Dividend Forecasting

Companies that are financed fully or partially through equity financing face a difficult decision as to whether to issue an interim or final dividend to their shareholders. For some companies that decision is easy to make as they do not have a profit from which their dividend can be paid, but for others it is a tough choice which can impact on the future development of the company. But the question today is not whether a dividend should be issued, but actually how important is dividend forecasting?

I work for a company which is jointly owned by two large multinational firms, both of whom have provided equity finance to allow us to grow and expect dividends in return. Last year was the first year in approximately ten years that we, as a company, have been able to issue a dividend to our shareholders. The reasoning behind this is largely due to the fact we have not been able to make a profit and not because we have chosen not to.

The problem we face as a company is that we have been forecasting significant profits over the last few years which should have resulted in dividend payments, however upon final completion of our end of year accounts we’ve actually made significant losses. The reason behind this is due to the large extent of accounting standards we have to report in, and the need to report in a certain way for one of our parent companies. To combat the problem, a project has been developed which will allow us to report monthly our financials under the set of standards upon which our dividends will be based, rather than only looking at them in this format at the end of the year. The hope is that this will allow for more accurately profit forecasts and thus more accurately forecast dividends. But whilst we work on this project, the question could be raised as to whether this is actually a worthwhile project? Do shareholders actually need to be informed in advance whether they will receive a dividend or not?

From a shareholders perspective it could be argued that yes accurate forecasting as to dividend payments is needed. Their aim is to maximise their wealth and if they cannot be seen to receive a dividend for the current financial year or for the next (depending on how accurate the forecasting is), is their investment actually worth it? But ultimately this depends on the type of shareholders who have invested. Pension and insurance companies who are looking for regular returns upon their investments would prefer this as they can pull out of investments that are no longer going to be beneficial to them. But in our position, where both our shareholders are large multinational organisations looking to help us grow and develop, would they not be happy with a statement at the end of the financial year which said why they didn’t get a dividend rather than continuously changing forecasts?

Looking at the issue from a company accurate dividend forecasting will be useful as it will allow for the company to make decisions in advance as to whether to issue a dividend and be prepared to factor this outgoing cash into their plans for the rest of the year, and allow for the company to decide whether it is worth issuing a dividend or whether that money would be better spent on R+D so as to maximise wealth in the future. But due to the time and cost taken to produce these forecasts and make these decisions regularly, is it really worth it?

In my opinion, yes it is worth it. Dividend forecasting for the reasons discussed will keep both the shareholders and management of a company happy. Shareholders who know the circumstances they are facing will be kept satisfied, whereas those who don’t will be more inclined to invest elsewhere where the knowledge is more readily available or the investment is guaranteed to be worthwhile. As a company, better forecasting and cash planning can only be a good thing if we are too keep our shareholders happy and if we can plan in advance whether the money can be better used in other aspects of the business we can forewarn our shareholders what investments we are making which may affect their dividends, rather than use a backward looking approach to the matter. But as with everything, circumstances changed and it should be emphasised that although dividend forecasting is a good thing, it should not be relied upon as the confirmed truth.

Is there such a thing as a strong capital structure?

In November 2012, Moody’s cut the triple A-rating of the ESM recuse fund by one notch and gave the rescue fund a negative outlook. The reasons behind this being that the agency felt that ESM would not fulfil its financial obligations. However Moody’s were criticised for their approach by the managing director of the ESM who argued that Moody’s did not acknowledge ESM’s exceptionally strong capital structure. But is there such a thing as a strong capital structure and should this actually make a difference when considering credit ratings?

The traditional view on capital structure argues there is an optimum capital structure at which the WACC is the lowest possible. This is caused by altering the levels of debt and equity within the organisation. But there is no argument to suggest whether this is optimum level equates to a strong capital structure. Having an optimum WACC indicates that up to that point in time, gearing will increase shareholder wealth, whereas anything after this point becomes risky and will see a decrease in share price and shareholder wealth. But does this mean it is strong? Well yes and no. It could be suggested that this optimum point is strong because organisations have been willing to lend to this organisation and have no financial worries about the company, and shareholders have seen potential in the company’s future growth opportunities, but if they are at this point where can they go from here? Is the strongest point therefore not at a point before this optimum level where a company has the opportunity to raise finance from both a debt and equity position?

However, in the 1950s Modigliani and Millar presented a paper which suggested that capital structure has no impact on WACC and therefore no optimal structure exists. So, if no optimal structure exists does a strong structure exist? Well this argument is very similar to that considered in the traditional view. If you are in a position where you are able to finance both through debt and equity without damaging overall value then yes you could be seen to be in a strong position. If your structure does not allow you to finance through debt or equity then it could be argued that you are in a weak position.

Ultimately the conclusion as to whether a company has a strong capital structure or a weak one is dependent upon whoever is making viewing that company at that point in time. A shareholder might argue their company has a strong capital structure when it is providing them with the most wealth; a lending company on the other hand might view a strong structure as one which minimises risk. Therefore it could be seen that Moody’s were right to base their decision excluding an analysis on capital structure as the strength of the capital structure changes depending on who is making the analysis and what their view point is on a strong structure.

Trust and Culture

Moran (2005) argues, "We audit and we regulate when we cease to trust", and personally I think it's evident that this is the case. After every big scandal or crisis the rules and approaches to auditing and governing change significantly in the hope of preventing similar things from happening. But are we missing a fundamental issue? Why is auditing and regulating not stopping further scandals from occurring?

I can understand the argument as to why we regulate and audit when we loose trust. We do it so that over time we can rebuild that trust we had and be assured that people are acting how we want them to. But it seems that every time we rebuild our trust, we loose it again. So what are we missing? Well to me it seems like we're failing to understand why we're loosing our trust. Something must be causing this recurring cycle of gaining and loosing trust that we find ourselves in, and I believe that something is Culture.

Culture is arguably one of the most important things in an organisation. Communicated in the right manner, a good culture can encourage employers and managers to work together to meet the needs of the business. A bad culture on the other hand can destroy an organisation. But what makes a good and bad culture? Well, that's open to interpretation. From my experiences, a good culture is one in which everyone is encouraged to grow to their full potential. A bad culture on the other hand is one in which you're seen solely as a worker and not as a person.

In the banking industry, it appears to me that managers operate in a culture where you're encouraged to take risky short term decisions in order to maximise short term shareholder wealth, rather than do what is best for the employees and the organisation in the long term. To me this is a bad culture. Yes you need to keep your shareholders happy, I dont dispute that, I just think that risking a lot to do that is the wrong message to promote. If I was a shareholder I'd be more interested in having a stable income for ten years than having a few years with large payments and a few with little to no returns. But that's me.

If I was in a position now where I could make a difference in the banking industry I'd be seriously questioning whether the culture being promoted is the right one. And fundamentally I'd be asking whether banks should be running in the interests of shareholders or stakeholders.

Nothing's going to fix the banking crisis over night, especially not a change in culture. But maybe if someone was to take this into consideration, it might prevent more problems in the future.

Are Auditors to Blame for the Credit Crunch?

In 2007, the world began to feel the effects of the global credit crunch. A credit crunch we are still struggling to recover from 6 years later. A number of groups and organisations have been blamed for the cause of the crisis, but one such group which has received criticism is that of the auditors. In 2008, Prem Sikka (a Guardian journalist) wrote "Each collapse shows that highly paid directors had little idea of the value of company assets, liabilities  income, costs, profits and financial health. This has been accompanied by one constant factor: the silence of the auditors. Auditors collected large amounts in fees and dished out clean bills of health." But are the auditors really to blame?

In some sense yes. As an auditor your job is to search for evidence to enable reasonable assurance to be given on the truth and fairness of financial and other information provided. Therefore the hidden and undervalued assets on the balance sheet should have been raised as issues as they don't provide a true and fair representation of the real situation. But what is key within the description given of an auditor's job is the words "reasonable assurance". In my opinion reasonable assurance is a subjective term and one person's view on whether they can reasonable assure that something is correct will differ from that of another. So can the auditors be blamed for being reasonably assured that what they is seeing is right?

In my opinion, no they can't. As Sikka said many of the companies being audited didn't know the value of their own assets so how can the auditors know whether, based on the information they've been provided or have requested, the assets are valued correctly? Yes they probably could have dug a bit deeper than they originally did but if the information isn't there within the company for them to dig into how are they supposed to give an accurate judgement?

This leads me to believe that despite a number of groups, organisations and individuals being blamed for the crisis the fundamental cause of the problem was the banks themselves. With a culture and reward packages based around becoming the biggest and best bank in their market it is no wonder that many organisations manipulated their accounts, didn't value their assets properly etc. They were being rewarded extremely large bonuses for doing well, who wouldn't adapt things slightly to suit them better if you were going to get an additional £1 million in bonuses?

So yes, auditors should have been a bit more proactive and aware of tricks being played, but fundamentally the issues lie within the banks and their corporate governance structures and it needs addressing so as to prevent anything like this happening again.

Thankfully, I'm not the only one to realise this. Since the crisis banking corporate governance (BCG) has been investigated and it has been found that typical corporate governance and BCG differs in some ways. Realistically, since the global banking industry is the biggest industry in the world you'd have thought this would have been looked at long before now, but no it was only as a reaction to the crisis that BCG was looked at. Hopefully measures will now be introduced to improve BCG and prevent another crisis in the future. And hopefully, the auditors will take into consideration the lessons they have learnt and be a bit more cautious in the extent that they are reasonably assured the information is correct.

Vodafone and Verizon Merger

Last week I discussed FDI, today I will consider one possible type of investment opportunity: Mergers and Acquisitions. Mergers and acquisitions (M&A) involve the buying, selling, dividing and combining of different companies and legal entities. M&A trends tend to occur in a cyclical pattern in line with changes in domestic and world economies. The last cyclical trend began in 1999 during the tech boom with a significant increase in the number of M&A activities, and their values, compared to previous years. When the tech-bubble burst and economies began to slow, the level of M&As fell. 2004 is believed to be the end of the downturn, and the start of our current cycle.

Despite being in the downturn of our cycle, there are still M&As occurring. Today, the focus is not on the trends of M&A activity, but on the merger of Vodafone and Verizon. Vodafone currently possesses a 45% stake in Verizon, but this week it has been announced that Vodafone hopes to up it's stake and fully purchase the company. The deal, worth $160 billion, will potentially result in the largest M&A activity on record. But what can both parties expect during and after the merger, and is it a good idea?

In Anglo-American organisations, the fundamental principle is to maximise shareholder wealth. But to what extent will this occur? The answer is dependent upon how you view the acquisition. Theoretically, the shareholders of the target company (i.e. Verizon) are likely to see their wealth maximised as their share prices rise by 30%. However, for the shareholders of the bidding company (i.e. Vodafone) they are likely to experience little or no gain on their shareholder wealth. Why? Because investing into Vodafone at that moment in time would be too risky as the success of the activity cannot be predicted. So the question is raised, if the wealth of Vodafone's shareholders is not being maximised then why is the activity being performed?

In my opinion, the reasoning behind the Vodafone and Verizon transaction is to provide synergy between the two organisations. This basically means that the two organisations together are worth more than they are separately. It is argued, that if the merger occurred 70% of Vodafone's total earnings would be from Verizon, a significant increase from the 40% it had in 2010. I believe that by entering into this merger, Vodafone will see an increase in market power and presence, allowing them to receive better economies of scale and easier entrance into new markets and industries.

However, a worrying thought is that there could be some managerial motives behind this merger. It is speculated that Vodafone's management are also pursuing other possible acquisitions and mergers if the Verizon one was to work successfully. Could this be an indication that Vodafone's management are looking to increase their own status and power, and possibly build their own empire? If so, this is very concerning for all parties and stakeholders involved.

For me however, I feel that the most worrying and concerning aspect of this merger is the reaction from Verizon's management, the press and some stakeholder groups. There are a lot of criticisms regarding these discussions, and a lot of reluctance from Verizon to agree to the takeover. This strongly suggests to me that if the acquisition was to occur, it would not occur easily and may damage shareholder wealth in the future.

Studies have found that there are three key reasons why mergers fail; misguided strategy, over-optimism and failure to integrate management. If the Vodafone Verizon transaction was to fail, my bet would be on failure to integrate management being the reason behind it. I feel that there is already too much resistance to the news now, and this will only get worse as talks continue. This is likely to result in damaged morale for the takeover company and won't provide the synergy and savings Vodafone are hoping to benefit from.

Personally, I can see why Vodafone would want to enter into this deal, and I can understand some of the reasons behind why Verizon are against the deal. I don't think there's an easy resolution and at some point one side will have to compromise. For the time being this is a news story I will be closely interested in and hope that whatever happens, it happens successfully. These are two good companies, who need to focus on maintaining their good relations with each other if they hope to continue working together in any way in the future.

Foreign Direct Investment

In Anglo-American organisations is it argued that the overall aim of the company is to maximise shareholder wealth. One way to do this is through foreign direct investment (FDI). FDI is the purchase of physical assets or a significant amount of a company's ownership in another country so as to gain a measure of management control. But, why do companies choose FDI over other options such as exporting or licensing?

Truthfully there is no simple answer to this question. It depends on the circumstances of the organisation. If I was a UK based organisation looking to expand my target market, and sell my products in Europe the sensible choice would be to export. It would be relatively low cost and wouldn't require any large levels of financing or transferring of knowledge. But if I was the same organisation looking to expand my target market, and sell my products in Latin America, licensing and FDI would be more sensible choices than incurring large transport costs through exporting. The choice lies solely with the organisation. But that does not mean we can't speculate why an organisation has opted to do something the way they have.

Let's take Kraft, for example. Kraft Foods Group Inc are a US based food conglomerate who in 2012 announced their acquisition UK based chocolatier, Cadbury. The reason? So they could expand into the snack business of emerging markets, in particular India. But why, if their sole aim was to expand into new markets, did Kraft choose to invest into the UK?

In FDI theory there are a number of reasons discussed as to why organisations choose FDI over exporting or licensing. A lot of these theories, such as market imperfections, transport costs and eclectic paradigm, could be easily applied to Kraft if they had opted to invest in India, or another developing market, rather than the UK. But the question is not why India, the question is why UK? Why Cadbury?

I think the answer to that is in the question itself. Kraft have not chosen to invest in the UK for it's location, it's easy access to other locations, it's stable economy etc. They have chosen to invest in the brand, Cadbury. And who could blame them? Cadbury as a brand name was known in over 50 countries worldwide and was the industry's second largest globally. Having Cadbury in their brand portfolio was not only going to provide Kraft with an easy way into new developing markets, it was going to allow them to enter existing markets with minimal effort, develop upon existing product ranges and ultimately maximise their shareholder's wealth. Cadbury had the skills and knowledge needed to operate on their own so Kraft was not risking any knowledge transfers and was minimising it's exporting costs to some places in the process.

The Kraft takeover wasn't as smooth as Kraft would have probably liked. There was a lot of negative press regarding the takeover, especially in the UK, and Cadbury themselves weren't keen on the acquisition in the first place. Up until now I've never really had an opinion on the Cadbury takeover, but it's seems to me that Kraft's reason for acquiring Cadbury isn't as transparent as the reason they gave to the press. Yes saying you're buying Cadbury so as to reach new developing markets may be true, but it just seems that there are a number of other ways FDI options that could have been explored which would have made more sense, theoretically anyway. In my honest opinion, the whole purpose behind this method of FDI was to maximise shareholder wealth by buying into the brand. And since I've already said that is the main aim of an organisation, I can't really argue against the decision.

The only things certain in life are death and taxes

In an age where emphasis is placed on improving turnover and reducing costs, it is no wonder many organisations have begun to view tax as an expense they can reduce. Tax is a legal obligation and whilst tax evasion is illegal, tax avoidance is not. The key debate is whether organisations are acting ethically by using tax avoidance schemes.

Margaret Hope (Chair of the Public Accounts Committee) argues tax avoidance is "completely and utterly immoral", a view echoed by much of the media and British MPs. Whereas, Eric Schmidt (Google's Chairman) is proud of his company's avoidance and argues they acted within the rules set out by governments. So, who is right? As with any ethical dilemma, this is a difficult debate and depends entirely on what the observer of the activity believes is legitimate behaviour.

It was once said that "the only things certain in life are death and taxes", although this quote was aimed at individuals I believe the meaning still stands with organisations. Tax is a legal obligation and is something no one can avoid. We as individuals are required to pay tax upon our earnings, value added tax (VAT) is included in the majority of our purchases and business are required to pay corporation tax. It's safe to say that at some point in your life you're going to pay tax. But, who's to say that you shouldn't try to minimise the amount you're paying? That I believe is the real issue. We can argue all day about whether tax avoidance is immoral, but we wont resolve the dilemma unless we adress the fundamental problem, and that is how do we stop tax avoidance from happening? 

Since the announcement at the end of 2012 that Starbucks, Google and Amazon had all used tax avoidance schemes to improve their financial positions, the need for combatting the issues has become apparent. Unfortunately, this is not something that can easily be done by one government alone and is why the G20 committee have convened this week to come up with a global strategy for resolution. But how easy will this resolution be? In my opinion, not very.

The underlying issue is the irregularity of tax rates across the world. The UK has a corporation tax rate of 26% (2012), whereas companies in Ireland pay just 12.5% (2012). In the USA corporation tax is 35% (2012), whilst the Cayman Islands have a tax rate of 0% (2012). It is this range of tax rates and an increasing ease to set up companies abroad which has led the way for tax avoidance. And although the resolution seems simple, setting one standard tax rate for all countries across the world is not an option. Doing this will only result in damaged relations and reduce the ability for organisations to trade and develop internationally.

I personally don't believe tax avoidance is immoral. If an organisation is playing within the rules then I do not see why an organisation should not be able to exploit these. However, it is very likely that Google, Starbucks and Amazon will not be the only companies criticised by the media over the next 12 months for using tax avoidance schemes and to ensure that some tax is payed into the UK economy I definitely agree that something needs to be done to combat the issue. What that something is, I do not know. That is in the hands of the G20 committee, and is a piece of news I look forward to reading.