Greenlight's Dual-Class Proposal To GM: It May Not Mean What You Think It Means

Did credit agencies misinterpret David Einhorn's proposal to General Motors Company GM Wednesday?

That is the question that remains regarding Wednesday's press releases from S&P Global and Moody's, which both backed GM's view that Greenlight's proposal of a dual-class common equity structure would be credit negative.

A Moody's Misunderstanding?

Moody's press release on Greenlight's proposal refers to the dividends as cumulative. The term cumulative — which was not used by Greenlight or GM in their respective press releases on the matter — is most often associated with preferred shares. It describes a class of stock that, among other things, carries the obligation in the event of bankruptcy to issue any unpaid dividends on those shares before addressing obligations to common shareholders. Though there's no rule that only preferred shares may have cumulative dividends, it is only to preferred shares cumulative dividends have traditionally been applied (preferreds without cumulative dividends are called "straight preferreds").

However, the proposed “Dividend Shares” would not be preferred, and wouldn't be considered senior to the other class (called “Capital Appreciation” shares) in any respect. GM would still bear a responsibility under the proposal to accrue a liability for any declared dividends on the “Dividend Shares” until they're paid. This creates balance sheet implications, and GM would also be required to pay any accumulated, declared dividends in total before undertaking any other capital return to either class of shares...IF they declared a dividend.

No Duty To Declare A Dividend

Bear in mind, nothing in Greenlight's proposal creates an obligation for GM to ever declare a dividend, and only declared dividends create a liability where common stock is concerned. Greenlight has made it clear it doesn't wish to alter or control GM's capital return policy. For all intents and purposes, the so-called Dividend Shares are just another class of common stock, leaving GM the flexibility to increase, maintain and reduce the dividend — or elect not to pay it at all.

With the Capital Appreciation Shares due to receive any earnings in excess of declared dividends, and eligible for buybacks with capital return funds in excess of declared dividends, the board's freedom to declare or not declare a dividend on the Dividend Shares brings the potential value of the Capital Appreciation Shares into sharper focus.

What Does It All Mean?

Taken together, would this make a dividend declaration the only scenario in which the Dividend Shares resemble the cumulative preferred shares to which they're being compared? This distinction between common and preferred matters quite a bit, as Dividend Shares would be on equal footing with Capital Appreciation shares in a liquidation scenario.

Moody's raised the issue of the agency problem regarding the board's ability to serve the seemingly divergent interests of shareholders of the two classes, and probably rightfully so. But aside from that, did the agencies fully appreciate the fine distinction between the proposed common shares and preferred stock, in terms of liability and the unfixed nature of the dividend, as it's proposed? Moody's and S&P both referred to increased liability and reduced flexibility, indicating an interpretation of the dividend as fixed and perpetual. This doesn't seem to match with what Greenlight proposed, at least not as presented in public documents.

Ultimately, these are the questions GM investors are confronted with. What intrinsic value does one ascribe to a security with no claim on a company's earnings, no preferential treatment in a bankruptcy, and no guarantee of capital return, despite having the word “dividend” in its title? How do investors appraise an unprecedented capital structure, one that GM calls financial engineering and Greenlight calls value creation?

Nicholas Donato contributed to this report.

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