This past Tuesday at Goldman Sachs' Communacopia Conference, AT&T (NYSE:T) CEO Stephenson said the company's pension plan will be "fully funded" at the end of 2013. Stephenson was referring to AT&T's application for exemption from the Department of Labor's ERISA and associated IRC requirements, which is open for comment by stakeholders until November. It proposes to create, value, and issue 320,000,000 of $25 liquidation value preferred shares from its wholly owned subsidiary, AT&T Mobility, to itself.
AT&T will then subsequently contribute these shares to its pension plan. The pension plan will then hold employer securities in excess of the 10% fair market value of assets currently allowed by ERISA. Thus, AT&T will need an exemption similar to those granted to Northwest (which merged with Delta Air Lines (NYSE:DAL) in 2008), General Motors (NYSE:GM), and Kaiser Aluminum (NASDAQ:KALU) -- all of which have declared bankruptcy. AT&T says it needs to make this contribution because it cannot contribute this amount of cash.
Essentially, AT&T has decided to liposuction some fat off its sagging hindquarters and to inject it into its lips.
- Instruct the wholly owned subsidiary to create a new class of equity, called the "Preferred Interest" or "Preferred Equity Interest."
- Do not issue the shares to the public for a readily determined market price.
- Seek out an independent fiduciary (paid $2 million/year by the plan) to determine price.
- Issue shares to the parent using the value determined by the fiduciary.
- Do not pay cash, but record a payable on the parent's books and a receivable on the subsidiary's books; therefore, consolidated statements will not show the liability.
AT&T Mobility's Books
Inv in AT&T Mobility
Plan Assets, FMV
Add Newly Created
Plan Assets, FMV
Data from AT&T 2012 10k
Percent Plan Assets in "Employer Securities"
Percent Decrease in Pension Liability
Percent Decrease in Long Term Debt
This is what Stephenson cited as evidence that AT&T will have a fully funded AT&T pension. Every company should use the "get out of pension debt free" card. Punch a few numbers and presto chango -- liability reduced. So, let's ponder what AT&T did not do and how it affects shareholders.
Why not issue the shares to the public, which would have determined the FMV of the asset, and then contribute the cash to the pension? In fact, why do this accounting maneuver at all? If the wireless subsidiary is such a cash cow, it can afford to continue meeting its pension payment obligation that AT&T estimates it will need. Why subject future shareholder earnings to one stakeholder over others?
Could this maneuver might have something to do with its recently announced global ambitions, while maintaining its leverage ratio? (Shrink their pension liability and then increase liabilities to fund the European acquisitions.) Regarding its pension accounting, AT&T does not use conservative assumptions and it has for the last three years booked non-cash charges to income for its pensions.
S&P 500 Average
Return Assumption (2012)
S&P 500 Average
Actuarial Losses Re: Pension and PE Benefit Plans (in Billions)
From AT&T 10-K and S&P Dow Jones Indices
And now, according to Stephenson, an unapproved $9.5 billion in-kind contribution that would still leave a pension deficit of over $4 billion is called "fully funded." If I were a shareholder, this would be disconcerting to say the least. Besides, the obvious portfolio risk to pensioners by the lack of diversification, we should examine AT&T's ability to continue to pay its current dividend to shareholders. First, its notice of proposed exemption has a very clear restriction. If AT&T Mobility fails to pay the dividend:
...the Issuer will not be permitted to make any transfer of cash to its parent, AT&T Inc., or any other member of the Issuer, whether pursuant to a loan, equity distribution or any other arrangement; and (ii) AT&T Inc. will not be permitted to declare any dividends on or make any repurchases of its common stock.
So, even if other subsidiaries are thriving, AT&T's dividend carries the risk of non-payment of the preferred dividend by its subsidiary, which may be small now but can certainly change over time. Moreover, AT&T's current dividend payout ratio for 2012 is over 140% of net income. Fortunately, its ratio is just under 27% of its operating cash flow. However, its operating cash flow is supported by a non-cash charge of almost $10 billion for its actuarial pension loss. This type of non-cash charge is very different than other non-cash charges, such as depreciation. This type will eventually need to be paid, possibly at higher amounts. Adding back the pension loss to the operating cash flow and adding the newly created preferred dividend paints a much riskier scenario for AT&T's dividend payout ratio.
Payout Ratios, 2012
AT&T may receive a tax benefit if the IRS allows the in-kind deduction retroactively for its 2012 return. AT&T should use the money it saves on taxes wisely by funding its other post-retirement benefits plans, which are underfunded by more than double the amount of its pension plan (pre-contribution): $28,136 million. AT&T's unfunded liability for pensions and other post-retirement benefits represents approximately 23% of its market capitalization of $180 billion. Until such a time that AT&T makes an actual, significant improvement to its pension and other post-employment benefit plans, investors should avoid AT&T.