Jason Cates Dividend Policy Ravi Patel2Part I: With reference to appropriate theory, critically evaluate the dividend and sharebuyback policies of Debenhams plc. Your discussion should include an evaluation of sharebuybacks as an alternative to dividends.Word count: 2000
Jason Cates Dividend Policy Ravi Patel4IntroductionThis paper evaluates Debenhams share buyback and dividend policies and considers theirimplications on shareholder return. This will be carried out by considering such policies in relation torelevant theory and conclude by considering the appropriateness of these policies in returningshareholder investment.Dividend PolicyThe graphs below show Debenhams level and costs of dividend since 2008.(Debenhams, 2008-2012)(Debenhams, 2008-2012)Debenhams reduced its dividend to 0.5p a share in 2009 and went on to cancel its dividendin 2010. This was in order to refinance its debt and improve upon its cash position which, in 2008,00.511.522.533.52008 2009 2010 2011 2012Value(Pence)Dividend Per Share01020304050602008 2009 2010 2011 2012TotalCost(£M)Total Cost of Dividend
Jason Cates Dividend Policy Ravi Patel5fell to -£2.9M. Cancelling its dividend allowed Debenhams to increase its cash level by £191.1Mbetween 2008 and 2009 and to repay 25% during the financial year 2011.These investments reducedDebenhams bankruptcy and financial risk by lowering its interest payable and improving its short-term liquidity. (Debenhams, 2008-2011)(Watson & Head, 2010)(Debenhams, 2008-2012)(Debenhams, 2008-2012)Share BuybackIn 2011, Debenhams reinstated its dividend and announced a share buyback scheme worth£40M. Share buybacks are seen as an efficient way of returning cash to shareholders in addition to adividend. Companies are generally reluctant to issue increases in dividend in which they may have toreverse. Share buybacks are a way avoiding this problem and increasing cash pay-outs withouthaving to reverse the decision in following years. A share buyback will also enhance the value of theremaining shares further contributing to shareholder return. (Barrett, 2011)(Brav et al, 2005)00.20.40.60.8188.8.131.52.822008 2009 2010 2011 2012Value(£Bn)Total Liabilities-500501001502002008 2009 2010 2011 2012Value(£M)Cash Level
Jason Cates Dividend Policy Ravi Patel6TheoriesModigliani & MillerModigliani and Millers proposal incorporating both tax and bankruptcy risk concluded thatincreasing use of debt capital reduces a company’s overall weighted average cost of capital (WACC).This is due to debt finance generally being a cheaper source of finance than shareholder equity inaddition to interest payments acting as a tax shield against profits. However, when gearing reaches acritical point, the associated increase in bankruptcy risk will drive up this WACC and eventuallyoutweigh the cost and tax benefits of financing by debt. (Watson & Head, 2010)An underlying assumption of this proposal is that shareholders are indifferent betweenreturns being in the form of dividend payments or capital growth. However, this ignores thesignalling and clientele effects, both of which will have an effect on a company’s cost of equity basedon the expectations of different shareholder clientele. (Brav et al, 2005)Relating to Debenhams dividend policy, the key issue of relevance is that of high debt andthe resulting bankruptcy risk. Debenhams dividend was reduced to 0.5p a share in 2009 andcancelled in 2010, this capital was then reinvested in improving Debenhams cash level and repayingits liabilities. In 2008, Debenhams net cash position stood at minus £2.9M; by 2010 this had reachedpositive £188.2M. Furthermore, total liabilities fell from £1.86Bn in 2008 to £1.39bn by 2011. Duringthis time, Debenhams saw its share price double from 39.75p per share in August 2008 to 79.5p pershare by August 2009. This level of share price growth implies that share price and therefore totalshareholder return are affected by other factors beyond simply dividend payments. (Debenhams,2008-2011)(LSE, 2013)Signalling EffectSpecific dividend and share buyback policies will signal specific information to shareholdersand other investors.The cut in dividend in 2009 and 2010 can signal two things. The first of these is thatDebenhams may be entering a phase of declining performance and thus, can no longer afford to paya dividend to shareholders. However, the second category involves the company prioritisinginvestment in NPV’s over paying out a dividend, thus leading to greater capital growth in the future.Therefore, the circumstances’ surrounding a decrease in dividends needs to be considered whendiscussing the signalling effect. This relates in part to the business life cycle which will be discussedlater on in this paper. (Debenhams, 2009-2010)(Brav et al, 2005)In this case, by Debenhams tying its cut in dividend to reinvestment in cash and therefinancing of its debt, it managed to convince its shareholders that it came under this secondcategory involving investment in NPV’s. Moreover, this change in dividend policy attracted moreinvestors leading to an increase in share price as shown in the graph below. This implies thatinvestors have other considerations beyond simply the level of dividends which will be discussed inthe clientele effect. (Debenhams, 2012)
Jason Cates Dividend Policy Ravi Patel7(Debenhams, 2012)In relation to Debenhams share buyback policy of 2011-2012, Debenhams saw an increase inshare price occurring around the same time period it implemented this policy. Although there maybe other factors causing this share price increase, it may be partly due to the signals such a policysends investors. In this case, investors have taken it to mean the company has surplus capital due inpart from savings from lower interest payments after its debt refinance programme. In summary,investors have taken these changes in dividend and share buyback policy as positive signalsregarding future company performance. (Debenhams, 2012)Clientele EffectThe effects these policies had on company share price may be due in part to the clienteleeffect. This is due to different types of investor preferring different forms of income. Generally, long-term investors such as pension funds prefer a more stable and regular income, typically in the formof dividends. This is compared to short-term investors who prefer high capital growth in the short-term. (Watson & Head, 2010)As seen in appendix 1, mutual funds which generally prefer safer long-term investmentshold only a minority shareholding in Debenhams. This is compared to Debenhams top tenshareholders that mainly consist of investment and asset management companies and together holda 57.9% shareholding. These investment funds generally, but not always, prefer capital growth overhigh dividends. This is due in part to the different tax considerations of these two clienteles. Simply,as high earners pay a higher rate of income tax, they will naturally be drawn to the lower rate ofcapital gains tax and therefore, would prefer high capital growth over dividends. As such, bycancelling its dividend in 2010 and issuing a share buyback in 2011, Debenhams is appealing to thisspecific clientele. (Debenhams, 2013) (Grullon & Michaely, 2002)This theory is supported by the increase in Debenhams share price as mentioned earlierafter it announced these changes in policy. This suggests that variations in dividend and sharebuyback may have an impact on shareholder return in the short-term. As such, the clientele effect isa significant factor when deciding upon share buyback and dividend policies. This is due to each ofthe two polices appealing to different types of clientele. However, research has found thatalternating between these two policies has no effect on long-term shareholder return and theysimply act as “substitutes”. (Skinner, 2008)
Jason Cates Dividend Policy Ravi Patel8Management IncentivesIn regards to management incentives, Debenhams CEO Michael Sharpe currently owns2.46M shares/share options in the company alongside CFO Simon Herrick’s 647,127 shares/shareoptions. This share ownership means the company’s two executives have a personnel interest inmaintaining or improving upon Debenhams share price. In regards to Debenhams share buybackpolicy, if total “corporate value” is to remain stable, having fewer shares on the market should leadto a higher share price. In regards to Debenhams, after implementing its £40M share buyback, itsshare price had grown to 96.05p per share, up from 55.35p a year before. As stated, this may be duein part in the reduction in the overall number of shares. However, it may also be due in part to thesignalling and clientele effects which will be discussed later on in this paper. (Debenhams, 2013)(LSE,2013)Performance IndicatorsFrom a corporate reporting perspective, having fewer shares can contribute to improvingkey performance indicators. The first of these is earnings per share (EPS). Prior to the share buybackin 2011/2012, Debenhams EPS was 9.1p with profits of £160.3M. After the share buyback, EPS hadincreased to 9.8p, even though profits had declined to £158.3M. This increase in EPS despitedeclining profits shows the impact a share buyback can have on a companies reported performance.(Debenhams, 2011-2012)(Watson & Head, 2010)Furthermore, issuing a share buyback also reduces the costs of maintaining or improvingupon the company’s current dividend. In 2011, Debenhams paid dividends of 3p a share with a totalcost of £38.6M. This is compared to 3.3 pence a share in 2012 which a cost £38.5M. This shows that,by issuing a share buyback, Debenhams was able to improve its dividends per share figure withoutincurring the cost of such an increase. Therefore, although issuing a share buyback reduces companycapital in the short-term, the lower costs of maintaining or improving the company dividend willlikely offset this in the longer term. (Debenhams, 2011-2012)(Grullon & Michaely, 2002)Business Life CycleIn regards to the business life cycle, Debenhams share buyback policy implies the company isentering a stage of decline. Firstly, by returning capital to shareholders rather than reinvesting it inthe business may suggest the company lacks positive NPV’s to invest in. If a company fails to investin new NPV’s, the company will enter a stage of decline when it’s current NPV’s start to reach theend of their lifespans. Secondly, issuing a share buyback reduces the number of shares in thecompany and helps to improve the company’s share price. This suggests the company believes theirshares are likely to underperform in the near future. This need to maintain share price furtherimplies the company may be entering a stage of decline. (Brav et al, 2005)(Vernon, 1966)In regards to dividend policy, Debenhams cut in dividend in 2009 and 2010 could imply twothings. Firstly, it could mean the company does not have the capital to pay out a dividend due toheavy investment in new NPV’s, leading to higher capital growth in the future. This may suggest thecompany is entering a new growth or “rebirth” stage. However, having insufficient capital to pay adividend might also suggest a decline in company performance, further implying that Debenhams
Jason Cates Dividend Policy Ravi Patel9might have entered the decline phase. Using the savings from reduced dividends in 2009 and 2010to invest in cash and lower debt suggests Debenhams comes under this first category. This is furthersupported by the reinstatement of its dividend in 2011. (Debenhams, 2009-2011)(Barrett, 2011)In conclusion, a share buyback may be more appropriate for declining companies whenthere is a need to return capital to shareholders over a short period of time. In contrast, dividendpayments may be more suitable for more stable mature companies who can afford to maintain thisdividend over the longer term. (Watson & Head, 2010)
Jason Cates Dividend Policy Ravi Patel10ConclusionAs stated earlier, research has found that differences in dividend and share buyback policyhave no real impact on long-term shareholder return. Furthermore, this research has found thatthese two policies simply act as substitutes when returning capital to shareholders. (Skinner, 2008)However, two issues to consider are the clientele effect and the business lifecycle whichhold significant influence on the suitability of these policies. Share buybacks may be moreappropriate for declining companies who wish to return capital to shareholders over a short periodof time. Whereas dividends may be more appropriate for mature stable companies with theprofitability to maintain such a dividend in the long-term.Regarding the clientele effect, companies largely owned by short-term investors would beencouraged to implement a policy of buying back shares and improving share price. Conversely,companies largely owned by long-term investors would be encouraged to implement a policyfocused around paying regular dividends. Both these policies appeal to different types of investorand should be implemented as appropriate.Relating to Debenhams, issuing a share buyback appeals to its main shareholder clientele ofinvestment funds whose timeframes are generally in the short-to-medium term. The reduction in itsdividend in 2009 might imply that it was on the verges of decline. However, the reintroduction of itsdividend in 2011 suggests it has entered the “rebirth” stage of the business lifecycle.
Jason Cates Dividend Policy Ravi Patel11SignatoriesWe commend this paper to the University of Hertfordshire to be delivered on or by 8 March 2013.Jason CatesRavi Patel___________Mail: AdrJasonCates@GoogleMail.comPortfolio: SlideShare.net/AdrJasonCatesLinkedIn: LinkedIn.com/in/AdrJasonCates
Jason Cates Dividend Policy Ravi Patel12ReferencingBarrett C., (2011) ‘Debenhams rises 7% over buy-back plan’, Financial Times, 21st October 2011Brav et al A., Graham J.R, Harvey C.R. and Michaely R. (2005), ‘Payout policy in the 21st century’,Journal of Financial Economics, 77, pp. 483 – 527Debenhams (2008) Annual report 2008. [Online] Available at: http://media.corporate-ir.net/media_files/IROL/19/196805/reports/ar2008_new.pdf [Accessed: 11th February 2013]Debenhams (2009) Annual report 2009. [Online] Available at: http://media.corporate-ir.net/media_files/IROL/19/196805/reports/ar2009_new.pdf [Accessed: 11th February 2013]Debenhams (2010) Annual report 2010. [Online] Available at: http://media.corporate-ir.net/media_files/IROL/19/196805/agm2010/ar2010.pdf [Accessed: 11th February 2013]Debenhams (2011) Annual report 2011. [Online] Available at: http://media.corporate-ir.net/media_files/IROL/19/196805/agm2011/ar2011.pdf [Accessed: 11th February 2013]Debenhams (2012) Annual report 2012. [Online] Available at: http://media.corporate-ir.net/media_files/IROL/19/196805/agm2012/ar2012.pdf [Accessed: 11th February 2013]Debenhams (2013) Ownership Summary. Available at:http://www.debenhamsplc.com/phoenix.zhtml?c=196805&p=irol-ownershipSummary [Accessed:13th February 2013]Grullon G. and Michaely R. (2002) Dividends, Share Repurchases, and the Substitution Hypothesis.The Journal of Finance, Volume 57, Issue 4, pp1649 – 1684LSE (2013) Debenhams 2013. Available at: http://www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary-chart.html?fourWayKey=GB00B126KH97GBGBXSTMM [Accessed: 21stFebruary 2013]Skinner D. J. (2008),’The evolving relation between earnings, dividends, and stock repurchases’,Journal of Financial Economics, Vol ume87, Issue 3, pp. 535 - 740Vernon (1966) cited in Proxim Group, (2013) The Business Life Cycle. Available at:http://www.proximgroup.com.au/Understanding-The-Business-Life-Cycle-Is-Important-To-Improving-Your-Small-Business-Success.php [Accessed: 23rd February 2013]Watson, D. & Head, A. (2010) Corporate Finance: Principles and Practice. 5th edn. Harlow: PrenticeHall.
Jason Cates Dividend Policy Ravi Patel13AppendixAppendix 1 – Debenhams Ownership SummaryTop 10 Shareholders Shares %O/SShareChangeSchroder Investment Management Ltd. (SIM) 202,969,928 16.2% -5,908,364Milestone Resources Group, Ltd. 89,183,155 7.1% 0Majedie Asset Management Limited 66,480,510 5.3% 55,719,596Artemis Investment Management LLP 63,855,868 5.1% 0Standard Life Investments Ltd. 63,332,751 5.0% -13,492,714Bestinver Gestión S.G.I.I.C. S.A. 61,554,348 4.9% -52,588,229AXA Rosenberg Investment Management Ltd. 60,803,116 4.8% 0Legal & General Investment Management Ltd. (UK) 42,075,474 3.4% 0Norges Bank Investment Management (NBIM) 38,491,542 3.1% -333,675LSV Asset Management 37,668,430 3.0% -790,500Mutual Funds Shares %O/SShareChangeBestinver Internacional FI 57,284,726 4.6% -4,406,677Bestinfond FI 37,751,534 3.0% -2,826,268Statens Pensjonsfond Utland 35,340,709 2.8% 14,752,863Delta Lloyd Select Dividend Fonds NV 20,100,000 1.6% 350,000Old Mutual UK Select Mid Cap Fund 18,981,000 1.5% 1,555,000CIS UK Growth Trust 18,000,000 1.4% 7,500,000Aberforth Smaller Companies Trust plc 13,952,178 1.1% 2,307,436Bestvalue FI 11,059,184 0.9% 11,046,913St. Jamess Place Balanced Managed 9,502,150 0.8% 0Old Mutual UK Select Smaller Companies Fund 9,315,000 0.7% 609,000