Dividend Policy

In my final blog I am going to talk about dividend policy and explore what makes managers pay out a proportion of the profits or even withholding dividend payments. The theme throughout my blogs has been shareholder wealth maximisation, shareholders generally do not know the ins and outs of a company so when high dividends are paid it indicates to the world that the company is doing well and the have large future expected cash flows. Or so it would seem, but as I explore the topic I soon realised that paying a dividend can have many meaning and certain dividends can attract different types of investors.
In Millar and Modigliani irrelevance theory, they believed that dividend policies were irrelevant to share value as long as the company had plenty of net present value. If a company had lots of positive net present value and paid out all its profits, it would not be destroying wealth as it could issue shares to cover the cost.
In contrast Linter believed that companies liked to bench mark their dividend payout policies as it attracted investors that wanted regular and consistent dividend, they know where they stand and are perfect for retirement or pension funds. Sometimes companies would signal by giving higher dividends, investors would believe this to mean that the managers know that future cash flows will be higher. But sometimes this is not the case. Managers can manipulate investors into thinking things are good, this is very short sited as funds will run out and they will have to reduce dividend payout and with it destroy share value.

Recently air lingus, the Irish airline, issued its first dividends since floatation six years ago, aiming to payout dividends every year it makes a profit, one of it main investors Ryanair is not happy with the 3 cent a share payout and share prices fell slightly to 98 cent a share. This is a problem with new companies, most new companies pay zero or very small dividends in the first few years, investors wait as they hope to see good returns, if the policy changes and investors do not get what they want then they will look else where for greater returns

Another example is Apple , who after 17 years has decided to pay dividends of $2.65 a quarter to its shareholders starting this July. It has also announced that it plans to spend $10 billion buying back some of its shares over the next three years as it deals with a cash mountain of $100 billion. So why has it taken apple so long to pay a dividend if they have so much retained earnings? They could be a tad prudent but they definitely have shareholder trust, share prices have increased for $10 ten years ago to $600 today. I think the figures speak for them self and the icing on top of the cake is the quarterly dividend they are about to receive. This communicates confidence of the brand and future estimated cash flows, they can pay their dividends, but still have plenty of retained earning for future investments. Apple time and time again come up trumps and soon I'm sure they will start to increase their dividends but they are firmly in the driving seat and what they say goes.

Source: Arnold, G. (2008) 'Corporate Financial management'
            Nuttall, C. (2012), 'Apples dividend and buyback - how it happened'. FT.com
            Moore, E. (2012), 'Tech sector backed for value and growth'. FT.com
            jacobs, R. (201), 'Aer Lingus to issue first dividend since floatation'. FT.com

The Credit Crunch - How could they not see it coming?

The phrase Credit crunch was the start of media frenzy back in 2007 and every household felt the impact. Most people seem to think this is a new phenomenon but it was happening to Canada in the 80’s, Argentina in the turn of the millennium, and the great depression of 1929. Although, it is believed that this crisis is bigger than the Great Depression. The scale of the economic breakdown is difficult to comprehend. No previous economic crisis has involved this sum of money, in the trillions of dollars, that have been squandered by the governments to prop up the banks and financial institutions who activities have triggered the global meltdown.

Credit rating agencies have been vilified for failing to properly assess the risks associated with subprime and other low quality mortgage debt ahead of the financial crisis. They gave triple A ratings to billions of dollars of mortgages securitisations that turned out to be far riskier. The impact caused banks and investors to suffer huge losses. It goes back to 2001 when the crack started to appear after the dotcom bubble and 9/11 attacks, but the full extent did not come to light until April 2007 when New Century Financial, which specialises in subprime mortgages, filed for bankruptcy. This was the start of the domino effect. Then in July Investment bank Bear Stearns hedge funds failed to perform and banks refused to bail them out. This continued when Investment bank BNP Paribas that could not value two of its funds, the amounts of money was substantial and realisation that the banks and investment centres were financially exposed. As the German bank Sachsen Landesbank faced collapse after investing in the subprime markets and had to be sold. This spark international attention and finally the finance world were listening as concerns of various issues relating to the subprime market emerged. As news stories develop you see a compound effect.

Banks lending to banks started to drop and interest rates started to increase, attaching much higher risk values to lending. You have to ask the question, what were they thinking using short term finance to finance 25 years mortgages? Then finally on 13 September 2007 the well publicised in the press bank Northern Rock now owned by the Virgin Group had to bailed out by the Bank of England, which started media frenzy, frightened customers queued for hours to withdraw their fund amounting to £1billion in one day and finally even the average Joe off the street knew about the financial crisis.  


May 2008 saw reports of more than 850 companies going into administration hitting the high street hardest, some of well known and loved shops started to disappear as the highly geared companies failed to pay back loans. Still five years on and it does not look like the end is near, shops are still disappearing as consumers are keeping hold of their money. The biggest losers in the financial crisis have been the UK and USA as small and medium sized companies fail for administration one by one, but some winners have materialised, Australian, Asian and Latin economies have emerged with clear balance sheets. The Asian economy escaped the worst of the banking sector problems. Something good that has come out of the crisis is tougher regulations on banks, but the economic profession does not come out smelling of roses. You have to wonder how did they fail to foresee the economic crisis of the noughties?  


Source: Arnold, G. (2008), 'Corporate financial management'.
              

Mergers and Acquisitions: How did they do it so right?

In recent year’s mergers and acquisition activity has been rising steadily. The UK has seen high levels of acquisitions in the pharmaceutical, banking and electrical sector.  Two factors that fuel an acquisition are strategic and financial forms. Companies may become subject to mergers and acquisition due to the possession of particular value chain strengths. This could be in the form of technology development or even research and development advances. Basically if your company has something they want, and they can create additional value from the activities in excess of the acquisition costs. If this is the case whether it be for market dominance, economy of scales, to diversify or just because of corporate egos, they could just be round the corner.

In the past companies have not always purchased other companies for the right reason, the main strategic goal should always be shareholder wealth maximisation. But sometimes they have got carried away, in pursuit of market dominance and realised that all they have been left with is a big pile of debt.  Vodafone went on a spree in the last decade running up to the economic downturn, which forced a group-wide consolidation of assets during the past three years. The arrival of the new chief executive in 2008 Mr Colao, markets the end of the “empire building “effect. The company has since focused on consolidating its position in its core stable European and growing emerging markets, and disposing of, or merging minority or subscale interests elsewhere, pretty much getting rid of any dead wood, which I’m sure the shareholders will be very happy with, as the money will be distributed amongst them.

This could also be to raise funds for a merger with struggling telecom group Cable and Wireless Worldwide, which they have announced an interest in. The company went through a demerger in 2010, since then they have had several profit warning and the company is not in good shape. But it does have a bunch of subsea cables, some tax assets, data centers and British bulk telecom networks. At the moment Vodafone is using rented land lines from BT, they are BT largest customer. Which, when you put it into context could mean huge savings for Vodafone if it goes ahead with the deal by off-loading some of its mobile data traffic to the fixed lines of the telecom group. As with any company this size, they are also looking at other options including FDI in India if regulations will allow it. At the moment no offers have been made but it will be interesting to see, which route they choose.

A successful merger that took place in 2004 was between General Electric NBC and Vivendi Universal Entertainment (VUE) forming NBC Universal in the largest media deal that year. Universal had come close to bankruptcy and the owners needed to get the debt down, so began the process of trying to sell as many assets as they possibly could, but burdened with €35bn debt agreed to sell its controlling stake in VUE to NBC. NBC revenues were 90% advertising and the rest from cable fees and VUE was the opposite, with box office and DVD’s. When you put this together, makes it 50/50, spreading the risk. This is a perfect example of a merger that gone right, they had other options to buy MGM as well but felt it was not in their best interest right now to grow any larger.  As they try to implement product quality and production efficiency, increasing cash flows.

The merger worked that well that in January last year Comcast completed its purchase of NBC Universal, when it acquired 51 percent of the media group by paying $5.8bn to Vivendi and $7.1bn to GE. The group now also has cable channels worth $30bn that Comcast has thrown into the pot, helping the media company become a successful combination of content and distribution.  In this fast moving environment it pays to be strategic and keep an eye, on what else could be a good cash injecting string to your bow. With this in mind NBC Universal, the media company owned by Comcast, agreed to buy Blackstone 50 percent stake in Universal Studios Florida in a $1bn deal that consolidates its ownership of the theme park. Confirming its long term commitment to NBC Universal, as Universal Park has enjoyed success from the Harry Potter attraction. The park offers consistent and significant return and free cash flow is performing well. As always, what it comes back to is Shareholder wealth maximization and they are bang on the money as it raised dividend payments due to strong earnings.


Source: Arnold, G. (2008), Corporate Financial management
Schoenberg, R. (1999), What Determines Acquisition Activity within an Industry?, European Management Journal, Vol. 17, pp. 93-98, 

Foreign Direct Investment: maximising shareholder wealth in multinational companies

FDI is the purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. As with all companies their aim is to increase shareholder wealth maximisation; and by saturating untapped or developing markets; where foreign governments have adjusted their policies to allow for FDI to take place, is an ideal investment opportunity.

China has been a magnet for FDI since the 1980’s, and has seen a huge rise in wages of 12% after adjusting for inflation over the past few years. But instead of FDI going elsewhere they have opted to go to China’s inland provinces. The shift inland has attracted the likes of Hewlett-Packard to the lower wage costs. China has managed to fight off competition due to its superior education levels in workers to that of other developing Countries like India and Indonesia. But in December it was reported in the Financial times that China’s economy was down for the first time in 28 months and that there was evidence of a growing economic slow down.

With this in mind, companies are looking for new areas to saturate and maximise share holder wealth as there are not many untapped retail markets left; and India with a population of 1.1billionn is a major source of future revenue growth. The Indian government now believes liberalisation of legislation regarding FDI will secure much needed investment into India’s farming sector and control continually high food inflation. Investment by Multinational companies will be capped at 51 per cent of any retailer; and the government will require foreign forms to commit a minimum of $100m of investment in the country. There would also be strict rules on acquiring their products from small to medium sized traders.

But with so many restrictions in place will it attract multinational companies to India? Carrefour, the French supermarket chain which has been in talks with the Indian government for over a year had warned that placing restrictions on local sourcing and requirement of minimum investment might affect viability of the projects. Other supermarkets which have jumped on the multinational band wagon are Walmart and Tesco’s, which may soon be allowed to open stores under stringent norms.

The legislation being set, in theory, helps the Indian economy and promotes employment opportunities. Marks and Spencer’s, started in India ten years ago as a up market chain as it was restricted by expensive imports, which had to be passed onto the customers. It has now successfully focused on the middle market, expending its network, cutting expensive imports and has started buying locally. This has allowed them to tailor their products to the local market. M&S first came to India in 2001and ran its stores as a franchise using a local Partner, Planet Retails which imported goods from the UK but this caused high duty costs. M&S are a perfect example of maximising shareholder wealth and increasing profits, through opening its doors to a larger market area by sourcing locally. It has also adapted to its environment, selling colourful clothing. Reaching out to its target audience as colour is an important factor in Indian Culture.

The concerns with FDI from multi brand firms are that local businesses in developing countries could be pushed out of business. Which when you look at the bigger picture just means that they may not be increasing employment but just replacing the jobs that were already there in the first place. But with the absence of adequate roads, airports, power and the world class telecommunication network can they afford not to allow FDI not to happen?


Source: Arnold, G. (2008), Corporate financial management'.
              beyondbrics, (2010), No win? How to price good inflationary india', FT.com
              Jopson, B, (2010), Walmart's $4bn bet on Africa consumers, FT.com
              Kazmin, A. (2010), Indian retail, more political backing for breaking the FDI taboo,      FT.com
              Surendar, T. (2010), 'Marks & Spencers Retail Rethink', FT.com
              Awal, A. ~(2011), India: a new brief for M&S, FT.com
              Wagstyl, S. (2011), Asia: growing economic gloom, FT.com

Foreign Exchange Markets: Is it worth the risk?

The volatility in the foreign currency market over the last 15 years has highlighted the fact that we all need to look more carefully at the associated risks when dealing with the international markets. Something that is worth £1 one day could be worth 80p the next day. Credit terms agreed in America dollars, six months later could be valued at a different price depending on the market. Overseas investment projects, which are creating investment opportunities need to be aware of currency change, as trading in the wrong currency could mean the end for your business. ‘Fluctuating exchange rates create risk, and badly managed risk can lead to loss of shareholder wealth’ (Arnold, 2008)

The foreign exchange market has grown spectacularly, figures show in 1973 the equivalent of US$10bn was traded, compared with figures in 2007 which was estimated at a massive US$3,210bn. London is one of the largest currency trading centres in the world, with a 34% share.  There is a variety of people trading they include exporters/importers, tourists, fund managers, governments and central banks. The larger players are commercial banks and speculators which include hedge funds. Banks try to speculate on future movements carrying out proprietary transactions.

The global currency exchange centres are open 24hours and the vast amount of money that is traded leaves them exposed to currency risk. There are three types of risk, transaction, translation and economic risk which operate in the international market. I am going to look at translation risk, which arises because financial data denominated in one currency are then expressed in terms of another currency. Also between two accounting dates the exchange range movement can be greatly distorted.

This was the case for GlaxoSmithKline (GSK) and how the currency rate affected the profit and loss account in 2007. As the weak dollar reduced cash sales, it overall had seen sales increase by 3% in the US market. The company that was 60% UK-based had no desire to move to the US market as their share volume increased. Even with the filing of the HPV vaccine which was associated with the cervical cancer developments and the sale of Alli, an over the counter weight loss medicine which was due to go on sale. Share prices fell in the company by 7p to £14.64 a share. This is an example of how the currency change can have an adverse effect on the group profits because of the translation of the foreign subsidiaries profits. This can still occur even when the managers are performing well and increasing profits in the currency market they operate.

Sources: (Arnold, G. 2008, Financial Times, The Guardian)

Raising company finance – Facebook’s IPO

For many companies the need to raise additional cash to increase company wealth is an issue that they will come across. There are two types of Finance, which are Debt and Equity capital. Debt capital finance; are available in the form of bonds, bank loans, Trust deeds, covenants and syndicated loans. The debt is usually repaid with regular interest and spread over a period or given in a lump sum. Debt is less expensive than equity finance, due to the lower rate of return required by finance providers. The rate of return is lower because investors recognise that investing in a firm through debt finance is less risky than through shares.

Debt is very different from equity finance as the lender has no official control, they cannot vote, choose directors or interfere with company strategy. But they can set rules regarding liquidity and solvency ratio levels; if a debt is unpaid they may also take charge of an asset.

The other form of capital is through equity financing, this is in the form of ordinary shares, and if a company is not already listed it would need to go through the process of gaining a quotation on the Main market of the London Stock Exchange (LSE) or other international exchanges. There is also the option of listing on the Alternative Investment Market (AIM) where the process is less costly and the regulations are less strict. Another option of raising finance is to make additional share rights issue. Ordinary shares issued have the right to exercise control, discuss strategy and are entitled to dividends being paid out by the company in regular payments.

A company which has been in the news for raising company wealth through equity finance, Facebook the social networking site has launched the process for its stock market debut – through which anyone will be able to buy shares in the company on an open stock exchange. It has filed papers for a $5bn initial public interest that will turn key shareholders into Billionaires including Mark Zuckerberg, whom still owns a 28.4% stake. The Initial public offering (IPO) that is likely to drarf Googles entrance to the IPO market in 2004.

But is this any good for the consumers and what will this mean? In the future the need to increase shareholder wealth maximisation, talked about in my first blog. Could we see the effects of money influences taking control? Will this in theory be the end of the fun Facebook we know and love and just another branding and marketing campaign that Mark Zuckerberg did not want. Can a multimillion pound company still have the same goal as when it started eight years ago in his dorm room or is its only goal a cash agenda.

Sources: (Arnald, G. 2008. Financial Times, CNN, Bloomberg)

Stock Market Efficiency: Trinity Mirror share price over reaction, after the closure of News of the World

The stock market is an area that is highly unpredictable; the market can be affected by news and like all news the outcome is unknown until it arrives and lands on the stock market. Each share price fluctuation is independent from the one before. News can have a positive effect on share price but sometimes this can be an overreaction, and then followed by a deflation as the hype begins to diminish. There are three types of efficient market hypothesise (EMH), they are operational, allocational and pricing. I am going to look at the case of Trinity Mirror and how their share prices jumped when News of the World (NoW) closed at the beginning of July 2011.

Trinity Mirror who own national newspapers Daily Mirror, Sunday Mirror, The People magazine and the Sunday Mail had already experienced share prices plummet as reports of a ‘slow and volatile’ recovery as inflation costs, investments and surging newsprint prices would outweigh their savings planned for the year. (The Guardian) Share prices dropped by 20% to 66p a share and in the following months dropped a further 37% to 41p a share.  The publically listed company found advertising losses were a huge part to play in cost cutting as 19 categories of advertiser spending less years on year and government advertising budget over £1m had been chopped to £100k, since the economic decline in 2008.

But as the news came on the 8 July 2011 that the NoW had closed, share prices in Trinity Mirror increased rapidly to 56.75p a share, in early morning deals.  As the excitement of the advertising potential and NoW customers that would now buy their Newspapers. This put them in a much stronger position to increase share holder wealth maximization. But are the markets always priced rationally? As emotions are running high with the very public case of NoW, can the price of stock be inefficient.

In this case it was an overreaction as share prices fell to 37.5p in August 2011. Even though the closure of NoW did help boost sales in July, the trading environment and decline in the amount of customer who now buy Newspapers, in favour of online publications has led to a decline in profits. The EMH asserts that the financial markets are ‘informationally efficient’ and achieving above average returns on risk adjusted investments in not very likely. Trinity Mirror is an example of single market inefficiency and how quickly and rationally a share price can change.

The Hypothesise falls into ‘weak, semi strong and strong’ versions and Trinity Mirror falls into ‘Semi Strong’. All public information is made available; the share price instantly reflects the new changes in public information as it reacts quickly and rationally to change. But is investing just chance, how can you really know what is the best company to buy shares in or is it just pot luck.

(Sources: The Guardian, The Telegraph, London Stock Exchange)

Shareholder wealth maximisation V the stakeholders: How Marks & Spencer’s executive pay scheme failed to meet the vote at the annual general meeting.

Shareholder wealth is also defined as maximising purchasing power. It allows a company to pay its owners in dividends. The promise of regular cash flow payments in interim and final dividends is what lures investors to hand over their hard earned cash instead of spending it in the here and now. They hand over their savings to a team of managers (agents) and receive shares in return. Shareholders are generally interested in the return on investment over a long period of time and not necessarily in a short term return. Managers investing in the company’s future will produce a much higher dividend payment in the future. ‘Maximising shareholder wealth means maximising the flow of dividends to shareholders through time- there is a long term perspective’.(Arnald, G. 2007)

But the economic downturn, brought about partly by bad economic decisions, not only destroyed shareholder wealth value but also hurt the stakeholders. Shareholders are holding stocks for less time and demanding a more immediate return on investment. Boardroom meetings are dominated by talks of moving over seas to save money. Long term strategy conflicts with what is best for the shareholder.

Should some of the key principles of modern capitalism be questioned, such as the idea that businesses should only be run for immediate benefit of their shareholders and that there isno limits to executives pay and bonuses?

Mark and Spencer’s new chief executive Marc Bolland who replaced Sir Stuart Rose in May 2010 has been offered the ‘Richest pay deal on the high street, dwarfing rivals running bigger chains on the high street like Sainsbury’s and his previous employer Morrisons’. Reaching a pay package close to £15m in his first year including £7m compensation for losses he would have incurred, from leaving his previous employment in shares and bonuses. (The Guardian)

In March 2011, share prices dropped to £3.29 as the outlook for the high street was looking gloomy as cost of living chipped away at consumer spending. As government cutbacks, rising prices and interest rate rises took effect increasing the price of commodities. The food division in April was ahead by 3.4% shopper treat themselves to the £15 Mother’s Day deal attracting 500,000 shoppers. The shares finished up 20.4p at £3.60, a rise of 6%. See Figure I

Figure I.

Marks and Spencer’s has also opted out of passing on the full extent of its rising costs to cash –strapped shoppers. As promotion in rival supermarkets take their toll. The dent in profits can be seen below in Figure II as sales are down 8% on last year.

Figure II.

One thing Bolland noticed when he took over the company was how Marks and Spencer’s was not cashing in on it heritage as an innovator. Shoppers are looking for quality on the high street and have started purchasing the more expensive range as shoppers look for quality. This is a sign that he is looking at the long term strategy of the company and trying to build on the brand.

Marks and Spencer’s has also been looking at ways to reduce operating costs as they expect costs to rise 5% this year. Some of the ideas were to move some of its manufacturing operations out of China to lower cost locations such as India and Sri Lanka,Increasing share holder wealth.

At the prior years annual general meeting about 16% of shareholders failed to vote in favour of Mr Bollands remuneration report, after concerns over the amount offered to persuade him to join the company. A move which originally angered some of its shareholders, when he was originally offered the position.  75% was originally based on the companies profit performance. Now bonuses are based more on the individual’s performance against targets. Due to this Bollan was only given £1m of his original £2.4m bonus, as M&S missed targets.

In this instance Mr Bollan appears to have the best interest and the long term goal of the company as his main focus, unlike his predecessor Sir Rose who appeared to be more aggressive in his role, which main goal was predominantly to maximise share holder wealth. Bollan is looking beyond the short term goal, I think yes he knows it is about shareholders, but also thinks it’s about customers, colleagues and community.

References

Arnald, G. (2007) ‘Essentials of Corporate Financial Management’, Prentice Hall Financial Times, pp. 25

Articles

Gribben, K. (2010) ‘Will taking the long-term view hit shareholder value?’, Financial Times

Roberts, D. (2010) ‘Capitalismin crisis: Corporate governance: Revolution in the air – but it could help resue business from itself’, The Guardian Financial Pages; Pg 30

Finch, J. (2010) ‘Capitalism in crisis: Executive pay: Rogues gallery in defiance of mounting investor anger’, The Guardian Financial pages; Pg 31

BBC News, (2011) ‘M&S Boss Marc Bollan misses out on £1m bonus’, BBC News Business