Dividends

As with previous posts, the chosen subject for this post will revolve around shareholder wealth.  The main purpose of a dividend is to; rewards shareholders as a type of compensation for the capital they have invested into a corporation.  However, these dividends are not only used as a reward, but also as tool used to analyse the performance of the company by current and potential investors.  Ahonory and Swary (1980) discuss the ways in which managers use dividends and earnings in order to release information regarding the performance of their company.  An obvious statement would be that the higher the dividend payment, the better the company are performing.  This could well be the case; however, there is a wide range of differentiating factors that could also affect the amount of capital used to pay dividends. 

Mothercare have recently announced that they will be halting dividends in order to “fund revival” (Financial Times, 2012).  Mothercare have made this decision in order to fund the restructuring of their company and finances, with hopes to make it a more profitable corporation.  Mothercare’s sales in the UK have fallen in comparison to last year’s figures, and this initially negatively affect share price.  This presents an efficient market, with a drop in profitability, a drop in company value.  Nevertheless, the announcement that dividends will be halted for the following 3 years sparked a 3.5 per cent increase in Mothercare’s share price.  How is this so? The company aim to retain all profits in order to reinvest to make the company more efficient and profitable within the UK. Mothercare’s shareholders have seen the potential in the new strategy and furthermore believe that by maintaining an investment in Mothercare, their investments will yield rewards; be that a higher share price or substantial dividends, or both. 

The initial announcement from Mothercare ignited a sharp decline in share price, displaying the Clientele Effect.  With some investors only investing into certain companies that meet their specific financial needs.  The shareholders that sold shares when finding out the news that dividends were being withdrawn for the following years, realised that this change in strategy did not assist them meeting their specific criteria, and sold their stocks and most probably re-invested. 

Mothercare are clearly interested in increasing shareholder wealth, as they are restructuring the company in order to become more efficient and profitable.  However this has taken a more long term view and sacrifices have to be made in the short term. 

In conclusions, dividends are important to some investors and meaning less to others.  Certain investors want an investment that provides an additional income, whereas the opposite type of investor is more occupied with the growth of the share price. 

Corporate Social Responsibility

The term Corporate Social Responsibility (CSR) has an abundance of definitions, which are often biases toward specific interests (Dahlsrud, 2006).  However, Altschuller et al. (2008) believe

The field of corporate social responsibility (CSR) comprises a wide array of diverse issue areas, standards, initiatives, and both hard and soft law mechanisms, all of which seek to define the nature of corporate responsibility and accountability for human rights, labour rights and environmental issues.

Go back two decades, and CSR was just a theory passed between academics.  Now it is such a big thing for huge multinational companies, there are whole departments devoted to the way in which the organisation conducts itself in society, be that a specific country or the world media.  CSR ensures that stakeholders of an organisation are treated ethically or responsibly.  Hopkins (2007) describes the ‘ethically or responsible’ term as; “treating stakeholders in a manner deemed acceptable in civilized societies.”

Back in the 1990’s, Nike Inc was accused of using suppliers that mistreated workers.  And 2012 has seen Apple Inc, the world’s most valuable listed company, accused of poor working conditions among its low cost suppliers (Forbes, 2012).  However, I’m sure, that in the countries that both of these ‘suppliers’ are/were based, this type of abuse happens frequently, and almost acceptable in their society.  However, once the international media from the developed countries gained access to this type of information, there was global uproar, especially for the Nike Inc case. 

Well, what does this show? Principally, it shows that large multinational corporations are continuously in the media spot light regarding their CSR activity.  Consequently, needing a whole department dedicated to ensure they are conducting business activity ethically.

Socially Responsible Investing (SRI) is an investment process that integrates social, environmental and ethical considerations into investment decision making (Renneborg et al., 2008). Back in 1999, a merger took place between the two huge motor giants, Nissan and Renault, which highlighted a key example of SRI.  Renault was brought in (or should I say Carlos Ghosn), in order to turn Nissan into a profitable organisation and reduce its mountain of debt, $11 Billion.  The reason for this debt is not important, what is important, is the fact Nissan actually had plenty of money, but it was locked up in non-financial investments.  The two main reasons of non-financial investments were down to trying to gain, loyalty and cooperation from their supplier base.  These two reasons are built in throughout the Japanese culture, highly influenced by ‘Confucianism’ (high family values) and are known as Kieretsu partnerships. 

This clearly represents SRI within a large well-known global industry.  This specific example highlights what can happen when poor SRI is evident.  However negative this example may portray SRI as, it is crucial to understand that often SRI can be done strategically for the better good of organisations.

Altschuller, S., Feldman, D., Blecher, L. (2008) ‘Corporate Social Responsibility’, The International Lawyer, 42(2), p. 489 -547.

The Path to the.....

'The Credit Crunch'... a term that brings a lot of apprehension both on a personal and business level.  The cut backs, the job losses, the stock market drop all negative memories yet to dissolve.  2007 -2008 was when the global economy was struck by the tidal wave, that was the recession.  But what was the reason behind it? Surely, with all the academics, and historical events, someone would have seen this coming? Obviously not.

According to Paul Mizen (2008), one of the key reasons for the economic disaster was ultimately down to the US of A.  In the beginning few years of the millennium the American housing market saw a Boom, and became the driving force of the economy.

 A combination of low interest rates and large inflows of foreign funds helped to crete easy credit conditions (BBC News, 2008).

This is where it became quite easy for people to take out mortgages, and as more and more of the population acquired mortgages, the demand for property increase, fuelling the increase in house prices. Mortgages lenders were asked to find more potential home buyers in turn for bonuses and other incentives. Why was this? The fundamental word is...Greed. Since it was a good time and property prices were soaring, the only aim of most mortgage firms was to give loans to as many potential customers as possible. This resulted in many consumers with low incomes and bad credit history able to acquire mortgages for houses that, realistically, they couldn't afford. And then...POP.....the bubble burst.


The initial driving force of the ever strengthening house market was put into reverse gear. A surplus of houses could only mean one thing, not enough demand, so prices began to fall.  

10.4% of total homeowners had zero or negative equity as of March 2008. (economy.com)

This then lead to banks selling the homes of the owners that could not afford the repayments, this further effected the house prices, for the worse. With house prices reducing, as well as the demand, this resulted in the banks loosing profitability etc. So how does an american housing market problem turn into a global economy?


This whole process is only relevant when the term 'Subprime loans' comes into play.


Many big fund investors saw subprime loans as an attractive investment opportunity and invested heavily into.  This resulted in the growth in this fresh new market and the development of CDOs. The selling and then re-selling of these CDOs didn't immediately take effect and the sheer confusion was not clear.  However, all this confusion eventually took effect, and resulted in banks recording record losses.  All down to the mortgages being considerably higher than the price of the house, and in turn the banks having to write this off as losses.  And?
Well, all the huge financial corporations had invested heavily into failing product, and to make matters worse, the confusion about the complexity of CDO ment that know one truly knew how much they were set to loose.


The link below shows just how devastating the process was to huge banking corporations.


http://news.bbc.co.uk/1/hi/sci/tech/7557526.stm


This began the domino affect which effected the majority of markets throughout the world, resulting in......The Global Recession. 

Mergers and Acquisitions…

After evaluating FDI last week, I have been introduced to another way in which businesses’ can expand their operations: Mergers and Acquisitions (M&A).  But how does this effect shareholder wealth?

From reading an interesting article on ‘The Economist’, my understanding of why mergers occur has grown.  The article discusses the reason for the decline in some of the biggest electronic companies such as Sony, Panasonic, Fujitsu, etc.  Since 2000 these firms have lost two-thirds of their value, for reasons that they could have controlled, through mergers. One of the main reasons for these vast losses is down to the type of market they are in. With many of these companies making more or less the same product, The Economist highlights, 

The overlap is inefficient: it duplicates research and development, reduces economies of scale and destroys pricing power.  This practice clearly wastes huge amounts of capital, which leads to less competitive power.  This has been seen by the likes of Samsung and Apple who are currently more innovative.  However, why haven’t any of these companies merged with any others? Surely, it could cut their losses and therefore restore shareholder wealth.

With the Car market being highly competitive Peugeot and Citroën have seen that in order to better their competition, they decided to merge and become PSA Peugeot-Citroën. Not only has this merger been successful, Fiat have now commented about getting involved, due to competition from the powerful car giant Volkswagen who have 23.3% of Europe’s market share.  If Fiat were to join the merger, then all companies involved would massively benefit with the increase in power, thus becoming more competitive towards the strong competition of Volkswagen.

In regards to acquisitions, primarily it depends on which company we are focusing on, be that the company acquiring or the company being acquired.  From the lectures this week, I have learnt that companies pay a premium for well performing companies, which was demonstrated with the example of the Exxon-mobile deal. By understanding this in regard to shareholder wealth, the shareholders of the company being purchased for this high price often benefit from an increase in share price.

However, what about a poorly performing company? If an acquisition takes place where the company is poorly performing, the price agreeable may be considerably lower than the current value of the business, obviously negatively affecting the current shareholders investment. But, in some cases, could it be argued that if the acquisition of an inadequately performing business is saving shareholder wealth, from possible bankruptcy?

The main reason that drives most M&A’s is the idea of synergy. Why have the core capabilities of one organization when you can have two.  Investopedia.com highlights that  -

One plus one makes three: this equation is the special alchemy of a merger or an acquisition.  This concept believes that by the combination of two companies, the value of this is greater than them separate, in regards to their shareholders.

Foreign Direct Investment

FDI is a measure of foreign ownership of domestic assets such as factories, land and organisations. Foreign direct investments have become the major economic driver of globalisation, accounting for over had of all cross-border investments (BBC, 2011). FDI has become a major source of finance inflows for both developed and developing economies. The purpose of this blog is to understand the different types of FDI and show evidence in relation to current affairs.

From reading a journal written by Qui. L. and Wang. S. (2011), there are two different types of FDI; Greenfield and Brownfield investment. “Greenfield FDI refers to investments that create new production facilities in the host countries (e.g. starting a new plant), whereas brownfield FDI refers to cross-border mergers and acquisitions.”

Reported in the news this week is a relevant and interesting story, Fiat plans to invest $1.1bn in Russia (BBC News, 2012). The plan for this investment is a building of a plant in order to produce 120,000 cars a year for the Russian and nearby economies. The acronym BRIC, refers to Brazil, Russia, India and China, which are in a similar stage of economic development. The point being, many multinational companies are keen to invest in these countries, due to the advancing economies. The Russian government website, ‘Invest in Russia’, boast a GDP of 8.1% (2007), which far outperforms international growth rates. Another claim, is that they have one of the largest consumer markets, with around 140 million people, ‘whose income is increasing every year.’ Furthermore, Russia links Europe with Asia and also borders the North American continent. The government website continues to brag interesting facts about why Russia is so investable, however, fails to mention it is a cheaper investment alternative than the more developed countries, such as UK, the US and Japan (For more information – visit http://invest.gov.ru/en/why/reasons/).

This is prime example of ‘Greenfield investment’, however the question that need to be answered is, will it benefit the Russian economy?

With the current unemployment figure at 6.6% (January 2012), the new manufacturing plant should create more jobs for the economy. However, this could result in job transfer (relocation of employment), instead of actually generating new jobs. The obvious outcome is that the Russian economy as a whole will benefit from this prime example of FDI ‘Greenfield investment’.

Before Fiat planned to invest $1.1bn in to the Russian economy, Fiat were interested in a ‘Brownfield’ type investment with a Russian company Sollers. The original plan was to create a joint venture, which they hoped to produce 500,000 cars per year, as a result of. However, the Russian company opted to replace Fiat with Ford. Evidently, Fiat would have benefited greater by attaining the joint venture with Sollers, due to the sheer difference in manufacturing numbers. However, the main focus is that Russia has gained vastly with the joint venture between Sollers and Ford as well as Fiat investing a substantial amount into the economy.

Some would ask, why have Fiat still entered into Russia after losing such a crucial contract to its competitors. Well, according to an article published by Reuters (2012), Russia’s car industry looked set to overtake Germany as the biggest in Europe before the global economic crisis took effect. Apparently, four foreign carmakers and their partners have now agreed to invest $5 billion on local manufacturing.

So if the Russian car manufacturing industry is so popular with investment, who else will soon be investing in Russia? Would you invest in Russia?

Qui. L. and Wang. S. (2011). FDI Policy, Greenfield Investment and Cross-border Mergers. Review of International Economics. Volume 19, Issue 5, pages 836–851, November 2011

Tax...Evasion vs. Avoidance?

The word tax makes most people shudder.  Everyone knows and understands why we pay a percentage of our hard earned money to the Government, but nevertheless the majority of us don’t like it.  Well surely, this is applicable to the business world.  The profits produced by an organisation’s time, effort, capital and resources, is often issued with a 25% corporation tax bill (HMRC, 2012) from the UK government.  Is that fair? Well obviously some corporations don’t agree, hence the existence of Tax Evasion and Tax Avoidance.

Tax revenues are the lifeblood of democratic government and the social contract, but the majority of multinational businesses have been structured so as to enable tax avoidance in every jurisdiction in which they operate.

(Christensen and Murphy, 2004).

Tax avoidance is a legal way of structuring a business in order to avoid paying the highest tax percentage, without breaking the law.  A prime example of a popular way of avoiding tax, is the use of an off-shore ‘tax haven’.  Certain multinational corporations make use of a ‘holding company’, whose headquarters are located in a tax haven. By the use various methods, organisations can conduct business around the globe, yet save paying high tax premiums by filtering money into the holding company.  This sounds very ‘Dell Boy’, but as long as it is done correctly, there is no law being broken.  There are many different types of Tax Havens, a country offering 0% income tax (such as the British Virgin Islands) will benefit certain companies, however a complete tax exemption for all international business operated by non-residents (such as Seychelles) will attract other companies.  For more information on offshore jurisdictions visit:

http://www.offshorebvi.com/offshore.company.providers/choosing.offshore.jurisdiction/

By avoiding tax (legally, of course), surely a company will benefit from increased profits, which in turn will be passed on to shareholders of the company, who are anyone who has invested in the company, such as me or you. So what is the problem, the only one losing is out is the Government, because they can’t get their grubby little hands on the money. Isn't it?

No, not at all, the graph below shows 66.26% is free floating shares that are available to general public.  Yet the 21.66% shows long term strategic holdings by investment banks or institutions seeking a long term return.  These institutions will have large stakes in numerous large corporations, thus benefiting hugely by the increase in dividend payments.  Is this wealth creation or corporate abuse?



 Source: How Corporate Ownership Affects Trading Costs in the Case of UK Firms (2009)

Referring back to the Government point made earlier. Surely, if the Government lose out on potential revenue (from taxes), then the secondary looser is in fact, the UK population. With less corporation tax revenue, the Government will either have to find additional revenue or make cut backs to spending.

Tax evasion is a much more serious act.  The illegal practice where a corporation intentionally avoids paying its true tax liability (Investopedia, 2012). Whoever found guilty on charges of tax evasion are subject to criminal charges, substantial penalties and more often than not, imprisonment.

India have recently been in the business media spotlight, due to 'seismic corruption and rampant tax evasion. With 645 million inhabitants living below the poverty line, India is not the first country when you think of corporation tax.  However, a major problem with India, is the rich are getting richer and the poor getting poorer, which is primarily down to tax evasion.

India is subject to $500 billion illegally deposited in tax havens. This often occurs when money is taken to Dubai/Singapore etc, transferred to Swiss bank accounts and the routed the British Virgin Islands or other tax havens.  India's top corruption official blames not only his rich countrymen but also the 'bureaucratic hurdles' created by overseas financial centres.



An interesting report conducted regarding why American business owners are moving to tax havens.

http://www.cbsnews.com/8301-504803_162-20047260-10391709.html

And finanlly, Geoffrey Colin Powell (a former economic adviser to Jersey), defines a tax haven as:

The existence of a composite tax structure established deliberately to take advantage of, and exploit, a worldwide demand for opportunities to engage in tax avoidance.



Well surely, anyone deliberately aiming to avoid tax, is actually evading tax?

Raising Capital...

When a company (listed on a stock market) has potential investment opportunities yet does not have enough internal capital, it has two main options; Equity finance or Debt finance.  This raises one of the most challenging decisions facing financial managers.  With both options presenting pros and cons, which one should a manager choose and why? 

Equity finance, this raises capital by obtaining capital from investors in exchange for an ownership share of the business.  This capital can come from a wide variety of investors, such as competitors, banks, capital investors, wealthy individuals etc.  The beauty of raising capital in this way is that businesses are not obligated to repay the money back.  However, there is the small issue of handing over a percentage of the business for this capital, thus giving investors ‘a say’ in business decisions.  The use of apostrophes around the words, a say, is because it depends on a certain factors.  Including what type of shares owned by the investor, the percentage of shares owned by the company etc.  51 per cent ownership gives control of the business, so as long as the company itself owns 51 per cent of the majority then they can continue to make the key business decisions.  An additional drawback includes the topic of tax.  In the UK, capital gains tax can apply to investors.  Firstly, the company is taxed on its profits, after this the business is left with its net profit, which it can decide whether to use to issue dividends.  However, once dividends are paid to the investors, this is then taxed again under income tax, and finally, if an investor wishes to sell his/her shares they will be subject to capital gains tax.  Is all this taxing of the same money necessary? That’s a topic for another day…

Back in December 2011, Zynga, a US game company, announced plans for a stock market floatation.  According to the BBC, the firm plans to sell 100 million shares (14.3% of the company), valuing the company as much as $9.04bn.  Zynga have opted to raise capital in order to pursue future investment opportunities.  The minimal 14.3% is no way near enough to risk a takeover, thus still leaving Zynga with the controlling power. 

Having only been listed on the NASDAQ stock exchange for 3 months, Zynga have seen their share price climb to $14.55, a $4.55 premium over the IPO in December.  However, on the day the social games developer reported record revenues in its first earning report as a public traded company, its shares fell 17.8 per cent. Why is this? Record profits yet a fall in share price?  The main reason being is the stock market had expected more.  The stock market had obviously overreacted in relation to the share price, and when the announcement came about regarding record profits, this was not what the stock market were expecting, thus the fall in share price.  Zynga, have performed well and this fall in share price is not their fault.  The stock market has therefore begun to deflate the share price, moving it closer to the ‘fair value’ price.  In regards to ‘Efficient Market Hypothesis’, does this show semi strong form efficiency?  Well yes, course the mistake initially does not help the argument, however upon the news regarding profits; the market reacted quickly and rationally.

Malcolm Walker, CEO of Iceland, has 42 days (from 2^nd Feb 2012) until he and his management team lose their pre-emption rights to purchase additional shares.  Malcolm Walker and his management team currently own 23 per cent of Iceland, yet could lose controlling power of their corporation if they do not match the final offer from one of two private equity firms (Bain Capital and BC Partners).  This is all down to Landsbanki (Iceland’s largest bank) coming into financial difficulty, thus selling its 67 per cent stake in Iceland.  How will Malcom Walker and team raise capital? The equity finance option is unavailable, due to by releasing more shares, he will dilute his percentage held.  Therefore, he is turning to his friends and family, and asking them to purchase shares and in turn hand over voting rights/control back to the CEO and managers.

The raising of capital will always be a difficult decision for owners and managers.  No one likes the thought of debt and the main way of avoiding debt, is by selling percentages of your company, thus losing some control.  



The complex world of the Stock Market

The value of shares… What do they reflect?

The biggest news in the investing world currently is Facebook.  Mark Zuckerberg  (CEO) founded the idea eight years ago and this empire is soon to be floated.  Mr Zuckerberg was proposing a valuation of Facebook at $100 billion.  However, Facebook’s privately traded shares have apparently risen 10 percent since the social networking company filed for an IPO.  According to SharesPost Inc, this percentage increase has pushed the potential market value past the $100bn mark.  So where has this 10 percent increase come from?

Facebook have not produced any ‘good’ news or bad news; yet have experienced a positive share price movement.  Normally this would be accountable to an information leak, however my personal opinion is that Facebook shares are increasing in the hope that they will be a sought-after commodity once the company is floated. 

Does this show stock market inefficiency? Well no not really.  The shares have yet to be floated on the stock market, so surely it cannot be compared to that theory.  What does this increase in share price show? Lets take a similar situation.  Back in 2004, Google Inc. went public and issued shares.  Since then the share price has increase eight-fold.  With this as Facebook’s nearest comparable, investors must be hoping for a similar highly profitable story with the ever-growing social network company. 

Will this increase hold out? This depends on the amount of shares issued by Facebook themselves.  The final amount of shares to be issued is still yet to be confirmed, but information has estimated it to be around the 2.33 billion.  However, if the number reduces, this could cause the share price to increase due to a diluted amount of shares available.  On the other hand, a saturation of shares could reduce the share price. 

What would Warren Buffett do? The self made billionaire has made is fortune by investing when no one else dares.  I think Facebook is not even in his peripherals due to the sheer media coverage and minimal potential returns.  Undervalued shares are what Mr Buffett is on the prowl for in the investing world.

Undervalued shares… how does this come to be?  Well, an example is that of the merge between Xstrata and Glencore.  The newly merged firm would be worth $90bn, with Xstrata accounting for $39bn (BBC Business New, 2012).   However, two of Xstrata’s major shareholders are voicing that they believe this undervalues their shares.  The valuation of Xstrata therefore does not adequately reflect the share price warranted by these two major shareholders.

ARM's Strength

When comparing the use of shareholder wealth maximisation vs. profit maximisation, the benefits are clear.  Shareholder wealth maximisation increases the ability for manager to focus on the long term future of the business, against the myopic [short term] view that profit maximisation can often encourage.  Nevertheless, profit maximisation can in turn fuel the success of shareholder wealth maximisation, as well as other elements, such as increasing sales, increasing market share, etc.  However, shareholder wealth maximisation is an interesting use of words.  The term wealth can be interpreted differently, especially in regards to shareholders.  Do they believe that the company they have invested their hard earned money into, should pay them proportions of the company’s profits? Or, alternatively, invest the profits wisely in order to generate greater value for their shares? 

In 2008 ARM Holdings, currently the world's leading semiconductor intellectual property supplier, celebrated the 10 billionth processor chip shipped.  Since then, ARM’s shares have outperformed their industry.  With some people calling it the ‘iPad effect’, ARM can partially thank Apple's iPhone and iPad for their recent success, with ARM recently declaring that annual profits jumped to £157m from £110m.  However, one of ARM’s biggest threats is that of Intel (the world’s largest semiconductor chip maker, based on revenue) declaring potential entry into the mobile phone industry with a partnership with Google.

“ARM's strategy is for our technology to gain market share in long-term structural growth markets, such as mobile phones, consumer electronics and embedded digital devices.”

With no mention of shareholders, one would wonder why invest.  However, surely an increase in market share will increase share price and in turn shareholders' are happy, yes? No!!! ARM holdings are adopting a 'growth stratergy', which aims to increase sales/revenue, capture market share and beat the competition.  By focusing too much into gaining market share, ARM holdings could be neglecting such elements as profit margins. This combined with the type of industry ARM are in, which requires vast amounts of capital expenditure due to high R&D costs and costly high tech machinery, could leave ARM with reduced capital, increased debts and additionally falling share price. 

Nevertheless, a picture speaks a thousand words.  Since 2008, ARM Holdings plc has clearly outclassed its industry.



(London Stock Exchange, 2012)



However, with the recent success of ARM, share prices have increased a further 7pc with the news that;

Steve Ballmer, Microsoft’s chief executive, announces plans to base the next generation of Microsoft’s Windows operating system on microchips designed by ARM.

Does this all sound too good to be true?  I think so.  I believe the share price of ARM maybe accountable to 'valuation premium'.  An article published by Morningstar states that the research that Brain Colello has carried out, shows the market is overvaluing ARM Holdings.  Mr Colello believes that the firms profitability could come crashing down if ARM does not live up to their lofty expectations.

As I have stated previously, Intel are the main threat to ARM.  Intel are taking a slightly different approach with regarding the development of chips for mobile handsets.  While ARM's directors and financial managers are investing in the R&D and technology for more processing power, Intel are striving for a more energy efficient chip.  With such powerful and dominant forces going head to head in one of the most lucrative markets, this will be an interesting few years for ARM.