How a Dividend Can Destroy Portfolio Value

I’m all about dividends, but with a caveat: A company that pays a dividend must afford what it pays.
I spend considerable time vetting dividend-paying stocks. The question of affordability is first and foremost. Can the company afford the dividend to create shareholder value?
The question of affordability was first and foremost when I received a wire alert on Patriot National (NYSE: PN) this past November. Patriot National, a microcap provider of workers’ compensation programs for insurance companies, had declared a $2.50 per-share special dividend.
The special dividend was an attention-getter in both amount per share and yield. Patriot’s shares were trading at $6.85 when the dividend was declared. A $2.50 per-share dividend applied to a $6.85 share price creates a 36.5% yield. More than a third of the company’s market value was being returned to shareholders as a dividend.
Management further amplified the munificence by increasing Patriot National’s share-buyback program to $40 million from $15 million. Management was planning to return $115 million to shareholders through dividends and share buybacks.
I imagine that many Patriot National investors responded with a “YES!” or a “cha-ching!” upon reading the press release. After a cursory analysis of Patriot National’s financial statements (which required all of 10 minutes), I responded with “This is nuts.”

Borrowing for Patriot National Dividend

Patriot was generating roughly $200 million in annual sales. It had $91 million in cash and cash equivalents. Patriot National would need to borrow more money  ̶  much more  ̶  to fund the special dividend and the share buyback.
And it did. Remarkably (a euphemism for “stupidly”), a few intrepid lenders stepped up with full wallets splayed open ready to lend.
The same press release announcing the special dividend also announced the source of borrowing. Patriot National had established a $30 million revolving credit facilities and a $250-million term-loan facility led by Cerberus Business Finance, LLC.
What was the attraction from the lenders’ standpoint?
A spotty earnings record, uneven growth, irregular cash flows, and a short operating history as a publicly traded entity. (A cursory skimming of the 10-K for 2015  ̶  the 2016 10-K isn’t posted on the SEC website  ̶  also pointed to eyebrow-raising dealings between the company CEO, his investment companies, and Patriot National.)
Patriot National had gone public less than two years before the special dividend was declared at $13.50 a share. Now it was issuing a $2.50 special dividend on a share price that was half the IPO amount.
What could go wrong?
Investors who had performed more than my 10 minutes of analysis knew a lot could go wrong. They went to work. They filed a request for a restraining order on the special-dividend payment. Unfortunately for them, the restraining order was lifted and the Patriot National dividend was paid.
A slew of lawsuits ensued. No institutional investor saw merit in the special dividend and the share-buyback program. When these institutional investors weren’t contacting their legal counsel to file a lawsuit, they were calling their broker to sell Patriot National shares.
In July, Patriot National’s board of directors accepted the resignation of company founder, CEO, and benefactor of the special dividend, Steven M. Mariano. I’ll let other investors decide whether this was good or bad.

The Stock Price Tanks

As for that $6.85 share price that prevailed when the Patriot National dividend was declared, it had been sold down to under $2. The selling pressure didn’t cease when Mariano ceased being an officer. Patriot National shares trade at $1 today. Patriot National risks delisting from the NYSE.
So much for the special dividend and the enhanced share-buyback program creating value.
Patriot National’s market cap has shrunk to the microcap $26 million we see today from a small-cap $205 million we saw last November. The debt obligation holds steady. Patriot National has $231.5 million in long-term debt against $26 million of equity capital and $92 million in cash and cash equivalents.
Yes, I like dividends as much as anyone, but only if they have the proper provenance to create value for shareholders. As Patriot National proves, not all do.

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