Managing CHS's equity is easy. Each year, all patronage earnings are allocated to patrons. 35% of patronage earnings are paid in cash. This cash approximates the cash patronage refund or income tax obligations that recipients of CHS's distributions are expected to owe to their patrons or to federal and state governments, respectively.
The balance of CHS's patronage earnings (65%) are distributed with qualified written notices of allocation (QNAs). Over the next twenty to fifty (or more) years, CHS's board will devote as much of its available cash flow to redeeming allocated equity (QNAs) as it can. All of these redemptions will be free of tax, it being the case that all taxes or cash patronage obligations are paid upon the receipt of the 1099-PATR.
The CHS Board has no idea whether its future earnings will mirror recent years, whether earnings will be stronger or weaker than the past, or what types of expenditures for property, plant and equipment it will face in twenty to fifty years or more (the crystal ball of the CHS Board’s is no clearer than the crystal ball of any other Board of Directors).
If things go like they can go sometimes, competition and an evolving market place will place continuous pressure on earnings, turning CHS's $2.3 billion of allocated equity into the tallest, most jagged mountain in the universe. The CHS Board - like any Board of Directors - has no idea how long it will take to redeem QNAs or whether in the meantime, the underlying economic and financial metrics of its business model will change for the negative or positive. Twenty to fifty years (or more) is simply too long of a planning horizon to realistically manage with any degree of accuracy.
If things go well, $2.3 billion of allocated equity may look like the smallest, most gentle, most easily traversable knoll in the universe. We cannot be sure it will be tougher for CHS to generate earnings in the future and should not be judgmental about CHS’s prospects. Perhaps pressure to spend money on property, plant and equipment will ease. Perhaps CHS will reduce its reliance on debt capital in its capital structure. Perhaps the growth of its business will abate and ease pressure on liquidity. Who knows, maybe it will get easier to make money?
Regardless whether prospects are better or worse in the future, note that starting in 2010 CHS has a $2.3 billion allocated obligation. The CHS Board cannot reduce that obligation except to redeem the equity. The time to manage this obligation is before the patronage earnings are allocated, not after the patronage earnings are allocated and CHS has created an expectation and an obligation that allocated equity will be redeemed.
Bear in mind also that redemptions of equity are always the last priority of the CHS Board of Directors (or any Board of Directors), who owe fiduciary obligations first to the Co-op. Members and patrons – like stockholders in a corporation – are almost always second vis a vis the Co-op or corporation, particularly in regard to distributions of cash to members, patrons or stockholders to redeem equities.
Consequently, the CHS Board's fiduciary obligations that are owed to CHS direct that the Board will always spend capital first for (1) maintaining and building CHS's liquidity position, (2) repayment of CHS’s long term debt, and (3) replacement of or new property, plant and equipment for CHS. Only after those and other expenditures are provided for can the CHS board make capital available for redemptions of QNAs to members and patrons.
So while CHS's equity management approach might be easy at the outset when the patronage earnings are first allocated, its effect is to create a unwieldy capital structure with an enormous obligation to redeem equity up to the next fifty years; perhaps longer. If as is usual CHS will face more pressure to generate earnings in the future, and if it becomes more difficult for CHS to redeem allocated equity, what was easy at the outset will become increasingly burdensome and difficult as time goes on.
No comments:
Post a Comment