Dividend Policy

Group-based case report Torstar Corporation BUSN81 Theory of Corporate Finance 2011 Autumn

1. Introduction

The case of Torstar Corporation suggests the plan and result of repurchasing its Class B shares in December of 1997. Besides this, the situation of its business structure, capital structure and expenditures, future plan are also described in the case. Therefore, the purpose of our case study is to state, analyze and drew to some important conclusions about Torstar Corporation, and try to estimate its power to compete with a new national newspaper. . Background Torstar Corporation was incorporated on February 6, 1958 and published Canada’s largest newspaper Toronto Star. It had two main rivals which are Sun Media Corp. and the Globe and Mail. One launching second national newspaper by Southam Inc. would also be one competitor of The Star. Since 1975, by acquisition of domestic and international book publishing and supplementary educational products, Torstar found its three major business, newspapers, book publishing and supplementary education.

After the acquisition of Troll in fiscal 1997, it also has one 3-year-time plan to acquire more companies which fit with its core business at the reasonable price. As of March 31, 1998, Torstar share structure included 5 million Class A voting shares and 34 million Class B non-voting shares. Since they believed prevailing Class B stocks were undervalued, they began to repurchase it back from December 17, 1997. In 1997 the debt-to-total-asset ratio was 18%, and management believed that 30% was more appropriate.

Actually they also suppose that they could carry a 50% debt-to-total-asset ratio if they had a suitable strategic acquisition. Therefore, based on this background, we will analysis the effects of repurchasing stocks of Torstar, the advantages and disadvantages of its leverage ratio and its ways to investment. Then by adding some assumptions, one prediction of Torstar’s power to compete with new launching rival is possible.

•  Overview of Cash Flow, debt, Operating Situation and Income

The company was doing well so far, until 1997.

The cash flow, operating situation and the income were all healthy. We can conclude that from the Balance-Sheet the company had adequate cash flow, exhibit 3 shows that the operating cash flow kept increasing from 1995 to 1997 with the free cash flow, this was enough cash for Torstar facing with some possible risky. The only problem is that how to stop the continued increasing free cash flow since too much cash means increasing costs of keeping cash and decreasing market value of cash. The amount about $50,000 would be a good expectation.

The three main business of newspaper, book and supplementary education were operated well, they had sustainable increasing revenue and stable expenditure, so the profit was increasing positively after 1993 acquiring the business of supplementary education, especially in 1997, it got a rapid increasing of net income. See the return of equity below, it shows a well increasing on return of investors. (Base on Net Income over Total Equity) The debt ratio was a little bit low as our analysis, it had space to increase.

But how? Increasing dividend payment or repurchase in the open market? We analyzed these two possible ways below.

• Dividend policy

Torstar Corporation has a stable dividend policy recent years which was to pay out 30 to 35 percent of the previous year’s operating cash flows. Cash dividend was paid regular quarterly which was keeping $0. 26 per share in 1997. Dividend empirically decreased in the propensity of firms due to its benefits are not attractive than repurchase, but it is still important for management. Advantage of payout dividends . Dividends may appeal to investors who desire stable cash flow but do not want to incur transactions cost from periodically selling share of stocks

On behalf of stockholders, paying dividends can keep cash from investors

Dividends can be used to reduce agency cost of managerial discretion * Managers may increase dividends to signal optimism concerning future cash flow

Disadvantage of payout dividends

• Dividends are double taxed .
• Dividends can reduce internal sources of financing.

Dividends may force the firm to forgo positive NPV projects or to reply on costly external equity financing * Firms often view dividends as a commitment to their stockholders and quite hesitant to reduce an existing dividends. Once established, dividend cuts would adversely affect the firm’s stock price as a negative signal As illustrated by Torstar, a stable cash flow in paying dividends implied a well operating status. The sale of Hebdo provided additional financial flexibility in 1997, free cash flow increased rapidly as can be seen in Appendix.

An extra or special cash dividend and share repurchase are two choices to payout adequate cash. Special dividend is expressly not intended to be a recurring event, but as mentioned above, paying dividends with the tax drawback and may produce a negative signal when fluctuating. So keeping the stable payout ratio was a better choice for Torstar. 3. 3 Repurchase Compared with dividend payout, shares repurchase have the listed effects on Torstar Corp, * Send a costly signal to investors that stock of Torstar is a good investment.

Recent investments seem to cause side-effect on investor’s confidence about the company. As mentioned in the article, institutional investors treat Torstar as a ‘pure play’ investment into the area of newspaper and book publisher. But from year 1995 to 1997, acquisitions into children’s supplementary education products are viewed as not favorable. They hope Torstar Corporation can continue the historical expansion of the newspaper and book division. In order to mitigate the side-effect caused by recent investment.

Repurchase would result in fewer shares outstanding and thus higher equity value per share which leads to a better performance of the stock. It also sends a signal to the market that the management believes the stock is undervalued. The price of the stock would go up. As a result of the repurchase sends a strong signal to the investors. The signal is costly as a repurchase would use up corporate cash and hard to mimic. Increase the EPS which shows great confidence of future performance Repurchase would decrease the number of shares outstanding which leads to directly change of EPS of the Torstar Corporation.

In the interim financial statements, the EPS shows great improvements after the repurchase. (Show in Figure 1) Figure 1 EPS change in 1997 * Availability of excess cash from operations By checking the interim financial statements, cash provided by operating activities of Torstar Corporation face an increase in the year 1997, from 25. 6 million to 130 million dollars. The retained cash from operation activities is too much as the normal on-going capital expenditures was expected to be 25 million to 30 million dollars.

Additionally, Capital cycle in the publishing industry is approximately six years and Torstar Corporation has recently modernized its plant. There’s no major capital expenditures were forecast for the near future. Thus, excess cash should be paid out. By checking the retained cash in the Quarter 1, 2008, the operating cash is 27. 97 million dollar. It is sufficient for on-going capital expenditure. (shown in figure 2) Reduction in excess cash would reduce the agency cost of managerial discretion as the manager has fewer resources to pursuing consuming perks.

Figure 2 Cash provided by operating activities Compared with the dividends payout, repurchase is tax efficient as dividends is taxable. Compared with dividends payout, repurchase avoid price drop results from dividend issuance. Institutional investors are happy when the performance of the stock is good. High price shows the strong performance of the stock. * Optimize capital structure. Torstar’s long-term debt outstanding was reduced from 321 million in 1996 to 197 million in 1997 result in a debt-to-total assets ratio of percent.

While the management believed that a 30 percent target debt-to-assets ratio was more appropriate. Too less debt may cause the loss of tax shield and influence the value of the firm. While at this level of debt-to-assets ratio, the risk is still acceptable. Torstar Corporation still has excess debt capacity for future capital expansion. Thus repurchase can decrease the shares outstanding, and also decrease the value of assets. It would push up the debt-to-assets ratio to the appropriate level. By using the interim financial statements, we get the trend of debt-to-assets ratio.

In December 31 1997, the decrease of debt-to-assets ratio is mainly a result of the long-term debt decreasing from 510. 007 million to 197. 322 million dollars. And in March 31 1998, the increase in debt-to-assets ratio is a result of repurchasing shares (decreasing in value of total assets).

Conclusion

After analyzing, we all agree with the activity the Torstar hold, stock repurchasing transfer a strong and credible signaling to the market that the company is in a good situation and will do better in the future, the debt ratio increases and the market value will also goes up.

We estimate that Torstar will keep increasing in the next financial year.

In this case study, I will value Galen Holdings PLC, a medium-sized biotechnology company listed in London Stock Exchange (LSE), base on the various valuation methods, and explain the differences in valuation. For the purpose of providing a better understanding of these methods, another three biotechnology companies are used as a comparison. They are Acambis PLC, Celltech PLC, and Skyepharma PLC. Consider the comparability, all these four companies are listed in FT-SE 250.

Business Valuation:

What is the business value? Before a business is valued the purpose of the valuation must be determined. Different purpose results in different values. There are a lot of purposes to value a business, such as buying or selling a business, transfer shares, employee stock option plan, going public. By the EMH, the business value is determined by the market, which provides a fair value of the business. Simply, a listed company’s value is how much you can sell or buy the share in the open market. Thus, this case study will try to estimate the share value of Galen Holdings PLC. What the investors really want to know is why and how the share traded at the real market price, are there any clues about whether the share price will go up or down in the future. In other words, whether there is a fundamental value of a share? Unfortunately, as Crockett (2002) said ‘It’s not obviously clear’. Theoretically, the fundamental value of a share is estimable. Generally agreed there are three main methods that can be used to valuing a share, that is dividend-discount model (DDM), price/earnings ratio (PE ratio), and the net assets value model (NAV). In the following parts, each of these three methods will be used to test the value of Galen PLC, comparing with the competitors, and the methods employed will be estimated.

The dividend discount model approach:

First of all, the dividend discount model will be employed to value the company. This model provides a classic formula that explains the underlying value of a share, which believes that the share is worth the sum of all its prospective dividend payments, discounted back to their net present value. There are two formulas can be used, P0=Div/r and P0=Div1/(r-g), where P0 is the present price of the share, Div is the dividend per share, Div1 is the dividend per share at year 1, r is the required rate of return or the cost of capital, and the g represents annual constant percentage growth in dividend per share. The first formula assumed that the company would distribute a fixed figure of dividend per share in the foreseeable following years; the second assumption that the future dividend will grow in the fixed rate per year, which also called the dividend growth model (DGM), and the growth rate is less than the cost of capital. Look at Galen’s history dividend; the final dividend was 1.66 pence per share at 25th-Jan-2002, final dividend at 2 pence per share at 24th-Jan-2003, and interim dividend at 1.2 pence per share at 25th-Jul-2003. If it is assumed that the final dividend at 1.2 pence per share at the first of 2004, then it can find that dividend has a growth of around 20% per year (g=0.2). For the required rate of return (r) can be calculated by the CAPM, r=rf + �(rm-rf), where rf is the return of risk-free, which can be seen as the rate of 3-month treasury bills, according to Financial Times the rate is around 3.8%; rm-rf is the market risk premium which usually assumed as 6%, and according to Yahoo Finance the company’s beta is estimated at 1.79. Then the required rate of return is 14.54%.

Also, there is an alternative formula to get the r, r=DIV1/P0 + (1-DIV/EPS) X ROE, where ROE means the return of equity, DIV/EPS is the payout ratio and 1-DIV/EPS equal the plow back ratio. Use the figure collected from the annual report, r=2.4/495 + (1-2/32) X 92042/671959, r=12.90%. Compare both two required rate of return (14.54% and 12.90%) with the rate of dividend growth (20%), one of the assumptions is conflicted, the r should be more than g, so the dividend-discount model is not suitable to value this company. The problems with the dividend-discount model are not that it is wrong; indeed, most economists agree that the theory is fine. The problem is the uncertainty surrounding both its components: the future stream of dividends and the appropriate discount rate. For example, does the zero dividend policy mean the company is no value? Of course, wrong. Look at the other three competitors, zero dividend policy are adopted by all of them, but they are still traded in the market. Furthermore, whether the company can insist on the fixed dividend or growing rate forever? Impossible. Since no one can ensure there always have enough net NPV projects in the future. If no more valuable projects, dividends cannot be maintained. Thirdly, will the required rate of return always exceed the growth rate of dividends? Not always. The Galen group is a good example of this problem. All in one, if shares change in the value, that must be the result of a change in either the prospective dividend flow or the right discount rate, or both.

Investor Ratios There are various ratios that are designed to help investors who hold shares in a company to assess the returns on their investment. These are: Dividend per Share The dividend per share ratio relates the dividends pertaining to an accounting period to the amount of shares in issue during the period. The ratio is given as follows: Dividend per share = Dividends pertaining to a period Number of shares in issue The ratio provides an indication of the cash return a shareholder receives from holding shares in a company.

Although it is a useful measure, it must be remembered that the dividend received will usually only represent a partial measure of the return to an investor. Dividends are usually only a portion of the earnings generated by the firm and available to shareholders. A business may decide to plough back some of its earnings back into the business in order to achieve future growth. These ploughed back profits belong to the shareholders and should in principle increase the value of the shares. Thus w h e n assessing the total return to an investor we must look at both the dividends received and any movement in the share price.

The dividend per share for Alexis Ltd is given as follows: Page 1 of 5 Dividends per share can vary considerably between companies. A number of factors will influence the amount that a company is willing or able to issue in the form of dividends to shareholders. These factors include: • • • • The profit available for distribution to investors The future expenditure commitments of the company The expectations of shareholders concerning the level of dividend payment The cash available for dividend distribution

Comparing the dividends per share between companies is not always useful as there may be differences between the nominal value of the shares issued. It may be more useful to monitor the trend in dividends per share over a period of time. Dividend Yield Ratio This ratio relates the cash return from a share to its current market value and is given as follows: Dividend Yield Ratio = Dividend per Share Market Value of a Share * 100 1 The ratio for Alexis pic is given as follows: Page 2 of 5 In essence this ratio measures the real rate of return on a share.

Investors can compare the returns from a company’s shares to the returns that could be earned by investing either in another company or by investing in another form of investment. Dividend Cover Dividend cover (for ordinary shares) looks at how many time a firm’s profits (after interest, lax and preference dividends) cover the ordinary dividends. Dividend Cover = Profit after interest, tax and Pref Share Dividends Ordinary Share Dividends For Alexis plc this ratio is calculated as follows: Interpretation: Alexis plc profits covers ordinary dividends 3. 96times.

Dividend cover is calculated using the profit after interest and tax figure because banks, government and preference shareholders have a preferential claim on the profits of the firm. This ratio is of particular interest to ordinary shareholders. Earnings per share The earnings per share relate’s the earnings generated by the company during a period and available to shareholders to the number or snares in issue. For ordinary shareholders the amount available will be net profit after interest, tax and preference dividends because banks, the government and preference shareholders have a preferential claim on the profits of the firm.

Page 3 of 5 Earnings per share = Earnings available to ordinary shareholders Number of ordinary- shares in issue For Alexis plc this ratio is calculated as follows: The EPS is regarded by many investment analysts as a fundamental measure of share performance. Tracking the EPS over time can help assess the investment potential of the company’s shares. Care must be taken when comparing EPS from different firms as capital structures differ from one firm to the next. Price Earnings (P/E) R a t i o The price earnings ratio relates the market value of a share to the earnings per share.

It is calculated a s follows: P/E Ratio = Market value per share Earnings per Share The P/E Ratio for Alexis is calculated as follows: Page 4 of 5 The ratio reveals that the capital value of the share is 9. 4 times higher than its current level of earnings. The ratio is essence is a measure of market confidence in the future of the company. A high P/E ratio means that relative to profits the price of the share is quite high. Why would this be the case? The higher the P/E ratio the greater the confidence in the future earning power of the company i. e. lthough current earnings are low investors expect them to increase in the future and therefore investors are prepared to pay a high price for the share in relation to the current earnings of the share. A low P/E ratio means that the share price is quite low compared to earnings – this implies a pessimistic view of the future. Nobody will be willing to pay a high price for a share in a company that has unexciting trading prospects. Because the P/E ratio gives a guide as to market confidence in a share it can therefore be helpful when comparing different companies although P/E ratios per sector will vary. Page 5 of 5

They basically wants to ensure that HASH branches which are in the right locations for their customers and on occasions this means that they need to close those branches where customers foot fall has fallen dramatically or there has been a shift in customer shopping patterns. And also raise the transaction cost from E to E. 0 In he name of the new fees were part of a providing “clearer and more transparent pricing. ” The bank also said behind of cost cutting bank want to switching to be ‘hassle-free’ , standard IS- turn on free accounts and free banking claim is ‘ridiculous’. They also said the closures branches were a result of customers using the branch network less than they used to “we are seeing a shift to customers using phone, Internet and mobile devices. ” For this kind of reasons the HASH cope with cost cutting Q. 2. The Impacts of cost cutting on overall Financial Performance of HASH (comparison with past year)?

Answer: For the Impacts of cost cutting they have closed about 70 branches in the I-J last year and more than 50 in 2011 and in 2013, 9 branches has been closed and declared with 85 closures in UK towns and cities so far this year. The bank has closed more than 200 branches in the I-J over the last three years and Derek French, of the campaign for community banking services, expressed some surprise at Hash’s plans “These figures suggest that after a pause, they are now galloping ahead with closures, as in previous years. ” It is thought a further 20 closure announcements will e made before October.

When the branches of HASH at Alongside Penumbras and Conway- which is the only bank in the town with a cash machine are due to closed in February, 2013. Town leaders criticized the decision and called for the bank to reconsider the closing branches. Some of their state PM And Alongside the town mayor Bob Label said the closure was “terrible news” for residents, business and tourists. And he Explained the impacts over economy by saying “l am very surprised by what the bank is claiming about the economic viability of Alongside branch in IEEE of the huge number of tourists who visit our town, especially during the summer months. So, all of them when the bank branches are closed their political members realized the regional economical condition is under threat. Also the impact on increase its charges for 700,000 small business customers, with many losing their free banking service. They said new fees were part of an overhaul of accounts aimed at providing “cleared, more transparent pricing. ” Minimizing plan for cost cutting they increased fees of transaction as a result the small business customers is effected. They also said some customers would see their charges reduced.

So called Free banking ‘Myth’ the bank impose some extra charges on each small business transaction. The issue of “Free banking” system sparked controversy from last year. Q. 3 The Benefits of cost cutting on the performance of HASH (I. E. NYSE and ELSE). The share pence of HASH (ELSE: HASH) (NYSE: HASH. US) fell by APP to IPPP dung early expectations. The 3% fall in its share price made it the leading loser among FETES 100 blue-chips. The bank reported profits of $22. Ban (EYE. Ban), compared with $20. Ban in 012, boosted by a range of cost-cutting measures.

In total the bank made $1. Ban in savings by, among other things, reducing Jobs as well as cracking down on the number of staff taking business-class flights. The bank currently employs 254,000 full-time staff, down from 295,000 at the beginning of 2011. In total $4. Ban has been saved since 2011 , exceeding targets set by the bank. Revenue was stable, coming in at $63. Ban compared with $61. Ban in 2012, underpinned by a “resilient” performance in the global banking & markets business, as well as growth in the commercial banking division.

Pay for chief executive Stuart Glover increased last year from $7. Mm to $mm while the bonus pool increased 6% to $3. Ban. The chief executive commented: “Our performance in 2013 reflects the strategic measures we have taken over the past three years. Today the Group is leaner and simpler than in 2011 with strong potential for growth. In 2013 we grew underlying profits by US$6. Ban, generated US $10. 1 ban in core tier 1 capital, achieved an additional IIS$I . Ban of sustainable cost- savings and declared IIS$9. Ban in dividends in respect of the year.

Our strong capital generation continues to support our progressive dividend policy and reinforces Hash’s status as one of the best capitalized banks in the world. ” Earnings per share increased from app to app while the dividend was increased from app to app. Therefore, taking into account the hit to Hash’s share price earlier, the shares may therefore trade on a PIE of 13 and offer a potential income of 4. 5% Of course, the decision to ‘buy’ ? based on those ratings, today’s results and the wider prospects for the banking sector ? remains your own decision.