At 3M, Lawsuits Threaten to Transform the Company

3M is contesting thousands of lawsuits alleging that long-lasting chemicals known as PFAS developed by the company decades ago have contaminated soil and drinking water and contributed to illnesses. The company also is a defendant in what has become the largest civil injury case in U.S. history, with about 250,000 veterans alleging that 3M’s foam earplugs failed to protect them from service-related hearing loss.

3M is in talks to settle the earplugs case, as well as a major part of the PFAS litigation dealing with contamination of municipal drinking water from firefighting foam produced by the company.

Fighting the cases at trials would take years. Settling the litigation will come with a steep price tag that would potentially reshape the company.

Some analysts expect 3M to reduce its stock dividend that costs $3.4 billion a year as it becomes a smaller company with a heavier debt load. The company said last July that it planned to spin off its healthcare business—its best-performing unit—to shareholders as a separate public company late this year or in early 2024.

The dividend, which was almost $6 a share last year, is a crucial reason why Kinloch Capital has held its investment in 3M despite the share price falling by about one-fifth in the past year, said Peter Walls, chief investment officer for the Virginia-based firm. A cut in the dividend would be a reason to sell, he said.

“We are willing to ride relatively large ups and downs and be extremely patient as long as the dividend is coming in every year and being increased every year," he said.

3M declined to comment on potential settlement strategies or how the company could pay for any settlements. 3M Chief Executive Mike Roman said in May at a conference that the dividend has been a priority for the company.

Some analysts have estimated the cost of settling the earplug litigation at $10 billion to $15 billion. A settlement with municipalities for PFAS in drinking water alone could cost $10 billion or more, they have estimated.

Ryan Batchelor, chief investment officer of Utah-based Clifford Capital Partners, said his firm believes 3M can absorb large settlements without undermining its businesses.

“We think this is an equity panic, not an enterprise panic," he said.

3M traditionally has been a prodigious cash generator, with thousands of products in business lines that carry high profit margins. 3M hives off products from a core set of materials that include adhesives, abrasive materials, nonwoven fabrics and reflective films. This year, 3M is likely to have more cash on hand than usual because of the spinoff of its healthcare business.

RBC Capital Markets estimates that 3M will have access to about $17.4 billion of capital by the end of the year, including an estimated $6.7 billion from a one-time dividend the new healthcare company is expected to pay to its former parent. 3M is expected to retain a 19.9% equity stake in the new company, which could be valued at roughly $3.2 billion if 3M opts to sell it, according to RBC.

Roman has said he is in no rush to sell the stake after the spinoff. “We can monetize over time," he said in announcing the move last summer.

3M’s dividend is the highest among its peers in the industrial-conglomerate sector. The company maintains a streak of increasing shareholder dividends annually for more than 60 years. About 94% of 3M’s free cash, which is the money left over after interest payments and capital expenditures, is channeled to the dividend, according to analysts.

The healthcare spinoff is expected to reduce 3M’s earnings before taxes and interest by $2.4 billion, leaving less money in the future for the dividend, according to analysts’ calculations. As more of 3M’s free cash is needed for settlement-related expenses in the coming years, analysts expect the ever-increasing dividend to become unsustainable.

“They’re now a dividend aristocrat, but we think that likely comes to an end," said Deane Dray, an analyst for RBC Capital. “They’ll be a smaller company."

Even if 3M settles the case currently due to go to trial, involving firefighting foam with PFAS produced by 3M, the company faces other PFAS-related litigation. 3M is also a defendant in thousands of personal-injury lawsuits related to PFAS and cases filed by state attorneys generalover water and soil contamination. 3M, which manufactured PFAS in Belgium, also is facing PFAS complaints in other countries.

“It’s going to be a liability with a lot longer tail," said Gianna Kinsman, a vice president for Capstone, a Washington-based firm that advises investors and companies on regulatory issues.

Capstone, which doesn’t work for any company that produces PFAS chemicals, forecasts that 3M’s cost to settle PFAS litigation will be more than $40 billion.

The litigation hangover prompted credit-ratings firm Moody’s to give 3M debt a negative outlook in February, though the agency left 3M’s rating at an investment grade of A1. Moody’s Senior Vice President David Berge said the outlook reflects uncertainty over PFAS litigation inside and outside the U.S.

Analysts expect that 3M eventually will need to borrow to pay PFAS settlements. 3M currently has nearly $16 billion in debt. Adding $10 billion or $20 billion of debt would come up against a smaller base of profit after the spinoff to pay for the interest expenses.

“The net leverage would rise to an uncomfortable and arguably unsustainable level," said Wolfe Research analyst Nigel Coe in a note to investors. “Settlements that make funding payments over time could mitigate the leverage concerns."