Goodwin (GDWN)


This bonus scheme makes the blood boil

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This bonus scheme makes the blood boil LTIP director bonus share options
Goodwin's (GDWN) annual report is largely reassuring, but there's an unexpected development: A long term incentive plan (LTIP) that could give as much as 10% of the company to the directors.

Despite a small fall in revenue and a considerable drop in profit, the company earned a 10% return on capital. Goodwin's patented check valves, used to control the flow of fluids in pipelines, are no longer in high demand. The collapse of the oil price two years ago, and the consequent reduction in investment in infrastructure by oil companies, means Goodwin is selling fewer valves and making less profit from them.

To make up, it's seeking more business from defence contractors and construction companies, which also require giant cast and machined alloy parts, and it's relying more heavily on a smaller group of businesses that supply jewellery and tyre casters with minerals and moulds, as well as minerals used in fire resistant products like paint and insulation.

Long-term shareholders should perhaps breathe a sigh of relief. Even during a recession in the oil industry the company is still viable, and through modest acquisitions and investments, it's adapting.

Loathing, lies and LTIPs

I can't begin to tell you how much I loathe LTIPs, though. Most companies have them. One of the attractions of Goodwin was that it didn't. Often almost every letter in the acronym represents a lie. Usually the associated performance targets are short-term or medium-term at best, typically requiring the business to perform well over three years.

By encouraging radical action to lift the share price or profit, LTIPs encourage managers to take the easy route, slashing costs instead of investing, or leveraging up the company to buy profit through acquisitions.

Naively, perhaps, I didn't see the need for an LTIP. Goodwin's directors already own 53% of the company so, should it recover, they have the most to gain irrespective of incentives. On many occasions, including the latest annual report, the company has gone out of its way to restate its opposition to large annual bonuses, precisely because they are bad incentives.

The cash value of executives' share options could be approximately £3 millionFiguring out the value of LTIPs is a horrendous task, partly because the answer is contingent on a number of variables, and partly because you know you're not going to like the answer when you've worked it out.

According to my calculations and roughly speaking, Goodwin intends to give its directors 1% of the company each if the share price in April 2019 is above its 2012 high of £42.50.

If the company reaches that target, I reckon it will be worth about £310 million - double its current market capitalisation - so the cash value of the share options the executives will receive could be approximately £3 million once the cost of exercising them (£7,200) is deducted.

The award could be worth less. The directors will receive incrementally fewer options if the company performs less well, and those options will be worth less. The award could also be worth more. Although the number of share options each director will receive is capped, they will be worth more if the share price is even higher on the day.

'Doesn't make sense'

On the face of it Goodwin's LTIP is a bad one. The potential value is high, the performance period is three years (April 2016 to April 2019), and it's largely dependent on movements in the share price*.

Although the stated purpose of the LTIP is to encourage long-term value creation, the share price is not a good measure of management's contribution. It will be influenced by many other factors including demand in Goodwin's markets, the value of sterling, and investor sentiment, all of which are volatile.

Goodwin has an unusually large board of eight executive directorsBut it just doesn't make sense to me that Goodwin would suddenly go short-termist. It's a family business built from long-term investment.

I've never met chairman John Goodwin, but I have corresponded with him many times, and I think he's honourable.

It makes even less sense when you consider the fact that the company's two largest shareholders, John and his brother Richard, will own less of the company despite receiving more shares from the LTIP.

Goodwin has an unusually large board of eight executive directors. Between them John and Richard own nearly half of the company:

Assuming the maximum payout of shares at a share price of £43, the pair should receive options worth just over £6 million, but, if the share options were all exercised immediately, the company would have to issue shares with a market value of £24 million, diluting existing shareholders including John and Richard. The "cost" to them in this specific scenario would be just shy of £12 million.

All other things being equal, after April 2019 the directors' interests would be:

Looked at this way, the LTIP is less likely to be a covert cash bonus and more likely to be a transfer of ownership from minority shareholders and John and Richard Goodwin to Goodwin's next generation of leaders, four of them sons of John and Richard. Minority shareholders bear the brunt of the cost, though, which I suppose is the price of the family's stewardship of the business.

Keeping Goodwin in the family will be a good thing for the business if the next generation is capable of steering the company to prosperity like the current generation has. The share options will only work properly as a long-term incentive, though, if the recipients have to hold the shares they will be awarded in 2019 for many years after.

The board is putting the LTIP to the vote at Goodwin's forthcoming Annual General Meeting. The result is almost certainly a foregone conclusion as the directors own a majority of the shares. The documentation sent to shareholders contains no terms restricting the sale of shares awarded by the LTIP, although I believe they may be under consideration.

I will be seeking confirmation before deciding whether to raise my hand in protest at the potential size and short-term nature of the award.

*The performance target in the LTIP is based on Total Shareholder Return, which includes dividends. My calculations assume the dividend in 2017 and 2018 will be the same as the dividend in 2016, which has not changed since 2014.

Contact Richard Beddard by email: [email protected] or on Twitter: @RichardBeddard

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.