Wednesday, July 09, 2008

Pacific Andes – A Discussion of the Scrip Dividend Scheme

The circular for the proposed scrip dividend scheme implemented by Pacific Andes (PAH) had just arrived yesterday, and I spent some time reading it and digesting the facts; and some more time after that lying in bed thinking about the ramifications, possible effects and choice to be made. Suffice to say that this scheme is new to me as well as I had never invested in a company which came up with a scrip dividend scheme before, and I am now analyzing this scheme using my own understanding of how it works (as described in the circular) as well as my own personal interpretation of the merits and demerits of this scheme.

First of all, some of the salient points in this scheme should be mentioned:-

a) The scrip dividend scheme is optional. This means that shareholders can opt for the cash dividend or for the scrips, depending on their preference. They can also issue a standing order for all future dividends to be paid out as scrips, which can be terminated at any time in writing should the shareholder wish to revert back to receiving the dividend in cash.

b) You CANNOT elect to opt for only part of your holdings to be paid in cash, with the rest in scrip. This means that you either choose for ALL of your shareholders (as at books closure date) to be paid fully in cash or all in scrip (additional shares of the company). Unless one receives more than one Notice of Election (NE), this is not possible and anyway it would be an administrative nightmare should the company allow for this.

c) The computation for the number of scrips issued is based on the formula X = (A x B) / C, where X is the number of scrips issued, A is the shareholding as at books closure date, B is the dividend per share declared (net of corporate income tax) and C is the issued price of each scrip share. The interesting part is how C is computed, as A and B are known variables and are objective facts. The price per scrip is taken as the arithmetic average of the closing market price of PAH for the last twenty (20) market trading days prior to books closure date, with a maximum allowed discount of 10% to this price.

a. Note the word arithmetic is used and not weighted average, thus this means the simple average of all the closing prices taken from 20 days BEFORE the books closure date (i.e. not inclusive of the actual day of books closure);

b. 20 days is used as a benchmark seemingly to even out any fluctuations in the share price which may result from speculation or panic selling, and I think it is intended to assuage investors that they are getting a fair price based on market conditions;

c. A maximum discount of 10% is allowed to this average price, but is up to the sole discretion of the directors, which means this is the only wild card in the equation which cannot be determined by shareholders until AFTER books closure date. Thus, the discount can be anything from 2% to 10%, but of course everyone who chooses the scrip option hopes for 10% so that they can get the maximum number of shares for a lower price.

The analysis of these facts yields the following conclusions:-

i) By choosing the cash dividend instead of the scrip, one must believe that one is able to grow the amount of money which is received at a higher rate of return than that which PAH can provide. This is because choosing the scrip is actually a form of reinvestment of dividends, and is similar to what Berkshire Hathaway does when it chooses NOT to pay dividends but instead reinvests them for higher compounded annual growth. If one believes that one’s ability to grow his/her own money is better than that of the company, then one should choose to take the cash and reject the scrip.

ii) Choosing the scrip dividend has advantages to the company itself as well, as they would be able to conserve cash for reinvestment into the business and also grow their equity base at the same time. The amount of dilution to earnings will be very minimal and immaterial, and I think PAH’s intention to declare this scrip dividend was precisely for this reason – they are hoping more shareholders choose scrip over cash so that the company can conserve cash for expansion.

iii) Shareholders should also note that should they choose NOT to accept the scrip dividend, they will suffer mild dilution as the equity base of the company will grow but their shareholdings will remain the same. Thus, the pie will grow larger but your share of the pie (in percentage terms) will be reduced. However, the effect is not very pronounced and can also be considered immaterial.

iv) The choice will also depend on whether the scrip is being offered at a price which is attractive relative to one’s own cost of investment. I will use a hypothetical example to illustrate my point. Assuming Mr. T has 10,000 shares originally purchased at 60 cents per share. The arithmetic average of the closing price of the last 20 market trading days is about 48 cents per share (as at today). Hence, assuming a discount of 5% (to be prudent), this works out to be 45.6 cents per share. Mr. T would then receive a total of 453 scrip shares based on the final dividend of 2.07 cents per share for FY 2008. Thus, his total cost would now be S$6,206.57 on a base of 10,453 shares, which means his new average cost per share will be reduced from 60 cents to 59.38 cents. This simple example shows that this is one good method for averaging one’s cost assuming the final scrip dividend price is lower than one’s original buy price. One more additional plus point is that such scrip dividends do not incur brokerage costs or commissions and are free of transaction costs.

v) One negative aspect of this exercise is that one would almost surely end up with odd lots (i.e. shares which are not rounded to the nearest thousand which are traded as board lots on the SGX). This means that disposing of the additional scrip shares may prove a problem as one has to sell it in the odd lot market, which is generally more illiquid and has wider bid-ask spreads. However, if one adopts the perspective of a value investor and is willing to hold on to their additional scrip as the company’s value increases, then he will eventually reap the fruits of his patience.

Based on the analysis above, as well as my personal perspectives of the company and its growth potential, I will prefer to opt for scrip dividend. It allows me to increase my stake further to participate in the growth of the company, allows the company to conserve cash, allows me to average down my current cost and also prevents me from being diluted when others exercise their choice for scrip dividend.

24 comments:

Kelvin said...

I hate companies that do this. It is unfriendly to minority shareholders due to the odd lot issue. This reflect alot on the controlling shareholders treatment on minorities.

I dont have the statistics, but I believe that companies listed in Spore that adopt scrip dividend normally doesnt generate great value for shareholders.

Simon said...

scrip dividend is bad. shows the company needs the money while putting us shareholders at ransom if we take the money from them. i think u should vote against the scrip dividend scheme.

Anonymous said...

coy provides the choice for scrip or cash, can't say coy is not fair. if you also look from tax angle, one can elect the choice for more tax saving based on ones tax bracket.

durio said...

how does one sell scrips later, i mean these are merely paper money issued by company right?

so if one sells part of his shares at some point of time, will the values of scrip be changed due to decreased in share holding?

thks!

musicwhiz said...

Hi Kelvin,

As I did explain in my post, one of the "bad" aspects of scrip are the odd lots. However, if you intend to increase your stake in a company which you feel is growing, then why be in a hurry to sell the odd lots ? This can be seen in either a good or bad light, depending on your investment philosophy.

If you have the statistics, then perhaps we can compare if scrips really did generate more value for shareholders. Remember to update me if you get the info ! :)

Regards,
Musicwhiz

musicwhiz said...

Hi Simon,

Why do you see it that way ? The company gives a CHOICE on which you should choose, so there is no coercion. Plus, if the company needs the cash to reinvest, then so be it. Sometimes reinvestment is much better than paying out cash, as is the case of Berkshire Hathaway. While of course we cannot compare the two companies, what I am saying is that the rationale may be similar - use the cash to grow the business and generate future shareholder added value.

It's not very fair to make a blanket statement like "scrip dividend is bad" without carefully considering the factors behind such a decision.

Cheers,
Musicwhiz

musicwhiz said...

Hi Anonymous,

Yes, the company does offer the choice, so shareholders should decide based on their own circumstances and investment style. To each his own. :)

Regards,
Musicwhiz

musicwhiz said...

Hi Durio,

Sorry I don't really get what you mean. Scrips are actually shares of the company and their value is determined by the market price transacted. You can sell your scrip just like ordinary shares, but in the case of odd lots, you must sell through the odd lot market.

Regards,
Musicwhiz

Simon said...

well..as u said, pac andes is no berkshire. i can't help but notice their high gearing ratio and the timing of this scrip dividend. why can't they just have this scrip dividend a long time ago? why now? r there problems getting loans? is scrip dividend a nicer way of saying they can't afford the high dividend payout anymore? so instead of being directly forthcoming, they announce a scrip dividend, given the kind of negative message to the market if they cut dividends? i think these are reasons u have to take into consideration. things r not as straightforward as they appear to be...

musicwhiz said...

Hi Simon,

Thanks for highlighting the issues. PAH has always had high gearing and the current high debt is partly due to the acquisition of additional stake in CFG (which I am sure you are aware of, from 2007). This was already done some time last year and yes I think they do need to conserve some cash and this is one of the methods of doing so. Instead of saying "no dividends", they allow shareholders the choice to have the dividend in cash or scrip. That's better than just cutting the dividend outright, if you look at it that way.

I don't think it's a matter of being honest or forthcoming - scrip dividends ARE indeed a way for companies to conserve some cash, and it's no big secret. If shareholders or the market get a negative reaction, then so be it. This, as I mentioned, is a short-term focused reaction and I am more focused on the long-term growth prospects of PAH (which is now fuelled more by CFG as they own a 64.1% stake).

Things may indeed not be so straightfoward and Management could be less than candid, but if we were to suspect that every move was part of some conspiracy to hide something from minority shareholders, then investors in general will have a lot of sleepless nights ! :P Personally, I would rather focus on their long-term business plans and prospects and not just judge the company's Management based on one scrip dividend scheme alone.

Regards,
Musicwhiz

Tony said...

Hi Musicwhiz,

I totally agreed with your views on PAH. I have been investing in them since they first started and I like the way that the business is run. Given that I'm looking at long term and the fact that China and the large part of Asia is gaining affluency and consuming ocean catch, I'm confident of the growth of this company. Note: You can have all the rocket science calcuation on PE,RNAV or P/L and so fore. But as a matter of fact you still need to consume food and food supplies worldwide is depleting. Simple demand and supply.

musicwhiz said...

Hi Tony,

Yes, I agree that fish will always have staple demand and this is set to grow even further in the years to come. Though PAH and CFG are well-managed, I am a little concerned about the gearing of both companies though I did mention that there is no specific cure-all for gearing levels.

Given that we have a long-term perspective, I am confident that our investments will turn out well in the future.

Regards,
Musicwhiz

Anonymous said...

Musicwhiz,

You need to ask Management will PAIH prefer scrip dividend scheme.
If PAIH prefer scrip dividend scheme, it shows big shareholder has confidence on future of PAH.

So, ask management as they must know more.

Marc said...

Musicwhiz,

An excellent site you have here with lots of thought provoking discussion. Nice job!

PAIH inaugurated the scrip dividend scheme in their 2007 results. From the circular providing details of the scrip dividend scheme, if all shareholders at the record date opted for scrip, no more than 34,058,182 shares would be issued.

From the PAIH 2008 1H results announcement, a total of 25,553,581 shares were issued at HKD 2.17 per share. So just over 75% of the entitled share base received the dividend in scrip.

In answer to your previous correspondent; clearly the Ng's took their entitlement more or less entirely in scrip! I would be very surprised if they did not do so with regard to the PAH scrip dividend election.

I also elected to receive last year's dividend in scrip, having come to similar conclusions as you in your article on the subject. The shares were trading at an average of about HKD 2.39 in the 5 days preceding the record date. They issued the shares at a 10% discount to the market price at HKD 2.17. Seemed like a good deal at the time.

Needless to say, the shares have traded down to as low as HKD1.15 since then. I will be interested to see just how many opt for scrip this year?

Depending on where the share price goes in the next 5 weeks (scrip dividend price will be fixed at the AGM 05/09/08), I will still probably take the scrip option. Mainly because I see it as benefiting the company in which I have built a signficant investment over a number of years. I would also be surprised to see too much more downside from here.

Mind you, over many years, I've been surprised many times before!

The very best of luck to you on your journey!

Anonymous said...

Can somebody please tell me when do we have to decide whether to take the scrip option or the cash option for the dividend payout? (The last date for the decison, I mean.)

Thanks!

Anonymous said...

damn... i think i have misplaced away my circular... what if i did not vote? Will I get scrip or cash dividends?

nice site you have here. I will keep it bookmarked :)

musicwhiz said...

Hi Anonymous,

OK, thanks I will ask Management about it if I have the chance to.

Regards,
Musicwhiz

musicwhiz said...

Hi Marc,

Thanks for such a detailed comment, that was very helpful ! Yes I attended the AGM/SGM and Management has said they will opt for scrip dividend, like you mentioned. However, they are giving shareholders a choice as not all may want scrip (they say some die die prefer cash).

Anyhow, it will be interesting to observe the results of the scrip dividend and to see the % of shareholders who chose it.

As at the time of writing this, I am still undecided. :)

Regards,
Musicwhiz

musicwhiz said...

Hi Anonymous (both of you who posted on July 29),

PAH has released more details of the scrip dividend scheme via SGXNet. I suggest you check it out in order to clear your doubts on the scheme. As the XD date approaches, I will post another short post on the computation for the issue price and also give comments on whether it is justifiable to opt for scrip, along with some AGM highlights.

Cheers,
Musicwhiz

harry said...

hi musicwhiz,
the issue price for scrip dividend is S$0.44 which is higher than current price of $0.39. this means that we should opt for cash divvy and then simply buy whole lots from open market. this will incur comm and tax, but still better than getting stuck with odd lots and at a higher price.

correct me if i'm wrong here. no issue of dilution as we can buy more at lower price.

Anonymous said...

Exactly the same conclusion as harry. look at the price now - it's 0.39 while the scrip dividend is computed at 0.44 - this is a no brainer. Anyway I just received teh circular which says you need to return your Notice of election to the CDP by 5pm 4 Sep 08 if you want scrip. If you want cash you need do nothing.

I'm taking cash and buying lots from the open market. Saves the odd lots and offsets dilution. Only thing is that it doesn't help the company conserve capital. Oh well, tough.

Rellangis said...

Yes. I have a question here. What if I choose cash div now and decides to buy more lots in future. Those extra lots that I buy, will they get cash div or scrip div?

Thanks.

James Kwie said...

Hi musicwhiz,
I am also a proponent of value investing and initially found PA to be a good company to own. But as I reviewed the financials in more details, I realise their short term debt are extremely high... I wonder if the company has the ability to refinance in this current crisis... I person think that is what led to the stock decline... your views?

musicwhiz said...

Hi James Kwie,

I think PAH should be able to refinance as they have their vessels and VOA as collateral. Also, theirs is a capital intensive industry so no surprises on the need for such high gearing.

Regards,
Musicwhiz