DIVIDENDS & SHARE REPURCHASE

Transcription

1 DIVIDENDS & SHARE REPURCHASE 1 EY = Earning Yield ATCF = After Tax Cost of Financing CFO = Chief Financial Officer DRPs = Dividend Reinvestment Plans 1. INTRODUCTION Dividend payout to shareholders based upon numbers of shares owned. Board of directors declare dividend (sometime with consent of shareholders). Company s payout = cash dividends + value of shares repurchased Payout policy set of rules guiding payout. Payment of dividends is usually discretionary. Under some jurisdictions dividends are double taxed Dividend payout ratio = cash dividends (on common share) / NI. BVPS = Book Value per Share EPS = Earnings per Share MP = Market Price 2. DIVIDENDS: FORMS Cash Dividends Other Forms 2.1 Regular Cash Dividends 2.2 Extra or Special (Irregular) Dividends 2.3 Liquidating Dividends 2.4 Stock Dividends 2.5 Stock Splits Dividends Reinvestment Plans (DRPs) 2.1 Regular Cash Dividends Different markets pay dividends at different frequencies. US & Canada quarterly Europe & Japan semi-annually Asian markets annually Management can use dividend announcement to shareholder s confidence. An in regular dividend can share price Dividends Reinvestment Plans (DRPs) Open-Market DRP New-Issue DRP Blend of both types Company purchases shares in open market of the dividend amount & allocate to plan participants. Called Scrip dividend scheme in UK. Company creates (issue) new shares. DRP automatic reinvestment plan offered by some companies. Can be helpful for small shareholders as a means to increase no. of shares (long term). New-issue DRPs save floatation cost. Participating shareholders may not have to bear additional transaction cost. Potential disadvantage extra record keeping for tax purpose. If share price for re-invested dividend than the original purchase price then original dividend reinvesting will avg. cost basis. Cash dividends are fully taxed even when re-invested in the same year. Such plans are useful in tax-deferred accounts e.g. retirement accounts.

2 2 2.2 Extra Dividend Extra, special, irregular dividend paid by a company that does not pay dividends regularly. It can be an additional (one time) payment with regular dividend. Companies in cyclical industries may use this in strong cycles. Companies could have stated polices for extra dividends. Suspension Company stops paying any cash dividends. 2.3 Liquidating It is paid when a company: Goes out of business and net assets (adjusted for liabilities) are distributed to shareholders. Sells a portion of business & distributes its proceeds. Pays dividends in excess of accumulated retained earnings (impairing stated capital). 2.4 Stock Dividends Non-cash form of dividend also called bonus issue of shares. Company distributes additional shares usually 2-10% of outstanding shares. Total wealth (market value) remains same. Cost per share is reduced. In share price is offset by in no. of shares outstanding. Generally not taxable. Proportionate ownership & value of each shareholder s ownership position remain same. From company s perspective shares broaden shareholder base so advantageous and probability of more individuals owning stock. Stock dividend can keep stock in optimal range ($20 to $80 in US). It has no economic impact on the company. Cash dividend can affect capital structure: Reduce assets and equity. Liquidity ratios can. Financial leverage ratios can. Stock dividends have no such effects. 2.5 Stock Splits Similar to stock dividend in economic impact. Apart from usually 2 for 1 or 3 for 1, unusual split like 5 for 4 etc can occur. Companies can announce stock split any time. Typically it is considered a positive sign for future in stock price. Reverse stock splits share price, no. of shares outstanding but no impact on market value of shareholders equity. Reverse stock splits are done to price of stock to a marketable range. Reverse stock splits are done by companies coming out of financial distress.

3 3 3. DIVIDENDS: PAYMENT CHRONOLOGY 3.1 Declaration Date 3.2 Ex-Dividend Date 3.3 Holder-of-Record Date 3.4 Payment Date Corporation issue statement declaring specific dividend Dividend could be of any type. On declaration date companies also announce holder-of-record and payment date. First date when share trades without(ex)dividend. Time b/w ex-date & holder -of- record date is linked to trade settlement cycle of the exchange on which shares are listed. Investors owing share till/on ex-date receive dividend. Determined by securities exchange. Also called owner-of record date, date of book closure, shareholder of record date, record date, and date of record. Typically two days after exdividend date. Determined by corporation Owner of stock in company s records will be deemed to have ownership of shares for receiving upcoming dividend. Also known as payable date. Date when actually payment is transferred. It can occur on weekend and holiday 3.5 Interval between Key Dates in the Dividend Payment Chronology Usually time b/w ex-date & record date is fixed to 2 days. Other dates vary company to company. Most companies follow a fairly set routine. 4. SHARE REPURCHASES 4.1 Share Repurchase Methods 4.2 Financial Statement Effects of Repurchases 4.3 Valuation Equivalence of Cash Dividends & Share Repurchases: The Baseline A. Buy in the open market Changes in Earnings per Share B. Buy back a fixed number of shares at a fixed price Changes in Book Value per Share C. Dutch Auction D. Repurchase by direct negotiation 4. SHARE REPURCHASES Share repurchases (buyback) a transaction in which company buys back its own shares. Uses corporate cash. An alternative to cash dividends Repurchases shares are classified as treasury shares or stock. Not considered for voting, dividends or calculating EPS. In many markets it is becoming increasingly common. After amount of repurchase is authorized, companies may or may not follow. Unlike cash dividends, buybacks are not done proportionally to ownership percentage. Common method outside US & Canada is open market repurchase. Not all methods are permissible according to laws. Reasons why companies opt for buybacks Support share price (most frequently cited in the U.S. by chief financial officers) Flexibility in distributing cash to shareholders. To absorb in shares outstanding resulting from stock options. Tax efficiency in some cases where tax on cash dividends exceeds tax on capital gains.

4 4 A. Buy in the open market Most common method. Company buys back its shares in open market. Maximum flexibility for the company. No legal obligation to honor the program. For 1) liquidity 2) acquisition 3) capital expenditures, company may not follow through with an announcement program. In US open market transactions shareholders approval not required. It Europe open market transactions approval is required. A cost effective method if competently timed to minimize price impact and to exploit perceived undervaluation. B. Buy back a fixed number of shares at a fixed price A fixed price tender offer to repurchase a specific number of shares at fixed price. Typically it s a premium price. C. Dutch Auction A tender offer to existing shareholders but company stipulates a range of acceptable prices. A minimum price is uncovered. Company pays the price to all qualified bids. Can be accomplished in a short term period. D. Repurchase by direct negotiation In some markets company negotiate to buy back shares. A major shareholder is involved. Price is often premium to market. May be done to keep block of shares after overhanging the market. Greenmail premium purchase of accumulated shares from a hostile investor to prevent takeover. Large investors may negotiate at discount to generate liquidity when in a weak position. 4.2 Financial Statement Effects of Repurchases Both balance sheet & income statements are affected. Assets and equity refinanced by cash leverage. Leverage magnified when repurchase is financed with debt Changes in Earnings per Share No. of shares outstanding can EPS (assuming NI remains constant). Generally share repurchases may, or no effect on EPS. Effects depend upon repurchase financed internally or externally and their cost. For internal financing, EPS if funds are free (idle). For external financing, EPS earning yield > after tax cost of financing for repurchase. EPS is unchanged earning yield = after tax cost of financing. EPS earning yield < after tax cost of financing for repurchase.

5 Changes in Book Value per Share If MP > BVPS BVPS after repurchase. If MP < BVPS BVPS after repurchase. 4.3 Valuation Equivalence of Cash Dividends & Share Repurchases: The Baseline If tax treatment is similar, both share repurchase and cash dividends are equivalent. If shares repurchased at premium from one shareholder the remaining shareholders wealth is reduced.