News Analysis July 12, 2010, 8:50PM EST

A Costly Payday for Weyerhaeuser Shareholders?

The company's announcement of a $5.6 billion special dividend may cause volatility in the shares as investors assess the tax implications

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The prospect of a company's declaring a special dividend valued at $5.6 billion—and higher regular dividends in the future due to a tax-exempt corporate structure—should put a smile on investors' faces, right? Not necessarily.

Weyerhaeuser (WY), a major U.S. timber company, announced on July 12 that it will pay a special dividend in that amount in September to shareholders of record July 22. The special dividend represents all the earnings and profits the company has accumulated and not paid out in the form of dividends to investors since its inception more than 100 years ago. This is the latest step toward the company's eventual conversion to a real estate investment trust (REIT), which will exempt it from paying corporate income taxes. That's good news for investors, who are required by U.S. tax law to receive at least 90 percent of the company's net taxable income in exchange for Weyerhaeuser not having to pay corporate taxes. The shareholders will be responsible for the taxes on any dividends they receive.

On a conference call July 12, the company said the special dividend will include the regular quarterly dividend of roughly $11 million and that shareholders can choose to take the dividend as cash or stock, with the total cash payment limited to 10 percent of the total distribution, or $560 million. Weyerhaeuser's wood products, fibers, and homebuilding busineses will be placed into a separate subsidiary, whose net income will remain taxable.

Becoming an Income Play

Conversion to a REIT certainly would turn Weyerhaeuser into more of an income stock, says Dan Rohr, mining and timber analyst at Morningstar (MORN).

"Weyerhaeuser will have to offer a dividend payout commensurate with what other timberland REITs are paying, something on the order of a three, four, or five percent dividend [yield]," he says. In June, the company paid a dividend of 5¢ per share (a yield of just 0.5 percent), vs. Plum Creek Timber's (PCL) 42¢ quarterly dividend in May (a yield of about 4.67 percent) and Rayonier's (RYN) 50¢ payout for a 4.31 percent yield in June.

For shareholders, the only disadvantage of the conversion is the timing of their tax payment, says Rohr. "You get hit upfront, and you save over the longer haul," he says. "The pie that's available to shareholders for distribution is ultimately larger, because the government isn't taking a piece of the pie before distribution."

In a July 12 note, Credit Suisse Equity Research went so far as to say that the possibility of increased volatility in the stock price prior to the presumed ex-dividend date of July 20 could prompt some taxable investors to sell their shares "to avoid this massive $26.49 per share dividend reflected in their brokerage 1099s [tax forms] next February, and then buy the shares back after the ex-date." Conversely, any weakening in the stock price over the next six trading days could be a buying opportunity for tax-exempt investors, the note said.

Reasons Not To Sell

Dan Genter, manager of dividend mutual funds at RNC Genter Capital Management in Los Angeles, said he sees no benefit in selling shares in a company about to incur a special dividend, since you'll still be taxed at the capital gains tax rate, the same rate you would pay on the special dividend.

The additional income of $26.49 shouldn't come as a surprise to investors, because the company has signaled for the last three to four months that the payout would be around that level, says David Segal, portfolio manager of a handful of equity funds at the Mutual Series Group, part of Franklin Templeton Investments.