The Worst Stock Sale In History?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It's rare that someone can question selling an investment with a $100,000 cost basis that turns into $1.9 billion. However, that's exactly what I'm doing in questioning why SunTrust (NYSE: STI) would choose now to sell its 60 million shares in Coca-Cola (NYSE: KO)? I know that the company suggested that this move was designed to shore up its balance sheet and eliminate some of the uncertainty in its capital ratios, but I don't believe there's been a shorter-term thought process behind a stock sale that I can remember.
Just as a bit of background, one of the predecessors to SunTrust helped Coca-Cola with its initial public offering back in 1919. Instead of receiving $100,000 in cash as compensation, the company chose to receive shares in Coca-Cola instead. Anyone who knows much about the stock market can imagine what an unbelievable investment this has been. Since 1919 this original $100,000 investment has ballooned to 60 million shares of Coca-Cola common stock, with a value of $1.9 billion. SunTrust management apparently decided that after an almost 2,000,000% return that that was enough. I have no problem saying this might be one of the best investments in the history of the stock market. What's unbelievable is the company's disregard for the value of the dividend income they just gave up.
SunTrust announced several moves connected with this sale designed to improve their balance sheet and lower the company's risk going forward. The proceeds of the Coca-Cola sale will coincide with a provision of $375 million for mortgage putbacks from Fannie Mae and Freddie Mac. The company is also taking a $250 million write-down and transferring $3 billion in underperforming loans to loans held for sale. Because the upcoming Basel III guidelines treat equity holdings as higher risk than many others, the sale of stock and conversion to other types of assets will improve SunTrust's regulatory capital ratios. In fact, the Chairman and CEO of SunTrust, William Rogers said the bank's decision results in less risk on the balance sheet with the same regulatory capital and “I personally think that's a good trade.” To understand a little more about why SunTrust felt the need to make this move, let's take a look at the company's competitive position versus some other banks.
SunTrust was one of the banks that was subjected to the Fed's recent round of stress tests, and while the dividend was increased, the bank also issued additional debt and shares to repay preferred stock owned by the U.S. Treasury. The bank does not appear to be doing all that badly. In a recent investor presentation, the company said its performing loans increased 9%, and total deposits were up 3%. This certainly compares favorably to banks like Bank of America (NYSE: BAC), which last reported average deposits down 2% and everything from residential mortgages to home equity loans showing decreases. However, when compared to stronger institutions like BB&T (NYSE: BBT) and Wells Fargo (NYSE: WFC), the comparisons are a little tougher.
In its most recent quarter, BB&T showed total deposits up 17.7% and average loans up 6.3%. Where Wells Fargo is concerned, this bank saw average deposits up 9%, and loans increased 2.25%. As you can see, BB&T and Wells Fargo saw better deposit growth than SunTrust, with all three companies seeing sub 10% loan growth. In addition, Suntrust's credit quality is not that bad relative to its competition. The company's nonperforming loans in their most recent earnings were 2.37% of total loans. By comparison, Wells Fargo reported nonperforming loans at 3.21%, Bank of America came in at 2.87%, and BB&T led the big banks showing just 1.5% of non-performers. Overall, it looks like SunTrust is doing okay, which brings us to the original question of why the bank would sell its Coca-Cola shares at this time.
While there's no question that the gain on the company's Coca-Cola investment is impressive, what seems to be lost in the shuffle is the short term thinking in the loss of significant dividend income from this investment. With about 60 million shares and Coca-Cola paying an annual dividend of $1.02, this is the equivalent of $61.2 million in annual dividends that SunTrust is giving up. Considering the fact that the company's cost basis for the shares was $100,000, the company's effective yield is an astronomical percentage that will likely never be re-created. The fact that Coca-Cola has a history of increasing its dividend for over 50 years, and doesn't show signs of stopping, means SunTrust also gave up these additional dividend increases in the future. This begs the natural question, why was such an outstanding investment that could not possibly be duplicated liquidated?
I would suggest there are only two possibilities. The first possibility is the company is so desperate for capital that it had no choice but to cash in this massive capital gain regardless of the loss of future dividends and the huge tax implications. If this is the case, I would run from the stock as fast as possible. Management just gave up one of the best effective yields anyone will ever see in order to raise money for the short-term. The only other possibility I can come up with is that the bank is trying to simplify its balance sheet to prepare for a merger or acquisition. With the stock selling at about 0.80 of book value, SunTrust could be an attractive takeover candidate. The company's market cap is less than $16 billion.
However, a potential acquirer would gain the over $100 billion in loans and over $90 billion in deposits that SunTrust currently holds. Even if a bank offered twice the current market cap, that would would seem like a very good deal. The scary part for investors is this sale of Coca-Cola stock is either one of desperation for capital or preparing for a merger or acquisition. If you believe that SunTrust will be acquired, this could be a very good investment. On the other hand, if you question as I do why this stock sale would be necessary even if an acquisition were pending, then I would stay away from the shares. In either case, one of the best long-term investments in history just disappeared.
Interested in Additional Analysis?
To learn more about the most-talked-about bank out there, check out the Fool’s in-depth company report on Bank of America. The report details Bank of America’s prospects, including three reasons to buy and three reasons to sell. Just click here to get access.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America, The Coca-Cola Company, and Wells Fargo & Company and has the following options: short OCT 2012 $33.00 puts on Wells Fargo & Company and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend The Coca-Cola Company and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.