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Dung Nguyen

FINC 820
Case study 2
Ford Motor Companys Value Enhancement Plan (A)
Ford Motor Company was the worlds largest producer of trucks, and the second largest
producer of cars and trucks combined. Ford was the worlds most profitable auto
company, and many believed the firm had achieved efficiencies that would enable it to
sustain this position. Fords share price had performed poorly over the previous year , and
the proposal drew a positive reaction from analysts who had been urging the company for
months to distribute cash to stockholders. The performance of Ford was 30 points below
S&P 500 and Auto Index.
On April 14, 2000 Ford Motor Co. announced a shareholder Value Enhancement Plan
(VEP) to significantly recapitalize the firms ownership structure. Ford had accumulated
$23 billion in cash reserves, close to the companys largest ever cash position and
significant relative to Fords $57 billion equity market capitalization. Excess funds can be
a bad signal to the markets that the company has very few investment plans lined up.
Under the VEP, Ford would return as much as $10 billion of this cash to shareholders. In
exchange for each share currently held, the plan would give stockholders one new share
plus the choice of receiving $20 either in cash or additional new Ford common shares.
Ford also announced that it would distribute ownership of its Visteon Corp. parts unit to
shareholders.
With the recapitalization, they assumed that only 40% of shareholders would take cash
option. Even when the cash option was oversubscribed, the $20 per share payment would
e distributed pro rata to ensure that the company distributed at most $10 billion. Dividend
on new share would be reduced so shareholders who elected stock only would get about
the same dividend payment. The third option aimed at passive investors who want to
maintain the same percentage in the company as they did before the transaction.
Shareholders receiving cash distribution would suffer a meaningful reduction in their
percentage of ownership.
Ford believes the recapitalization will provide value, flexibility, liquidity, and alignment
for Ford stockholders, and tie Ford management even more closely to the interests of
Ford stockholders. Moreover, they believed that their stock is undervalued and the
recapitalization will highlight its cash reserves and cash flow generating capacity, which
have not been adequately reflected in its stock price. The recapitalization would increase
stockholders liquidity. Especially, this value enhancement plan would reduce the conflict
between the ford family, who does not want to lose voting power, and the shareholders
who want to receive cash distribution. As a consequence of the executive elections and
the adjustments in the employee incentive plans, the recapitalization will tie Ford
managements compensation even more closely to the performance of Fords stock price.

They expected that the spin off would further help Visteon create its own customer base
that would be separate from the client base of Ford.
With 3.6 percent of the companys total equity after the transaction, class B shareholders
still maintain 40% voting power. Over the period 1956-2000, class B share declined by
about 50% but the total share outstanding increased significantly. The Ford family
retained its 40% vote as long as they owned at least 60.7 million shares.
The Class B shareholders will, in fact, receive shares of common stock in the
recapitalization, against prohibition certificate of paying of common stock dividends on
the Class B shares. Common shareholders should have the right to independently approve
or reject a transaction that would result in the issuance of common shares to the Ford
family.
Employees would receive cash by default if they dont make an election and these cash
received will be invested on their behalf in Ford common shares. This will create agency
problem for Ford. In the stock market on April 14, 2000, investors initially welcomed the
announcements. Ford shares rose 2% to $55.56 in morning trading on the New York
Stock Exchange. But in a rapidly falling market, with the S&P 500 index down 5.8% for
the day, Fords shares closed down $3.07, or 5.6%, at $51.38. Ford rating was down from
A+ to A.
Institutional investors would choose combination of cash and shares. Because the
recapitalization favors Ford family members and reduce institutional investors' voting
power. In this case, the third option of combination of cash and new share is a better
choice for them. They can use cash of $20 per share to invest somewhere else;
meanwhile, they can remain interest in Ford. Individual shareholder doesn't care about
voting power and they may go for cash option to maximize and protect their money
because Ford could not find profitable projects.
Paying dividend was tax inefficient for many shareholders. They were taxed on cash
dividends at ordinary income rates, whereas gains realized on shares that were
repurchased received capital gains treatment. For individual taxpayers in 2000, the
highest US federal tax bracket for ordinary income was 39.6% while long-term capital
gains were taxed at maximum rate of 20%. Cash paid out in form of dividends or share
repurchases was tax neutral to Ford. However, paying dividend would imply the strength
and quality about its future cash flows.
In conclusion, I believe that share repurchases is better than paying cash dividend. In
addition, share repurchase would be taxed as capital gain at most 20% in 2000 and it had
neutral tax effect on the company. Like paying dividend, share repurchase signaled the
companys confidence in future cash flow. Share repurchases would decrease the number
of share outstanding and therefore, increase earnings per share. If they believe their stock
price was undervalued then share buyback is a good alternative. It reduces the assets and
equity, which could increase ROA and ROE. It is similar to paying dividend but in a
cheaper way. Ford family voting power would be decreased if they moved on with this
plan.