Sears, there's nobody in there.
O'Reilly: I don't know. I don't want to bash anybody, but I was in there with my wife recently to look for a new belt for our vacuum. That's why we went to Sears, but there were tumbleweeds, man.
Lewis: Yes. They're great for appliances.
O'Reilly: Right. That's why -- long term, this is of course the bull case -- but this is why I liked what they were talking about. Bringing it back around -- sorry, listeners, for the roundabout way we got here!
They are finally forming a real estate investment trust, called Seritage Growth Properties, and they're giving $2.5 billion worth of Sears real estate to this REIT; A total of 254 properties, so $10 million a pop.
They're going to form this by doing a rights offering to current Sears shareholders. They'll say to you, Dylan -- let's pretend you're a Sears shareholder. Let's say you own 100 shares. "Give us $10 per share that you own, and you'll get a share in this new REIT."
They'll get all the money, the proceeds from that, and Seritage will also be raising some debt in order to buy the properties from Sears.
This is actually not that surprising at all. The stock was up like 10% on the announcement, but then it came back a bit, so now it's only up 3-4%. But we've known about this for a year or two. It was part of their website for like two years now.
Lewis: It's something that they've been talking about for a while.
O'Reilly: Right. That's been the major bull case. There is this hedge fund, a year and a half ago, that came out with like a 250-page report, and that was the bull case. They valued the properties and all this stuff.
You were talking about what Sears is good for; the tools, the appliances, all that stuff. There's a pretty darn successful Sears appliance store in my hometown in Ohio. It's smaller, it's part of a strip mall, but it's pretty busy usually and it's got what Sears is good for.
If you had checked out this website, you would see that the current plan is, let's say you've got a big-box, two-story Sears that you'd typically see at a mall. Shrinking it down to something comparable to what I just described in my hometown, and then partitioning off the rest of the store into a bunch of smaller retailers.
I'm completely making this up, mind you, but just to give you an idea, putting in a Chipotle (NYSE:CMG) and ... not a Radio Shack, but just tons of smaller partitions for smaller retailers to come in there. Put in a Five Guys for Dylan.
Lewis: Love the Five Guys!
O'Reilly: It's basically trying to make use of the real estate. Some of Sears' most valuable real estate is going to this REIT.
That report that I mentioned, that was put out a year or two ago with a bull case for it, this is famous -- the stock went on this huge run and everything. But the real estate for the Sears that's owned in downtown Chicago is worth hundreds of millions of dollars, alone. The top 10% of Sears' properties are a big chunk of its value, and a lot of that's going into this REIT.
Lewis: Is this something investors should be excited about?
O'Reilly: Absolutely, because that's all they've got left! What were you saying? This is like separating the good from the bad?
Lewis: Yes. Matt Mckinley, an analyst at Evercore ISI (NYSE:EVR) New York said, "This is the last big thing that they can do. It basically takes the assets of the real estate and separates them from the liability that is Sears."
O'Reilly: Yup. Another transaction that isn't nearly as big, they formed a joint venture with General Growth Properties (NYSE:GGP), which happens to own a lot of the malls where Sears has locations. They're contributing 12 properties to the venture, and they're going to own half of it.
Then they'll also get $165 million in cash out of the deal, because they need money desperately. Their cash account is down like 75% from last year.
They had to actually raise some money last year through Eddie Lampert's hedge fund. He loaned himself money, because he's the majority owner of Sears, in order to keep it going through the holidays. It's getting tight. It's getting very tight.
Very good. Last but not least, I did want to point out the company still has 1,725 Sears and Kmart stores, so they can keep milking this stuff. Very cool!
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For Dylan Lewis, I am Sean O'Reilly.
Lewis: Fool on!
Dylan Lewis has no position in any stocks mentioned. Sean O'Reilly has no position in any stocks mentioned. The Motley Fool recommends Apple, Berkshire Hathaway, Chipotle Mexican Grill, Coca-Cola, Home Depot, and Netflix. The Motley Fool owns shares of Apple, Berkshire Hathaway, Chipotle Mexican Grill, and Netflix and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.