Long, Long-Term Dividend Investing: Corporate Structure Issues

| About: The Hershey (HSY)


Hershey's ownership structure is under scrutiny today.

But there might be a reason to like the model, which isn't unique. Hormel has a similar set up.

In fact, it's one thing that could set these companies apart as long-term investments.

Arie de Geus wrote a book called The Living Company based on research he conducted while working for Royal Dutch Shell (NYSE:RDS.B). The first part of the relatively short read should be fascinating for anyone interested in creating long-term wealth. And while Hershey (NYSE:HSY) is feeling a lot of heat for its unique ownership structure, there may be a lot to like about it, too. Here's why...

The living company
The basic premise of Arie de Geus' work is that companies are living, breathing entities with personalities and approaches to "life" that make some better than others. He found, some decades ago now, that most companies don't live past twenty or thirty years of age. And that it's a truly rarefied breed that makes it to the century mark.

One of the key differentiating factors for a company that stands the test of time is simply a will to live. These companies tend to have a larger purpose and as a collective the employees feel that the companies simply have to survive. That can mean putting the best interests of the company before the best interests of shareholders at times, and it's kind of a fuzzy image in a way, but you can start to see it when you look closely at the companies that have proven able to, for lack of a better term, stick around.

For example, International Business Machines (NYSE:IBM) is in the midst of a slow and somewhat painful business transition. Many investors don't see a positive future ahead. But IBM sees this as par for the course, just another thing that has to be lived through to make IBM better. I've interviewed several employees at IBM for previous articles and that's the clear impression I get-it's not something I've read, it's something I feel from talking with employees.

Which brings up a really long-term view of the world. If an investor wants to create truly long-term wealth, perhaps for generations into the future, finding companies that rocket higher for short periods and than flame out or get swallowed up by competitors isn't the way to do it. The way to create lasting wealth, and if you focus on dividends a lasting income stream, is to find the companies that qualify as a "living company."

Protecting the company
But there's more to it than just having the collective will to survive the bad times. A company also needs to be able to fend off unwanted suitors. Which is where companies like Hershey and Hormel (NYSE:HRL) come in. For relatively young companies, a founder can own a large stake and protect a company from takeover. For example, Elon Musk owns around a quarter of Tesla's (NASDAQ:TSLA) outstanding shares. It would be hard for a company to acquire Tesla without his approval. That doesn't make Tesla a "living company," but it shows one way a company can ensure it doesn't get swallowed.

For some older companies the family winds up with the ownership stake that it can use to protect the company's interests. An example is Taubman Centers (NYSE:TCO) which has a complicated mix of direct ownership and trusts related to the decadents of the company's founder. However, the end result is that it would virtually impossible to do anything at Taubman without the consent of the Taubman family.

And then there's situations like Hershey and Hormel, where shares are controlled by charitable trusts. The idea being that the charities associated with the trusts are funded by the businesses and, in turn, help protect the future of the businesses because they own enough of the company to ensure it survives any unwanted advances. In the case of Hershey, the Hershey Trust Company owns about 8% of the company but basically all of the class-B shares. That ensures it has voting control (about 80% of the vote) over any material developments, like an acquisition attempt.

Hormel has a similar structure, with the Hormel Foundation owning around 48.5% of the company's stock. It could pretty much block any major transaction if it wanted to. Interestingly, if you go to the Hormel Foundation's website, it doesn't even hide that goal. This is how the relationship between the foundation and the company is described: "The Foundation is the primary protection of the Company's independence."

Problems and solutions
With the news that Hershey snubbed a recent approach by Mondelez International (NASDAQ:MDLZ) the Hershey Trust finds itself in the hot seat. There may be good reason for that, but the trust has done exactly what it looks like it was created to do-it protected Hershey as a stand alone company. Hershey is, then, still a "living company," as de Geus might call it. It's facing a difficult market for its products, but it will live on to deal with it.

The bigger problems appear to be more complex, and perhaps deeper, at the Hershey Trust. And they could involve the misuse of funds. Pennsylvania's Attorney General is taking a close look at what's going on and there's supposedly an agreement being worked on to fix the problems. So there's a real reason to be concerned about what's going on at the trust. But, still, a takeover of Hershey would be impossible without the approval of the trust, so in some ways it's playing its role perfectly. The longer-term question for Hershey the company is whether or not the Trust gets altered in such a way that it is more comfortable with Hershey being acquired. That would be cause for concern.

Long-term wealth
Hershey has an annual dividend increase streak of around six years. However, that's because the company paused during the deep 2007 to 2009 recession. It's not due to a dividend cut. And despite the brief pause, the average annual increase over the past decade is around 9%, three times the historical average inflation rate. Hormel's dividend streak is an incredible 50 years, with the annual increase over the past 10 years of a little over 14%. Each of these long-lived companies have compelling stories to tell.

While both companies are fairly expensive today, that type of dividend growth and the ability to stay a going concern is what helps create long-term wealth. And the charitable trusts are a key part of that, just like insider ownership is at other companies. So, in many ways, looking for companies that have both the will to live and the structure to ensure survival is a good call for investors interested in watching their money grow today and knowing that it will, hopefully, keep growing well beyond one's own lifetime.

I've talked before about one of my key investing questions: Would I want my wife to own this company if I were dead? It's relatively new for me, since I'm getting a "little" older and death is more of a reality than it was before. But increasingly I find myself looking for companies that can stand the test of time. Hershey and Hormel have the history to suggest that they are worth looking at. But they also have the structure to ensure that major corporate changes won't get pushed through by activist investors looking for a price pop or short-term thinking managements.

I don't own either company because they are expensive today, but of the two Hormel is on my watch list. You could argue that trusts and insider ownership block transactions that would quickly return value to shareholders. That's true. I would counter that investing in a company is basically laying a claim to its long-term cash flows. And I'm happy to get those cash flows one dividend at a time rather than one big payday that may, in the end, turn out to be smaller than what could have been achieved over decades the slow and steady way.

Clearly, when it comes to investing, it won't always be smooth sailing. But knowing that a company has the time to deal with the trouble spots is comforting. And unique structures like the ones at Hershey and Hormel serve a real purpose, providing value to income investors with a true long-term bent.

Disclosure: I am/we are long IBM.

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.