FPL: Business Case

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The fourth largest electric utility company in the United States and the largest electric utility in Florida is the FPL Group, which formed in 1925 from the consolidation of several gas and electric companies. FPL as a company continued to grow after 1925 because the ever increasing Florida population demanded more and more electricity. This trend continued until the 1970s when operating problems, and the rising cost of fuel and construction, caused a reduction of the company’s profitability. To address this issue, then Chairman Marshall McDonald, decided to make four major acquisitions: Colonial Penn Life Insurance Company, Telesat Cablevision Inc., CBR Information Group Inc., and Turner Foods Corporation. FPL also attempted to improve operations by employing 1,700 teams for quality control to find ways to improve operations. This notion lead FPL to be recognized as “one of the best-managed US corporations,” when the quality control teams found ways to improve efficiency within FPL by decreasing customer complaints by 60%, and decreasing downtime operations by 12%. Despite these enhancements, FPL still had company troubles to include: problems with a nuclear plant, demand was growing at a faster pace in the 1980s than expected, one of their acquisitions had lost $250 million since being acquired, and employee morale was low due to all the new management regulations.

Kate Stark, the electric utilities analyst at First Equity Securities Corporation came across a decision involving this Florida electric utility company, FPL. The decision begins with the buzz that FPL may decide to freeze its dividend at $2.48 per share or even potentially reduce the dividend at FPL’s annual meeting. Kate had previously valued FPL with a “hold” recommendation three weeks earlier with the belief that FPL will either keep its dividend payout at $2.48 or slightly increase it. However, with the news of this new rumor about FPL dividends, FPL stock price fell by 6% because a freeze of the dividend would mean that FPL would end a 47-year streak of annual dividend increases. Now Kate is reconsidering her “hold” rating and contemplated issuing a new updated report to revise her investment recommendation. It is now to decided how a change, if any, to the current dividend policy would affect shareholders, which option would have the greatest benefit to the shareholders and FPL, and what should be advised to investors with regard to FPL stock.

Two theories of dividends come up with the FPL Group. The first theory is the Signaling Hypothesis and the second theory would be the Clientele Effect. The Signaling Theory is essentially the theory that managers of a certain company have better information and are more informed internally about a firm's future prospects than the public stockholders. Future dividends are paid out of future profits, so any change in dividends to be paid is viewed as an indication of what future profits are going to be. Thus, when dividends are increased or decreased, stock prices tend to increase or decrease.

The second theory relevant to the FPL group dividend policy is the Clientele Effect. Different clienteles of stockholders favor diverse dividend payout ratios. Different firms also have altering ways of calculating and paying out dividends. Thus, when a firm switches its payout ratio a current clientele will leave and a different clientele will join. The rule of thumb is that if more investors leave or leave faster than a new clientele could replace them, then there could be a temporarily depressed share price.

There are two important issues that are facing the FPL Group in the May of 1994. The first is the concerns of potential competition resulting from industry deregulation and the second is the reexamination of a high dividend payout ratio already previously noted. The arrival of retail wheeling from the National Energy Policy Act of 1992 threatens to change the shape of the entire electric...
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