Sifting Through Southern Union's Problems

Southern Union (SUG - commentary - Cramer's Take) is a natural gas distribution company with a market capitalization of roughly $750 million, and its stock currently trades at about $14. This company has a lot of problems, including a weak balance sheet and a hefty debt load. Book value, after subtracting goodwill, is negative. A read of its filings with the Securities and Exchange Commission also reveals a company burdened with a clubby board, conflicts of interest and excessive stock options:

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Between the Balance Sheets at L-3

The company loaned $4 million to its president, Thomas Karam, collateralized by stock options.

There is an uncollateralized loan of more than $300,000 to Executive Vice President Dennis Morgan.

The company pays annual lease payments of about $250,000 to a company controlled by three directors for use of office space.

What bothers me most about Southern Union, though, is the issuance of stock options to an executive in a position of dominance. CEO and Chairman George Lindemann owns 10% of the shares outstanding, and his three sons own about 5% each. Lindemann has options on an additional 900,000 shares on top of the roughly 5 million that he already has.

The purpose of stock options is to align the interests of executives with the interests of shareholders. As a 10% shareholder, Lindemann's interests are already aligned with shareholders. He is the largest shareholder. If, for example, the value of the company rises from $750 million to $1.5 billion over the next few years, Lindemann's personal stake would rise from $75 million to $150 million as a 10% owner.

A stock-option program for a dominating executive like Lindemann is nothing more than a grab for more wealth at the expense of other shareholders. And this grab is facilitated by the leverage he has as CEO and chairman of the board.

While Lindemann is not unique, some CEOs are quite different. As I explained in my column on Fastenal (FAST - commentary - Cramer's Take), CEO and 10% shareholder Robert Kierlin declines to participate in the stock-option program. In fact, his personal stock in Fastenal backs the stock-option program, so there isn't any dilution to remaining shareholders from options.

Getting Fundamental

There's something highly suspicious about Southern Union's dividend policy: It doesn't pay one. Every other competitor that I reviewed has a high-dividend policy: WGL Holdings (WGL - commentary - Cramer's Take) has a 5.3% yield, Semco Energy (SEN - commentary - Cramer's Take) yields 6.2%, and South Jersey Industries (SJI - commentary - Cramer's Take) has a 4.7% yield.

I don't think the no-dividend policy is a balance-sheet-related issue, despite Southern's weak financials. This industry has high leverage across the board.

It looks to me as if management is running the company like a private company. Instead of returning cash to shareholders in the form of dividends, management has made a series of poor investments, including venture capital-quality investments that have turned into disasters, e.g., PointServe, a business-to-business online scheduling solution provider, and Advent Networks, a digital broadband technology company.

TV Appearance

I'm looking forward to talking stocks and the market on "Kudlow & Cramer" tonight at 8 ET and again at 11 ET on CNBC.

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Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, neither Alsin nor ACM held a position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, The Turnaround Report.