Blog 10: Dividend policy

The problem on distribution of companies’ net profits can always raise a controversial debate. There are two approaches to allocate these amounts of money; one is using these capitals to reinvest positive NPV projects, another is return companies’ wealth to shareholders through dividends. Argument even shows that different way to distributing money will relatively affect shareholder wealth. If shareholders are given high dividends, it will increase share numbers which, in turn, will increase share price, hence share wealth improved accordingly. Indeed, a high dividend implies a prospective performance of companies, which helps to maintain and increase stock price.

However, it is still difficult for companies to make decisions on whether retain money from net profits or pay dividends. First and foremost, dividend payments have a strong dependency. It is hard to change a company’s dividend policy as long as it has been released, the reduced dividends by AIB is a typical example to show this theory. According to BBC News, share price of AIB has seriously plummeted due to the church in Ireland, hence, the reduced dividends act as a signal to reflect company’s bad financial performances which frustrate investors potentially. Moreover, according to the theory of “Bird in the hand”, because of the market’s uncertainty, shareholders are more likely to prefer the real cash in their hand instead of endure the risks in the long-term projects even though it maybe profitable. Nevertheless, Modigliani & Millar (M&M) argued that shareholders’ wealth has nothing to do with the dividend policy, they suggested that companies’ share price are heavily dependent upon its own profitability instead of the approaches on how to allocate dividends and how to distribute net profits. Honestly, I’m more inclined to this statement, as there are so many causes will affect companies to decide their dividend policy, but share price movement are more likely to decide by companies own financial performance.

Blog 9: Striking a balance between dedts and equities

As I have talked in previous blogs that there are several approaches to financing a company, namely raising equity and borrow bonds. However, debates on whether shareholders’ wealth can be improved through the way on how to financing their companies are always a hot topic for arguing. Traditional views toward the structure of capital mainly focusing on debt, in that it enjoyed a much lower cost when compared with equity. Nevertheless, it is rational for thinking that if a company suffered a huge amount of debts, their shareholders may worried about the risk of going to bankruptcy. That is one of the reasons for Schaeffler Group planning to reduce its massive debt load by selling some of its stakes.

Schaeffler Group is a ball-bearing maker in Germany; this company refinanced their capital structure through selling its shares on Continental which is an auto supplier in Germany. What surprised me most is Schaeffler Group using their selling proceeds to buy Continental shares, what’s more, in order to own 49.9% stakes in Continental, Schaeffler Group buy an additional 15.5 million shares from the banks who also owns lots of shares in Continental (Wall Street Journal, 2011).

The reason to why Schaeffler Group wants to change their debt structure to shares in Continental may probably lies to their consideration on shareholder wealth. In my opinion, stakes of 49.9% mean a potential control in Continental, to some extent, it is better for shareholders in Schaeffler Group enjoyed a high synergy from those potential merge than pay debts interests to Continental every year. Therefore, it is seems that this refinanced capital structure can be regarded as a creator for shareholder wealth, isn’t it?

However, according to Modigliani & Millar’s theory, shareholder’s wealth has noting to do with the financing approaches, it is business risks and business prospects that matters for creating shareholder wealth. Indeed, the calculation seems reasonable as the total value of the firm remains the same regardless of their different financing methods. Nevertheless, MM Models are based on several unpractical assumptions which are probably unsuitable for some certain situations. As a rule of thumbs, MM Models based on static analysis instead of developed views, to be more specifically, the ignorance of economic environment and changes in companies’ own financial situations lead MM Model only considering some short-term effects on company’s capital structure. For example, companies are required to relieve their debts in order to get rid of the risk on bankruptcy especially when the company suffered a financial crisis. Hence, like I have talked in last blog, academic theories can act as guidance for companies to refer, however, they are suggested to relate theories with their own practical performance rather than use theories blindly.          

Blog 8:Risks in making investment decisions

There are a wide range of factors need to be considered by companies if they want to invest in a specific business project. Indeed, apart of some financial indicators, other investment appraisal tools like NPV, IRR, ARR and payback period need to be taken into consideration. These tools can be divided into two groups; NPV and IRR have already considered time value, while ARR and payback period are not. After analyzed all these four factors, NPV is the one which owns the biggest popularities. The reason to this fact is primarily due to NPV’s goals, as it has the same goals of companies, which is maximizing shareholder wealth. However, should managers only concentrate on NPV but ignore other factors when doing investments? Absolutely not!

The failure investment in Microsoft by Nokia is a typical example. As I have already explained such investment in blog2, which I have estimated that

Nokia’s share price may increase due to these two technical giants’ merge. However, an astonished fell of 14% in Nokia’s share price have occurred after Stephen Elop announced the deal (Financial News, 2011). It seems that both Stephen Elop and I have underestimated the potential risks behind this investment. According to Nokia’s estimation on their return in this investment, their market ratio will reach 18 times and payback period are estimated as 3 years (BBC News, 2011). Ironically, let alone those unreliable figures, Nokia even don’t get the basic exclusive right to using Microsoft’s operating system and they are still required to pay royalties to use it. Hence, Nokia have already been regarded as the biggest looser in this investment deal. From my opinion of view, it is unwise for managers to isolate financial figures and investment appraisal tools alone when they make investment, as there are still so many potential risks need to taking into consideration. More specifically, those financial assessment are taken from uncertain estimation, what was worse, people are more likely to transfer those unreliable data into evaluators on their investments. However, those data’s feasibility only builds on some certain assumptions but ignore some practical business performance like whether it can create synergies or not.   

    

Blog7 Chinese companies are less influenced by credit crunch

 Credit crunch are regarded as a worldwide financial fiasco in 2008. People always related terms like sub-prime mortgages, CDO and credit rating with credit crunch. Now let me give a brief introduction about what are these terms mean and the reason to why Chinese companies didn’t suffer such a big lost during this crisis compared with US and other European companies.

Credit crisis is caused by two groups of people, the first is house owners which refer to their mortgages, and the other is investors like pension funds and investment banks. Here is how it works: a family who wants for a house should save money for their down-payments and contact the mortgages broker, then the broker will contact a lender who provide mortgage, hence family own a house after they received the mortgage. This is great for families as the price of house will rise forever. But how can the lender get money? They will sell those mortgages to investment banks; this means that every month investment banks will receive the payment from those house owners. Investment banks packed those mortgages into a box know as collateralized debt obligations (CDO), which will be divided into safe, OK and risky apartments based on their credit ratings. And then investment banks sell the safest CDO to the investors who only want safe investments. Therefore, those investors make a big fortune form these CDO and they ask the lender for more mortgages, but the worse thing is lends can’t find any home owners. Therefore, in order to find home owners, lenders changed their requirements which is people who need house do not require to pay down-payments and no proof of documents at all; the only thing they need to do is pay mortgages monthly. So instead of lending to responsible home owners, they choose sub-prime mortgages. This is the turning point; those sub-prime mortgages defraud their mortgages. What was worst, investment banks have no money to pay for those investors. That is why there are so many investment banks like Lehman Brothers announced bankruptcy at that moment.

But why Chinese companies seem did not seriously affected by this serve crisis? This can be due to government’s bail-out policies. Actually, the policy used by Chinese government is in the same theory of “Keynesian” (BBC News, 2010). This theory is mainly about teaching you how to spend money. It reminds me thinking about a metaphor: Chinese government spend 100 RMB to employ ten people dig a hole, while they spend another 100 RMB to employ other ten people fill out that hole. It sounds strange, isn’t it? Some people may think this is a waste of money. But are you ever consider the subsequent influence of using these amounts of money? People who gain money from government can buy bread for themselves, which will protect those bread factories from bankruptcy, and protect factories which made bread machines against bankruptcy as well. In reality, Chinese government spends more than four trillion RMB to protect companies from bankruptcy in that serious credit crisis. These amounts of money are used to construct railway and highway during credit crisis; it is not only benefit for the public afterwards but also stimulates the whole production sectors.        

Blog 6: Whose shareholder is the biggest beneficiary? The Bidder or the Target?

The world’s market seems saturated with consolidations recently, after D Borse announced to merging with NYSE, a consolidation between LSE and TMX in Toronto has began, together with cooperation between News Corporation and BSkyB. From these merges talked above, it is easily for people identify that almost all the merges and acquisitions occurred in the same sector. This is primarily due to their shareholders unwilling to buy shares from a different industry. Indeed, it is reasonable for thinking that every company runs their business in the interests of shareholders. However, people maybe question about who is the biggest beneficiary among these merges?

We are instilled about the concept that shareholders in the target company will be the biggest beneficiary, in that their company always has been bought with a high price, hence they can enjoy the share premium. A classic example is the merge between D Borse and NYSE recently. After this merge, D Borse shareholders holding 60 percent in a new company, while NYSE shareholders holding 40 percent. However, in order to acquire NYSE, D Borse gave a 10 percent share premium to NYSE (Financial Times). It seems that share premium act as a lure to attract target companies agree with the merge. However, put this fact alone, not all target shareholders are the beneficiary. Occasionally, merges and acquisitions may fall into a destructive situation. It is possible for companies choose merges because they have no choice or run out of ways to grow “organically”, David Lis, head of UK equities with Aviva Investors, says that “when companies want to keep the wolf from the door, the only choice for them is to have a friend”. If the target company merge with the acquirer in this situation, it is possible for them to be lost in a severe business environment. The acquisition between News Corporation and BSkyB is a typical example. As a rule of thumbs, News Corporation’s proposed bid for BSkyB is good for News Corp. After a scandal of “phone hacking” in News Corp last month, this company’s share price are serious been affected and set back Murdoch’s effort to takeover the full ownership of BSkyB. However, from BSkyB shareholder’s perspective, News Corp’s original bidding price of 700 pence per share turns out an underestimation of BSkyB’s share price (820 pence). Even though the final bidding price is 800 pence a share, it seems that BSkyB shareholders acted as a looser in this acquisition. Moreover, from BSkyB employees’ perspective, the merge still like a disaster for them, as BBC reported that Murdoch fired editors from “The Times” and “Wall Street Journal” after he acquired those newspapers, ironically, Murdoch even promise that he will remain editors’ independence before the merge. Hence, no one can guarantee that Murdoch will keep all of BSkyB employees even though he find his company no longer need those employees in synergy.

References:

http://www.reuters.com/article/2011/02/15/nyse-deutscheboerse-idUSWEN777320110215

http://www.ftchinese.com/story/001036883/en

Blog5: Country's agreement and disagreement on FDI

Foreign direct investment (FDI) enjoys more popularity recently. It focus on investment around the whole world, there are three main formats to explain FDI. First of all, one domestic country invest money in build factories and land aboard, which is also called “Greenfield Investment”. Secondly, companies taking a majority of a foreign company’s shares, hence, control that company. Last but not least, companies reinvest their profits, which gained from the original direct investment, into the same foreign company.

One of the successful FDI case recently is from Europe’s cross-border fund industry. Figures from the European Fund and Asset Management Association show that their assets under management of the Greek fund industry decreased by two-thirds during last five years. However, Europe’s cross-border fund industry, whose large foreign investment in Luxembourg, experienced a significant rise on its assets (Financial Times). The reason to this prosperous foreign investment may primarily due to the low cost for running business in those developing countries, for companies need to switch their focus from technology monopoly to products’ low price when it comes to a mature stage during Product Life Cycle. However, with an increase number of FDI, local government becomes worried about their financial resources. Italy government began modify their tax legislation, which reduced their tax rate to the same level with cross-border ones, in an attempt to stop the outflow (Financial Times). Honestly, I don’t think it will help local government to reduce FDI. Indeed, people could be forgiven for thinking that companies in Italy choose doing business aboard because of its high tax rate in its own country. However, if companies’ main market is in aboard, therefore, the main reason for them to do FDI may not rely on tax rate, as a rule thumbs; it is the high cost on transportation and impediments on export that let companies domiciled in another country. Hence, it is advisable for Italian government to reduce its cost on transportation especially on those products with low-profits but need to charge a high transportation cost. Moreover, in order to reduce the FDI as Italy wish, the essential part is to stimulate export policy, one of the main reason to companies prefer FDI is they want direct control of their foreign subsidiaries instead of franchise their operations to overseas companies, after gain the direct control on aboard, they will earn a high priority in the foreign competitive market. However, if Italy government release their export policies, like reduce tariffs. Is it seems much better for companies to do business within their home country than going aboard?

   

Blog 4: China says “No” to the appreciation on its currency

When we talking about currency and exchange rate, the first thing come into my mind is the cost of doing foreign-exchange business. As whenever a company import, export or even merge with a foreign business, they should consider the currency risks, thus minimize those risks.

    
China always reluctant to put its currency policies under the spotlight, especially in the international financial forum. After G-20, China becomes isolated by other companies like US and France, as Chinese government resist appreciating its currency (Wall Street Journal). What was worse, they even push great pressure to China, as one of the central bank in G-20 said that “negotiators can’t stay here forever and waiting for Chinese agreement”. French officials convinced China that Yuan appreciation can help contain inflation, in that it would makes imports much cheaper in dollar terms. However, appreciation in Yuan can make Chinese companies lose lots of profits. Let’s imagine that if one American tourist transfers his one million dollars into Yuan in 2005, which means that he can gain 8.5 million Yuan. After he spend 2 million in China for travel in last five years, he still can transfer his 6.5 million Yuan into one million dollars in 2010, this implies that he don’t even need to spend one dollar for this five years’ travelling because of the appreciation in Yuan. After considered the potential loss for companies, Chinese government resist to adopting exchange-rate appreciation.


People could be forgiven for thinking that appreciation on Yuan can boost China’s import business. Indeed, it can help importers improve its products volumes as the costs are much cheaper than before. However, on no account can we ignore the influence on the export business. A typical example is the benefits gained by UK companies from sterling’s weakness. As Financial Times reported in Thursday that Conductix-Wampfler which is a UK manufacturing company, taking advantages of the weak pound not only to improving sales volumes but also to increasing its profits margins. In terms of China, which is the world’s biggest debtor of America, owns almost two trillion dollars in 2009. From my perspective, if China has appreciated its currency, which means US dollar get much weaker against Yuan, this will result in amounts of hundred billion lost for China.  


In order to stimulate exports and balance the slightly appreciation on Yuan, China began to reduce or even eliminate some tax rates in exported products, which is called export Rebates policy. In my opinion, even though the cost on those exported products has reduced because of the reduction on tax rate, the biggest beneficiary is not China; it is still those countries that hold stronger currencies. As we all know that tax is one of the main financial resources to support governments, hence, the reduction on tax rate can be a great reverse problem to Chinese government, like the potential influence on constructing infrastructure to the public. Moreover, the reason why I believed countries like US can gain benefits from this export rebates policy lies with their steady currency. As those people are the final consumption group, who still can use the same amount of money to buy the same products. It seems that reduction on tax rates has noting to do with their money as they don’t have to spend extra to buy products, isn’t it?         

  

Blog3: Equity Finance& Debt Finance

Barclays, which was operated for almost 326 years in UK, has got numerous lessons in raising finance area. Bob Diamond, Barclays’ new CEO, declared the media conference in last week that the bank suffers great pressures of tougher capital requirement. In order to meet their capital demand, Barclays began its expansion plan. Consolidation with Spanish distressed regional savings bank and South African bank are typical examples in raising finance. However, given Barclays’ severe performance condition, will those investors still believe in Barclays without looking at the potential return of finance? Maybe not! Hence, in my viewpoint, if companies want to raise capital through equity, what they should consider is the rate of return which offers to their investors. Companies are not recommended to focus only on their own profit increase but ignore their investors’ interests. In terms of investors, they tend to analyzes companies’ information and financial performance according to prospectus provided by underwriters or brokerages. Therefore, banks like Barclays who suffers a great recession in its business may have difficulties to increase its capital through raising equities.

Apart of equity finance, debt finance becomes prevalent among companies. Bond is regarded as the most common debt raised by companies. However, from my perspective, bond can be one of the most risky methods for banks. For example, banks will suffer large risk of inflation if people borrow a large amount of long-term bonds. Therefore, so many central banks have real concerns about inflation, and make bonds interest materially more expensive for companies to do business. This can be one of the main reasons for credit crisis in 2007. Another method of debt finance is syndicated loans, which can retain customers and spread risks at the same time. Like Barclays’ cooperation with China Development Bank (CDB) in 2007, Barclays ask CDB to invest almost 22 hundred million euro to buy its 2 hundred million ordinary shares. According to Barclays’ CEO, they lend these capitals to Algemene Bank Nederland afterwards. Syndicated loans, indeed, do have advantages for banks to gain profits. However, did Barclays even considered the consequence if Algemene Bank Nederland failed to return those large amount of capitals? Regardless of the capital losses for Barclays itself, but the cooperation relationship between these two companies may be break down. Therefore, banks should focus on their long-term strategic viewpoint instead of short-term interests when they raising capital through debts or lend money to borrowers.        

Blog 2: Stock Market Efficiency

Barclays made an announcement that it would no longer offer financial advice to customers. It is primarily due to the fine￡7.7m after Barclays’ advisers failed to explain the risks of shares to elderly clients, many of whom lost significant sums in that investment. As Kendal’s theory: Random walks (1953) supported that share price movement within a company is based on new information which is hard to predict. Hence, some people even hold the opinion that investors who earn money from stock market are totally by chance. However, if this is true, then why there are still investors like Warren Buffett can earn money during 15 years?

Undoubtedly, from my own perspective, the share markets do have some potential rules for those investors. Firstly, on the weak form market efficiency basis, the classic mistake for investors is to buying high and selling low. Equipped with historical information on share price movement, investors tends to overpay their investments if buying high, while suffers loses if selling low. A specific example related to this is nowadays hot topic on the partnership between Nokia and Microsoft. As we can see that, Nokia is no longer the dominant telephone brand, its share price decreased dramatically from EUR11.61 to 6.13 per share (London Stock Exchange). Hence, people may sell their shares as they think Nokia’s share price has reached its bottom. However, in my opinion, EMH still happen which can reveal the new information of Nokia; moreover, there will be a prosperous market for Nokia after the cooperation with Microsoft, as Stephen Elop (Nokia’s CEO) said this partnership will value the business as it is jointly by two giants. Secondly, it is easier for investors to be trapped into the “Herd Effect”, for people are likely influenced by their mate recommendation and behavior. As Turner (2009) said that individual behavior is not entirely rational. If everyone in a company is talking about a share because it has risen rapidly in value, people tend to buy that share even without any knowledge on it, but remember rule one: don’t buy high.

In conclusion, stock market is a place where people can gain benefits from it only if people know the potential rules behind the market. It can be forgiven for thinking that some people’s information are outdated or even distorted, like in the weak form and semi-strong form efficiency. But we can’t turn blind eyes to people who have good performance in stock market. Hence, maybe we should question on the notion “random walks” in share price.    

http://www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary-chart.html?fourWayKey=FI0009000681FIEUREQS

               

shareholder wealthy maximization and value creation

BP launched a partnership with Russian state oil company Rosneft in last month; it formed a company called TNK-BP which is considered as the third biggest oil company in Russia. This joint venture is regarded as an opportunity to boost BP’s shareholder wealth after last year’s Gulf of Mexico oil spill.

The fundamental objective of BP is to protect and enhance shareholder value in a sustainable way, in both the short and long term. Peter Sutherland, the Chairman of BP, says that BP will still continue its policy of returning cash in excess of its investment requirements to its shareholders both through buybacks and progressive dividend policy (2006).

Nevertheless, in the end of January, ARR (a group formed by shareholders from Russian) argued that BP’s alliance with Rosneft breaches their shareholder agreement. Therefore, a legal decision on “Russian shareholders winning the injunction to halt the share swap” has been made by the High Court of London in the first of February. The court’s decision is considered as “legally just” and “morally” to the benefits of shareholders.

Moreover, a decision made by BP in January is to sell its Texas City refinery. This implies that BP divesting its assets in order to increase its value creation. Since the explosion makes BP had a terrible reputation in Texas City, there is no point to increase investments in there. This can be one of the reasons to BP’s strategy: extend cooperation within the whole world’s oil companies.

Since managers are selected on behave of shareholders, they are supposed to acting in the interests of those owners. Gerard Kleisterlee, the former chief executive of Philips, is appointed as the next chairman of Vodafone. Many analysers argued that Kleisterlee does not have broad experience of the telecoms industry. However, shareholders in Vodafone think that Kleisterlee is eligible as he has worked in Philips for ten years for chief executive, hence, he should be well placed to supervise the UK group. Nevertheless, shareholders in Mouchel are disappointed about managers’ rejection on several bid approaches over the past year. At Mouchel’s annual meeting on Monday, several shareholders said they were frustrated that the board has not made clear its position on the bid approach. Moreover, shares in Mouchel lost as much as 79% of their value last year, for the company’s fate is determined by managers. It is assumed that managerialism is a disaster for company’s development, for agent only acts on themselves instead of shareholders’ benefits.