Dividend policy: BP decided to increase dividend as profit rise

The final stage of maximizing shareholders wealth is how to return benefits to those investors and dividend is one of the ways to return the profits. However, the decision whether company pays dividend or not affect shareholders’ wealth. Miller & Modigliani (M&M) argued that dividend policy and share prices are irrelevant in theory. However, in reality, their argument still work? In reality, divided policy is related to share price.

What make reality different from theory?

Firstly, there is a group of investors concern much about stable and trustful cash flow from dividend. A rapid change of dividend policy, especially cut the amount of dividend (although using as retain earning to invest good future project) cause negative reaction from investors. Why  do investors concern so much about dividend payments? Reality is not perfect. Changing in dividend policy make investors have to change their investment portfolio, suffer tax payment. Both elements create expense which will turn profits of their future investments to dust. Investors will suffer lose due to minimize shareholders’ wealth. Second, the level of future risk acceptations of investors is different. Do you prefer receive dividend today or keep it for future investments which are consider as increase benefits? How many percentages do future projects success? So you would like to receive dividend or reinvest? Moreover, as mention about, reality is not perfect. Investors have to face a lot of expense such as: transactions costs, tax and agency costs.       

Thus, what company should do is keep a stable dividend policy and avoiding suddenly change if does not carefully consider its long-term effects. However, the stable dividend policy often makes investors think about its growth. Does company not develop much which related to unchanged dividend policy? Moreover, if company makes a lot profits while does not have any or have few positive projects, the result is company will keep to much cash due to waste money. All of those affect negative to share price due to shareholders’ wealth.       
        
As a example of dividend policies, according to BBC News (2012), BP has increased its dividend to shareholders by 14% because of increasing in profit. It seems to be a good news to investors. However, in reality, share prices of BP still suffer some lose because the legal liabilities because of the 2010 Gulf of Mexico oil spill continue to affect the company's shares. Thus, does the dividend policy relate to share prices? Or I wonder that because of the legal liability badly affect share price so BP has rise dividend payments in order to attract investors to increase share price which got negative suffer from the liabilities.     

In my opinion, the dividend policy does not solely affect market share price. There are other factors along to dividend policy affects share price.    

Source:   

http://www.bbc.co.uk/news/business-16915491

Capital structure: De Beers plans to cut debt

BBC (2009) stated that De Beers plans to raise its capital investments from investors to $1billion to reduce its debts. I think about my previous lecture topic’s capital structure. If the low level WACC of project presents high level of present value of future cash flows thus shareholders’ wealth is increasing, it will be beneficial to company with high level of debt. As the debt level increases, the actual cost of loan to the company is lower because the interest on the debt is deduced. Moreover, lenders does not share profits to company’s profit. They only require a fixed amount of interest annually. In addition, lenders do not dilute ownership interests and control of existing shareholders. In general, the cost of debt financing is cheaper than equity financing.

However, why De Beers plans to increase equity instead of debt? The problem incurs because of advantage of debt compared to equity which is company only has to pay a fixed amount of money and doesn’t have to pay any extra amount of money when company makes profit. Problem is what about when company makes lose? Company still has to pay that amount of money without any discount. De Beers experiences a bad year in which first-half profits fall by 99% as a result of a collapse in the price of diamonds. How can De Beer pay for the interest of current amount of debt ($3.5bn) while it has financial trouble? In this case, I think the De Beers’ s decision to increase level of equity is right. According to the case, it remind me about the advantages of equity compared to debt, during difficult financial periods, high level of equity can avoid company from risk because equity financing does not require to be paid. Moreover, the larger level of gearing, the more risky lenders and shareholders consider company. Lenders and shareholders would require more interest and dividends to guarantee their interests.

The lesson is that high gearing level is not always is the goods options. There is no perfect capital structure fomula applying to all project and company in imperfect world. In term of diversification approach, company should raising capital by both equity financing and debt financing because the two forms of financing together can work well to reduce the downsides of each. However, working to find out the right ratio is every difficult in order to maximize shareholder wealth. Depend on particular situation; company might decided the suitable capital structure to fit with the requirements. It will vary according to various aspects such as: type of business, revenue and profits, cash flows and a mount of money need to be financed.

Source:

http://news.bbc.co.uk/1/hi/business/8387839.stm

Socially responbile Investment: VEDAN Vietnam issue

After finishing my lecture about SRI, it reminded me about issue of VEDAN Company in Vietnam, my own country. VEDAN company seems to have no responsibility to Vietnamese people and environment when discharge untreated waste into Thi Vai River, made the pollution level increasing. In 1995, VEDAN had compensated Vietnamese people near Thi Vai River area 15 billion VND however, the issue was keep continuing until early 2009 when VEDAN Vietnam was caught in flagrant. As a result, the life of Vietnamese people near the river was affected badly.

Why was VEDAN Vietnam so bad about corporate social responsibility? I think it is all about company’s recognization of CSR.  According to research by the World Bank, barriers and challenges to the implementation of social responsibility of enterprises, including: awareness of the concept of social responsibility is limited; productivity affected to make and many rules of behavior and lack of financial and technical resources to carry out social responsibility standards (especially for small and medium enterprises); the confusion caused by differential regulation of codes of conduct and the Code of Labor and local regulations affecting the implementation of the code of conduct. As such, the implementation of social responsibility of business is not an easy problem. However, in this context, I think company need to take social responsibility because consumers, investors, policy makers and non-governmental organizations worldwide is increasingly more interested in the impact of globalization on workers' rights, environmental and community welfare. The company does not make social responsibility can no longer market access opportunities. Consider VEDAN case, now reputation of VEDAN Vietnam is not as the same as in the past. Compare to AJINOMOTO Vietnam, the profit and market share of VEDAN is much less as a result of ignore CSR. If I were a social responsibility investor, I would rather not invest in VEDAN because of what it did to my country.

Social responsibility investment covers many more aspects. Many studies have shown that a modern enterprise can only be considered as social responsibility investment when ensuring their activities do not cause harm to the ecological environment i.e. to show the environmentally friendly in its manufacturing process.  This is a very important criteria for consumers. Firm has to concern about its employees not only phisical but also on mental.  Firm forces employees to work until exhausted or has no solution to help them reproduce their labor power are entirely against to the social responsibility.  Company must also respect the equal rights of men and women, not be discriminated against in terms of gender in employment and wages. Moreover, firm has to provide good quality product, not harm the health of consumers, this is a very important criteria of being responsible business to consumers. Company should aside part of their profits to contribute to the community support activities. Because community and burden to the community is a goal that businesses have social responsibilities towards the development objectives alongside its profits. Indeed, there are many children were saved, more children are in school ..., if businesses are willing to share with the community benefits.

However, the problem is how company can balance all those aspects and support shareholder wealth when has to spend a lot of money to those social issues. I think CSR is not about company’s own responsibility, it is about shareholders’ responsibility as well. That is what we call socially responsible investment. Investors will make investment decision where they concern and think it is right by themselves.        

Credit crunch in 2008: the main reasons and effect on Vietnam’s economics

The direct and most obvious cause of the financial crisis is the collapse of the real estate market. There are three main factors created a bubble in real estate market. 

Firstly, starting from 2001, to help the economy out of stagnation, the U.S. Federal Reserve (Fed) has continued to lower interest rates, leading to the bank to lower interest rates for mortgages real estate.  In mid 2000, the Fed's interest rate is above 6% but then interest rates were cut continuously, until mid 2003, only 1%.

Secondly, in terms of home ownership, the government's general policy at that time was to encourage and create conditions for poor people to borrow money easily to buy a home.  This is done largely through two companies are government-sponsored Fannie Mae and Freddie Mac. The two companies will help to pump capital into the real estate market by buying loans of commercial banks, turn them into vouchers secured by mortgage loans (mortgage-backed securities - MBS), and then sold to Wall Street investors, especially investment banking giants like Bear Stearns and Merrill Lynch.

Thirdly, because of the transformation of loans into investment instruments, the credit markets to serve the real estate market is no longer the sole playground of the commercial bank or other lending company specializing in real estate mortgage anymore.  It has become a new playing field for investors, is able to mobilize capital from anywhere, including foreign capital flows.

Because the formation, trading, insurance and MBS, is extremely complex, it is out of control of the government generally.  Because of lack of control, the greed and adventure have become popular characteristics of investors. In addition, because the majority can sell loans to other companies that turn them into MBS, the commercial banks have become more risk in lending, despite the possibility borrower's repayment capacity.

For three reasons, the real estate market became very busy, there are many low-income people who have good credit or not, rushing to buy the house.  Regardless of ability to repay the subprime group, loan for this group skyrocketed. Because of easy loans, housing demand is very high up, pull up the property prices continuously.  This also leads to investment problems that people expect house prices will continue growth.  As a result, consumers are willing to buy houses at high prices, regardless of actual value and the ability to repay because they think they will sell if necessary to repay the bank.  Therefore, a bubble has formed in the real estate market.

 In addition, because of differences in risks of all kinds of MBS (mortgage-backed securities), so the insurance companies and risk assessment, such as AIG, also jumped in to sell insurance for investors MBS (mortgage-backed securities).   This incident has created new series and added other components to jump into the game, because this type of insurance sold in the real booming estate market are very profitable.

Worry about changes in inflation, Federal Reserve began increasing interest rates, forcing the banks to push interest rates for mortgages higher more; leading to the real estate market slowdown began in early 2006.  High interest rate cause the intensity of borrowing loans to  buy houses decreased .  House prices began to slide as supply exceeded demand.    People begin to lose the ability to repay beucase the new interest rates were adjusted quite high.  As a result, they decided to leave home for the bank expropriation.

 The more people unable to pay the bank every month results the value of the MBS was declining.  Thus, the devaluation  of MBS means that their properties lose value due to capital shortage.  Besides, the insurance company MBS, such as AIG, also fall into the hell when they guarantee more bad loans.  In addition, the commercial bank or mortgage company retains most of its loans also look at capital flows and their credit is exhausted because of loss rate repayment capacity of borrowers increasingly

In summary, because there are many tangled relationships between borrowers and lending components for direct and indirect, the decline in the real estate market has a direct effect on the financial markets in general.  Degree of spread and severity of the problem is due to the buyers and sellers of financial instruments has pulled too many investment components, inside and outside the country, in the game in the rules of the playing field is still missing or unclear.

The impact of crisis on Vietnam economic is probably negligible. The direct effect is limited because Vietnam did not participate much in the world financial market participants and trading derivative securities. Direct investment (FDI) in Vietnam is probably not affected much by the crisis in the U.S. currency because the main investors in Vietnam are Japan, South Korea, Taiwan, etc. The influences of the U.S. recession on Vietnamese economic may be in the export sector.  The United States accounts for more than 20% of total export turnover of Vietnam.  Most of our products are exported to the U.S are apparel, footwear and seafood, so in short-term those export portfolios are influenced most.

Mergers and acquisitions: Pringles sold by P&G to Diamond Foods.

BBC News, April 5, 2011, Pringles was sold to Diamond Foods for $2.35bn (£1.44bn). Diamond will pay $1.5bn for Pringles and take on $850m of its debt. Bob McDonald, chief executive of P&G said it was a "terrific deal for our shareholders". If it is a bad deal which does not create P&G shareholders’ wealth, why P&G keep going on the deal. In P&G chief executive position, Mc Donald wants to increase the value of deal in purpose by stating the quote. In reality, P&G’s core business is a personal care and household products. Pringles as a food bands stood as the exception in P&G’s portfolio. It might not bring many benefits to P&G as it imaged. It would be difficult to manage business in two different kinds of industries. It would made P&G forget about it core business. Thus, I think the decision to sell Pringle is the right decision for P&G business and shareholders.
In 2010, Diamond Food had bought Kettle Foods Chips for $615 million from Lion Capital. In both case, they are both mergers deal but merger strategies are different. I am confusing whether Kettle deal are horizontal merger or conglomerate merger. Base on the definition, in horizontal merger two companies which are engaged in similar lines of activity are combines. The past core business of Diamond are popcorn and nuts while Kettle’s business is potato chips. Is it in the similar line of activities? In contrast, a Conglomerate merger is the combining of two firms which operate in unrelated areas. Diamond’s previous business and Kettle’s business are in the same industry, food industry. Is it irrelevant? In Pringle deal, I am sure that Diamond Foods conduct Horizontal merger in which Pringles Chips are combined with Kettle Food Chips of Diamonds Inc.
The motivation purposes of two mergers are different base on the different strategic merger. In Kettle merger, the motivation is entry to new market. Compare to precious business, Potato Chips market is completely different one to Diamond Inc. Thus, the quick way to enter potato Chips market is merger. One more motivation makes Diamond enterprise decided to buy Kettle Chips is risk diversification. The investment portfolios of Diamond were diversified when firm bought Kettle. The overall income of company will be less risky if profits of popcorn and/or nuts reduce. In another hand, the motivation of acquiring Pringles is different. One of the forces driving the acquisition is the attempt to increase market power of Diamond. Diamond already owes Kettle chips, and then bought Pringles will increase ability to control over the price of product in theory. However, I wonder that Diamond still keep the previous brand name of products separately, Pringle and Kettle, can this increase its market power or compete between two brand in the same company? I think it fails to control selling price in term of customer power. However, in term of supplier power, Pringles merger will reduce supplier power as a result, Diamond could control price over price of inputs instead of outputs. Another significant advantage of Pringles acquisition is the ability to exploit economics of scales. Merger Pringles to Kettle Foods helps Diamond save money in manufacturing capital, distribution channel, R&D, administration. Although two deals’ motivation has some differences, they might have the same motivation which is managerial motives. The acquisition might lead to mangers’ higher salary, power, and achievement satisfaction.

In the previous merger, Kettle deal, Diamond paid by cash to Lion Capital. It brought benefits to Diamond that are to retain the same level of control of shareholder over their company and the transaction gave greater chance to success because cash have obvious value then cash is more preferable. However, if Diamond borrowed the cash to pay for the Kettle deal, it might affect financial gearing of company. Investors do not prefer company which have high gearing ratio. From my point of view, just because the value of deal is not much $625 million, the decisions paying by cash of Diamond did not negatively affect shareholders’ wealth. It created Diamond shareholders’ value. In contrast, Pringles deal is a big deal compared to Kettle, $2.35 billion, so applying by cash is impossible. Diamond decided to pay $1.5 billion in stock market and $850 million in debt. Because it is a big deal, so paying by shares would not ruin the cash flow of Diamond intermediately, but it will affect the power of existing shareholders’ position. Diamond shareholders own about 43% while  P&G shareholders will own the rest. In this case, I think the company, which creates more shareholder value, is P&G rather than Diamond.

The stock price of Diamond increases because of the acquisition decision.(http://www.nasdaq.com/symbol/dmnd/interactive-chart). Diamond shareholders were happy about that. The Pringles acquisition might go well as both enterprises expected unless there is no Department of Justice’s investigation in Diamond accounting practices in 2012. The stock market of Diamond went down more than 60% value after DOJ reported which make Diamond be unable to finance the Pringles deal. February 10, 2012, the stock price of P&G fell down 0.3% as the result  P&G has decided it will cancel its sales of Pringles snack to Diamond Food Inc. If the sales were in process, the stock market price of P&G fell down more than that. Fortunately, after terminating its deal with Diamond Foods, P&G has now entered into an agreement with Kellogg to sell its Pringles for $2.7 billion in cash which makes P&G’s stock price grow to $72.   

In conclusion, the Kettle deal has expanded Diamond’s business and created Diamond’s shareholders wealth. In contrast, Pringles acquisition between Diamond and P&G did not complete and brought benefit to both companies. It ruin shareholder’s wealth of both companies especially, P&G. The reason for the merger failure is an unexpected and unmanageable reason which is DOJ financial investigation.      

Sources:

http://www.bbc.co.uk/news/business-12973728

http://www.forbes.com/sites/greatspeculations/2012/02/21/pg-puts-down-the-pringles-stock-going-to-72/   

http://www.bloomberg.com/news/2012-02-10/p-g-said-to-seek-termination-of-pringles-sale-to-diamond-foods.html

http://business.time.com/2012/02/15/kellogg-to-buy-pringles-pg-diamond-end-deal/

FDI in Africa : the transformation

On Friday, 2 March 2012, Reuters stated that “capital flows into Africa are seen growing significantly in 2012 as investors seeking higher returns out of Europe, look at the continent for better opportunities in infrastructure projects, a World Bank's senior official said.” The question is that why have FDI developed strongly in Africa in recent years? What are the reasons make foreign investors ignore Africa as a location for investment?

Why FDI is an importance for Africa? FDI is seen as the solution for Africa economics problem overall. There are some main keys reasons why Africa wants to attract FDI.

·      Lack of capital sources. FDI is considered as a large inflow of capital when Africa capital base is low. Is is actually right? Although FDI provide fixed physical assets, profit from investment is mobile. Foreign investors can take profit away and reinvest outside countries. Especially, in service industry, the investment in physical infrastructures is low, the mobile portfolio capital flows is highly important. Profits may be higher than the initial investment value and FDI may thus contribute to capital export.       

·      Lack of technology. FDI is expected as one of the methods bringing new technology to Africa. Foreign companies will use their home technologies, then the technologies will be transferred and adapted by local firms.

·      Lack of skills. It is the same as technology innovation. FDI is expected to bring new skills from foreign countries, transfer those skills to local employers and employees.

·      Employment development. FDI is seem as create job opportunities for local people. However, job creation is seem to be domestic benefits in Africa countries. Its means FDI in Africa will reduce people’s job opportunities in other countries.    

·      Competitive motivation. When Africa encourages FDI, the local enterprises will face the higher level of competition. It forced the firms work harder to survive and develop. It is also potential threats for domestic competition. Transnational companies can be harmful host economies by inhibiting entrepreneurship in the country. They will use their competitive advantages such as knowledge, skills, brand image and a variety of support services needed to beat the local competitors and prevent the emergence of local small-scale enterprises.          

Why Africa does not attract FDI much? Even through the location of Africa, the central world location, is one of its advantages, helps foreign investors take transportation advantage, there is a need to take consideration when making FDI decision in Africa. The main reasons are the Africa image does not favourable. Thinking about Africa, people think about unstable political area, starvation, social and help problems and economic disorder. Furthermore, there is a number of reasons that prevent FDI into African countries including market size, lack of policies, lack of profit opportunities, inconsistent setup, negative perceptions, shortage of skills, labour regulations, poor infrastructure and corruption (Consumer Unity Trust Society, 2002). It required high up-front cost and long time preparation when starting investment in Africa. It is indicated that extortion, bribery, and the lack of access to global markets are also some of the factors that discourage FDI in Africa.

So what African governments have done in order to encourage FDI? Africa countries improved their policies and regulatory framework to attract foreign investors, namely, incentives, investment treaties, and investment promotion. Since the 1980s, all SADC governments have comfortable regulations for foreign investors easy to entry:

·      By relaxing the ability to borrow locally although it implies a constraint on a country’s foreign currency reserves,

·      Relaxation of land and mining concession ownership,

·      By forming new kinds of partnerships with the private sector (public private partnerships) in areas, which were previously the responsibility of the government e.g. water distribution. (Mwilima, 2003)

Those regulations can be classified into three main fiscal, financial and rule or regulatory-based (Consumer Unity Trust Society, 2001):

·      Fiscal Incentives

·      Reduced tax rates

·      Tax holidays,

·      Double tax treaties

·      Subsidies,

·      Exemptions from import duties

·      Accelerated depreciation allowances

·      Investment and reinvestment allowances

·      Specific deductions from gross earnings for national income tax purposes

·      Deductions from social security contributions

·      Financial Incentives

·      Grants

·      Loan and loan guarantees

·      Rules-based incentives

·      Modifying rules on worker’s rights

·      Modifying environmental standards

·      Greater protection for intellectual property rights

Besides, Africa countries have entered investment treaties, both bilateral investment treaties and multilateral ones to encourage foreign investors (Consumer Unity Trust Society, 2001) such as the Convention establishing the Multilateral Investment Guarantee Agency (MIGA) and the Convention on the Settlement of Investment Disputes between States and Nationals of Other States

·      Fair and equitable treatment for foreign investors in terms of applications for investment approval and setting up their businesses

·      Specific provisions on expropriation and non-commercial losses and compensation for the same, and

·      Dispute or conflict settlement mechanism

Last but not least activities which Africa country have done in order to attract FDI is investment promotion. many African countries suffer from a negative image. To overcome the drawback, most African countries have established investment promotion agencies (IPA) whose role is conducting marketing activities to attract FDI  and take care of foreign firms once they operating in the countries (Mwilima, 2003):

·      By acting as a one stop for investors to deal with regulatory and administrative requirements, and

·      By changing or modifying investor perception of the country by attending and organizing investor fairs and by distributing materials.

·      Investment promotion covers a range of activities, including investment generation, investment facilitation, aftercare services, and policy advocacy to enhance the competitiveness of a location.

React to the offers made by African government, in recent years, the trend of FDI in Africa in increasing. Foreign companies are more willing to invest in Africa such as royal Ducth Shell, Vodafone, Unilever, Nestle, etc. For example, Hans Kuropatwa, director of Vodafone Group International state: "Private investors rather than governments are developing mobile telecommunications in Africa. The market is promising, as cellular services are an excellent alternative to the overstretched fixed networks that are in place in many countries. Vodafone places great emphasis on political stability in making investment decisions and is currently concentrating on developing its mobile telecoms businesses in Egypt, Uganda and South Africa."  Changing image of Africa countries, stable political situation is more stable and potential growth opportunities have attracted foreign investment.  

However, all those intensives and actions are extremely favour to foreign investors? Foreign investors might use their economic power to overpower the government policies in order to get their own benefits and damage countries’ social benefits. They are able to take advantages in the form of excessive protection, tax reduction, investment allowances, specific provision, and employee’s right. Accidentally, African governments threat their society.  

In conclusion, FDI is significance to African economics however it potentially contains some drawbacks. Africa’s policies might be useful in the decade, but it might be against the economics in long-term. Thus, African governments need to carefully look at real situations, give right decisions.      

Exchange rate exposure: The fall of Yen currency

The yen has dropped to its lowest point against the US dollar in seven months (BBC news). The dollar rose to 80.24 Japanese yen late Wednesday from 79.71 yen in 21^st Feb 2012. According to BBC news, one of the reasons for the fall is    Part of the reason for the fall is the Bank of Japan's surprise increase of its stimulus measures. Another reason is the strengthen of USD.  

The fluctuation of Yen/USD exchange rate affects upon Japan’s multinational companies and multinational companies operating within the country. The bulk of Japanese exports and imports are denominated in U.S. dollars rather than Japan's local currency, the yen. Japanese exporters are likely to receive dollar revenues but incur most of their costs in yen. Likewise, Japanese importers make dollar payments though sales are likely to be denominated in yen.  

The fall of Yen against US Dollar have energized Japanese manufactures and the economy since Japan is heavily dependent on exports. The weak Yen make exporters cheaper overseas and therefore more competitive. For instance, car manufacturers such as Toyota, Honda and Mitsubishi, have been some of the benefits by the weak yen as it makes their products more competitive abroad. If the Yen’s strengths, it will be a worst hit for Japanese exporters. “Toyota, for example, bases its earnings on an exchange rate of ¥105: every ¥1 appreciation against the dollar costs the firm ¥35 billion ($350m) in annual operating profit. Almost 60% of the companies on the exchange's main market are trading at less than their book value.” (The Economist, 2008). An amount of cash, which Japanese exporters have received, will increase as the result of Yen’s fall. The fall also supports the demand of Japanese products and services so the market shares of Japan firms will increase. Generally, weak Yen have benefited Japanese exporters. However, some industries like automobile industry have to import raw materials, components from outsiders, the fall would incline the costs of those imports, and effect cost advantages. Even companies do not directly import raw materials from international markets, the fall indirectly take away cost advantages through their suppliers who use imports.              

In contrast, the fall brings the advantages for Japanese export companies while make disadvantages for Japanese import companies as well as foreign export firms. This is the drawback because overseas products’ price has been higher than domestics’ price. Profit, which importers and outsiders gain, will be less. Moreover, the weak Yen influences customer demand. The cheaper price of products and service of domestics will make customer switch from overseas products to domestics’ one. Market share of those companies will decrease as well. Foreign companies will lose their Japan market share.

The decline of Yen also effect multinational companies which operating in Japan especially US firms. The Japanese investment requires Yen currency. One, Yen drops against Dollar, the cost of international investment will decrease. However, returns and profits from Japanese subsidiaries have been decreased when foreign companies convert from Yen into USD.