David Winters, the Founder and CEO of Wintergreen Advisers, fired a shot at Coca-Cola's (NYSE:KO) management today by attacking their 2014 plan for equity distribution. Specifically, Winters alleged the following:
If approved, this plan in conjunction with previous equity compensation plans, will dilute existing shareholders [an] estimated 14.2 percent.
The company expects that the 2014 plan will award a mix of 60 percent options, 40 percent full value shares, resulting in the issuance of 340,000,000 Coca-Cola shares. At the current share price, these shares would be worth approximately $13 billion. In effect, the board is asking shareholders for approval to transfer approximately $13 billion from all of our pockets to the company's management over the next four years.
According to Coca-Cola's proxy statement, this is what the company outlined regarding its equity issuance plan:
If the 2014 Plan is approved, the aggregate number of shares of common stock that will be reserved and available for issuance pursuant to awards under the 2014 Plan will be 500,000,000.
At first blush, the amount sounds extreme. Coca-Cola is making available half a billion shares to be awarded across 6,400 employees which seemingly make it extraordinarily difficult for Coca-Cola to grow earnings per share with that kind of dilution. Coca-Cola currently has 4.4 billion shares outstanding, and the company is setting aside 11.36% of the current share count to be potentially distributed to employees. Of course, because some equity plans are forfeited and cancelled, not all 500 million shares will actually be distributed. It may be important to keep in mind that the equity issuance does not happen in a single year.
As a Coca-Cola investor, there are two questions worth examining in light of Coca-Cola's announced executive compensation plan: To what extent is Coca-Cola's 2014 plan consistent with previous practices, and to what extend will it dilute shareholders going forward?
The first thing worth noting is that Coca-Cola's current executive compensation plan is essentially a continuation of what it has always done; however, the effects of the stock split make the amount of shares at issue sound higher. That is to say, two years ago, we would be talking about 250 million shares of planned executive compensation. Today, we are discussing 500 million shares. Either way, it works out to a compensation package of $2.9 million per employee receiving the stock grants (of course, the shares don't have an even distribution).
Secondly, the company is using about 4x as much cash flow to buy back stock, as it is using to pay executives. To get specific: Coke bought back $4.5 billion worth of stock in 2012, and $1.4 billion went towards executive compensation. In 2013, Coke bought back $4.8 billion worth of stock, and compensation for executives totaled $1.3 billion. In other words, about seventy-five cents on every dollar of buyback goes towards actually reducing the share count, and the other twenty-five cents of the buyback goes towards mopping up the shares created to pay executives and other employees.
Right now, Coca-Cola's market cap is 169 billion. If Coca-Cola buys back $4.8 billion worth of stock this year, it will seemingly take 2.8% of the company shares off the market. But because Coca-Cola is going to be issuing another $1.2-$1.4 billion in stock to pay executives, so the actual share count will only decline by 2.0% or 2.1% (note: the reason why I projected 2013's figures onto 2014 is because Coca-Cola indicated that they will continue its previous practice). The headline risk, associated with hearing 500 million shares are going to be created, is substantial, but the reality is this: Coca-Cola's executive plan reduces the earnings per share growth rate by 0.7% or 0.8%.
I don't write this to sound like an apologist for Coca-Cola's share dilution plan. Asking hard questions is good, and when your shares are being diluted, you should examine the details to see if the compensation is justified. But high compensation is typical for executives across most blue-chip companies; if you study Procter & Gamble (NYSE:PG), Colgate-Palmolive (NYSE:CL), or IBM (NYSE:IBM), you will see quite a few shares created to pay executives and other employees. It would be hard to build a collection of 15-20 blue-chip names without exposing yourself to management teams that dilute shareholders.
Instead, I would ask myself this question: Considering that Coca-Cola dilutes shareholders to the tune of 0.7% per year, does the brand quality and growth potential, adjusted for the dividends and buybacks, make this still a good investment? If you think Coca-Cola is still going to grow 10% or 11% per year, then selling the stock out of protest for management compensation is only going to harm yourself. On the other hand, if you think the business is only going to grow 6% per year because of concerns about the company growing its soda business (in North America in particular), then I could understood why 0.7% dilution would be the tipping point that leads you to sell. I suppose the take-home conclusion has a slight nuance: the executive plan is nothing for shareholders to get excited about, but the headline risk of the 500 million shares overstates the damage to shareholder wealth. It amounts to roughly 0.7% dilution per year, and only you can decide whether you find that tolerable or not in light of the totality of company's business circumstances.
Disclosure: I am long KO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.