debenhams - dividend policy

Jason Cates Dividend Policy Ravi Patel

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Dividend Policy

Written by

Jason Cates Ravi Patel

09200538 08206396


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© Jason Cates and Ravi Patel, 2013

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acknowledged sources.

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Any queries regarding this publication should be sent to:

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To be delivered to the University of Hertfordshire on or by

8 March 2013

Ordered by Jason Cates and Ravi Patel to be printed

8 March 2013

Printed in the United Kingdom


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Part I: With reference to appropriate theory, critically evaluate the dividend and share

buyback policies of Debenhams plc. Your discussion should include an evaluation of share

buybacks as an alternative to dividends.

Word count: 2000


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Table of Contents Introduction ...................................................................................................................................... 4

Dividend Policy .............................................................................................................................. 4

Share Buyback ............................................................................................................................... 5

Theories ............................................................................................................................................ 6

Modigliani & Miller ........................................................................................................................ 6

Signalling Effect ............................................................................................................................. 6

Clientele Effect .............................................................................................................................. 7

Management Incentives ................................................................................................................ 8

Performance Indicators ................................................................................................................. 8

Business Life Cycle ......................................................................................................................... 8

Conclusion ....................................................................................................................................... 10

Signatories ...................................................................................................................................... 11

Referencing ..................................................................................................................................... 11

Appendix ......................................................................................................................................... 13

Appendix 1 – Debenhams Ownership Summary ........................................................................... 13


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Introduction This paper evaluates Debenhams share buyback and dividend policies and considers their

implications on shareholder return. This will be carried out by considering such policies in relation to

relevant theory and conclude by considering the appropriateness of these policies in returning

shareholder investment.

Dividend Policy The graphs below show Debenhams level and costs of dividend since 2008.

(Debenhams, 2008-2012)


Debenhams reduced its dividend to 0.5p a share in 2009 and went on to cancel its dividend

in 2010. This was in order to refinance its debt and improve upon its cash position which, in 2008,

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fell to -£2.9M. Cancelling its dividend allowed Debenhams to increase its cash level by £191.1M

between 2008 and 2009 and to repay 25% during the financial year 2011.These investments reduced

Debenhams bankruptcy and financial risk by lowering its interest payable and improving its short-

term liquidity. (Debenhams, 2008-2011)(Watson & Head, 2010)



Share Buyback In 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 a

dividend. Companies are generally reluctant to issue increases in dividend in which they may have to

reverse. Share buybacks are a way avoiding this problem and increasing cash pay-outs without

having to reverse the decision in following years. A share buyback will also enhance the value of the

remaining shares further contributing to shareholder return. (Barrett, 2011)(Brav et al, 2005)

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Theories Modigliani & Miller

Modigliani and Millers proposal incorporating both tax and bankruptcy risk concluded that

increasing 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 in

addition to interest payments acting as a tax shield against profits. However, when gearing reaches a

critical point, the associated increase in bankruptcy risk will drive up this WACC and eventually

outweigh the cost and tax benefits of financing by debt. (Watson & Head, 2010)

An underlying assumption of this proposal is that shareholders are indifferent between

returns being in the form of dividend payments or capital growth. However, this ignores the

signalling and clientele effects, both of which will have an effect on a company’s cost of equity based

on 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 and

the resulting bankruptcy risk. Debenhams dividend was reduced to 0.5p a share in 2009 and

cancelled in 2010, this capital was then reinvested in improving Debenhams cash level and repaying

its liabilities. In 2008, Debenhams net cash position stood at minus £2.9M; by 2010 this had reached

positive £188.2M. Furthermore, total liabilities fell from £1.86Bn in 2008 to £1.39bn by 2011. During

this time, Debenhams saw its share price double from 39.75p per share in August 2008 to 79.5p per

share by August 2009. This level of share price growth implies that share price and therefore total

shareholder return are affected by other factors beyond simply dividend payments. (Debenhams,

2008-2011)(LSE, 2013)

Signalling Effect Specific dividend and share buyback policies will signal specific information to shareholders

and other investors.

The cut in dividend in 2009 and 2010 can signal two things. The first of these is that

Debenhams may be entering a phase of declining performance and thus, can no longer afford to pay

a dividend to shareholders. However, the second category involves the company prioritising

investment 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 when

discussing the signalling effect. This relates in part to the business life cycle which will be discussed

later 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 the

refinancing of its debt, it managed to convince its shareholders that it came under this second

category involving investment in NPV’s. Moreover, this change in dividend policy attracted more

investors leading to an increase in share price as shown in the graph below. This implies that

investors have other considerations beyond simply the level of dividends which will be discussed in

the clientele effect. (Debenhams, 2012)


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(Debenhams, 2012)

In relation to Debenhams share buyback policy of 2011-2012, Debenhams saw an increase in

share price occurring around the same time period it implemented this policy. Although there may

be other factors causing this share price increase, it may be partly due to the signals such a policy

sends investors. In this case, investors have taken it to mean the company has surplus capital due in

part 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 signals

regarding future company performance. (Debenhams, 2012)

Clientele Effect The effects these policies had on company share price may be due in part to the clientele

effect. 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 form

of 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 investments

hold only a minority shareholding in Debenhams. This is compared to Debenhams top ten

shareholders that mainly consist of investment and asset management companies and together hold

a 57.9% shareholding. These investment funds generally, but not always, prefer capital growth over

high 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 of

capital gains tax and therefore, would prefer high capital growth over dividends. As such, by

cancelling its dividend in 2010 and issuing a share buyback in 2011, Debenhams is appealing to this

specific clientele. (Debenhams, 2013) (Grullon & Michaely, 2002)

This theory is supported by the increase in Debenhams share price as mentioned earlier

after it announced these changes in policy. This suggests that variations in dividend and share

buyback may have an impact on shareholder return in the short-term. As such, the clientele effect is

a significant factor when deciding upon share buyback and dividend policies. This is due to each of

the two polices appealing to different types of clientele. However, research has found that

alternating between these two policies has no effect on long-term shareholder return and they

simply act as “substitutes”. (Skinner, 2008)


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Management Incentives In regards to management incentives, Debenhams CEO Michael Sharpe currently owns

2.46M shares/share options in the company alongside CFO Simon Herrick’s 647,127 shares/share

options. This share ownership means the company’s two executives have a personnel interest in

maintaining or improving upon Debenhams share price. In regards to Debenhams share buyback

policy, if total “corporate value” is to remain stable, having fewer shares on the market should lead

to a higher share price. In regards to Debenhams, after implementing its £40M share buyback, its

share price had grown to 96.05p per share, up from 55.35p a year before. As stated, this may be due

in part in the reduction in the overall number of shares. However, it may also be due in part to the

signalling and clientele effects which will be discussed later on in this paper. (Debenhams, 2013)(LSE,

2013)

Performance Indicators From a corporate reporting perspective, having fewer shares can contribute to improving

key performance indicators. The first of these is earnings per share (EPS). Prior to the share buyback

in 2011/2012, Debenhams EPS was 9.1p with profits of £160.3M. After the share buyback, EPS had

increased to 9.8p, even though profits had declined to £158.3M. This increase in EPS despite

declining 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 improving

upon the company’s current dividend. In 2011, Debenhams paid dividends of 3p a share with a total

cost 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 without

incurring the cost of such an increase. Therefore, although issuing a share buyback reduces company

capital in the short-term, the lower costs of maintaining or improving the company dividend will

likely offset this in the longer term. (Debenhams, 2011-2012)(Grullon & Michaely, 2002)

Business Life Cycle In regards to the business life cycle, Debenhams share buyback policy implies the company is

entering a stage of decline. Firstly, by returning capital to shareholders rather than reinvesting it in

the business may suggest the company lacks positive NPV’s to invest in. If a company fails to invest

in new NPV’s, the company will enter a stage of decline when it’s current NPV’s start to reach the

end of their lifespans. Secondly, issuing a share buyback reduces the number of shares in the

company and helps to improve the company’s share price. This suggests the company believes their

shares are likely to underperform in the near future. This need to maintain share price further

implies 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 two

things. Firstly, it could mean the company does not have the capital to pay out a dividend due to

heavy investment in new NPV’s, leading to higher capital growth in the future. This may suggest the

company is entering a new growth or “rebirth” stage. However, having insufficient capital to pay a

dividend might also suggest a decline in company performance, further implying that Debenhams


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might have entered the decline phase. Using the savings from reduced dividends in 2009 and 2010

to invest in cash and lower debt suggests Debenhams comes under this first category. This is further

supported 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 when

there is a need to return capital to shareholders over a short period of time. In contrast, dividend

payments may be more suitable for more stable mature companies who can afford to maintain this

dividend over the longer term. (Watson & Head, 2010)


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Conclusion As stated earlier, research has found that differences in dividend and share buyback policy

have no real impact on long-term shareholder return. Furthermore, this research has found that

these 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 which

hold significant influence on the suitability of these policies. Share buybacks may be more

appropriate for declining companies who wish to return capital to shareholders over a short period

of time. Whereas dividends may be more appropriate for mature stable companies with the

profitability to maintain such a dividend in the long-term.

Regarding the clientele effect, companies largely owned by short-term investors would be

encouraged 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 policy

focused around paying regular dividends. Both these policies appeal to different types of investor

and should be implemented as appropriate.

Relating to Debenhams, issuing a share buyback appeals to its main shareholder clientele of

investment funds whose timeframes are generally in the short-to-medium term. The reduction in its

dividend in 2009 might imply that it was on the verges of decline. However, the reintroduction of its

dividend in 2011 suggests it has entered the “rebirth” stage of the business lifecycle.


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Signatories We commend this paper to the University of Hertfordshire to be delivered on or by 8 March 2013.

Jason Cates

Ravi Patel

___________

Mail: [email protected]

Portfolio: SlideShare.net/AdrJasonCates

LinkedIn: LinkedIn.com/in/AdrJasonCates


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Referencing Barrett C., (2011) ‘Debenhams rises 7% over buy-back plan’, Financial Times, 21st October 2011

Brav 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 – 527

Debenhams (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]


ir.net/media_files/IROL/19/196805/reports/ar2009_new.pdf [Accessed: 11th February 2013]


ir.net/media_files/IROL/19/196805/agm2010/ar2010.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 – 1684

LSE (2013) Debenhams 2013. Available at: http://www.londonstockexchange.com/exchange/prices-

and-markets/stocks/summary/company-summary-

chart.html?fourWayKey=GB00B126KH97GBGBXSTMM [Accessed: 21st February 2013]

Skinner D. J. (2008),’The evolving relation between earnings, dividends, and stock repurchases’,

Journal of Financial Economics, Vol ume87, Issue 3, pp. 535 - 740

Vernon (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: Prentice

Hall.

http://media.corporate-ir.net/media_files/IROL/19/196805/reports/ar2008_new.pdf




http://media.corporate-ir.net/media_files/IROL/19/196805/agm2010/ar2010.pdf






http://www.debenhamsplc.com/phoenix.zhtml?c=196805&p=irol-ownershipSummary

http://www.londonstockexchange.com/exchange/prices-and-markets/stocks/summary/company-summary-chart.html?fourWayKey=GB00B126KH97GBGBXSTMM




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Appendix

Appendix 1 – Debenhams Ownership Summary

Top 10 Shareholders Shares % O/S

Share Change

Schroder Investment Management Ltd. (SIM) 202,969,928 16.2% -5,908,364

Milestone Resources Group, Ltd. 89,183,155 7.1% 0

Majedie Asset Management Limited 66,480,510 5.3% 55,719,596

Artemis Investment Management LLP 63,855,868 5.1% 0

Standard Life Investments Ltd. 63,332,751 5.0% -13,492,714

Bestinver Gestión S.G.I.I.C. S.A. 61,554,348 4.9% -52,588,229

AXA Rosenberg Investment Management Ltd. 60,803,116 4.8% 0

Legal & General Investment Management Ltd. (UK) 42,075,474 3.4% 0

Norges Bank Investment Management (NBIM) 38,491,542 3.1% -333,675

LSV Asset Management 37,668,430 3.0% -790,500

Mutual Funds Shares % O/S

Share Change

Bestinver Internacional FI 57,284,726 4.6% -4,406,677

Bestinfond FI 37,751,534 3.0% -2,826,268

Statens Pensjonsfond Utland 35,340,709 2.8% 14,752,863

Delta Lloyd Select Dividend Fonds NV 20,100,000 1.6% 350,000

Old Mutual UK Select Mid Cap Fund 18,981,000 1.5% 1,555,000

CIS UK Growth Trust 18,000,000 1.4% 7,500,000

Aberforth Smaller Companies Trust plc 13,952,178 1.1% 2,307,436

Bestvalue FI 11,059,184 0.9% 11,046,913

St. James's Place Balanced Managed 9,502,150 0.8% 0

Old Mutual UK Select Smaller Companies Fund 9,315,000 0.7% 609,000

debenhams - dividend policy

Economy & Finance