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.