Jun 09, 2015
Blaise Jenner, PwC Middle East Partner in Capital Markets and Advisory Services
This article first appeared in Gulf Business in June 2015.
In the last 24 months the regional and global economies have shown signs of recovery – despite the recent slump in oil prices we have seen growth of 97% in the Dubai Financial Market, 22% in the Tadawul and the London FTSE recently broke the 7,000 points barrier for the first time.
As groups return to profitability, this often triggers an expectation from shareholders to start receiving these profits in the form of cash dividends. Often, however, a “dividend trap” will be a fundamental barrier that prevents a group from returning value to its shareholders.
Firstly what is a “dividend trap” and what causes it? The recent financial crisis resulted in financial pain for many regional and global investors. Falling asset values often triggered accounting impairment of assets – especially of those assets acquired at the peak of the market. Companies ordinarily need positive retained earnings in order to pay dividends and where these impairments depleted those retained earnings it forced a number of groups to suspend dividends payments.
Whilst many of these groups have recently returned to net cash and profit generation, the recent profits are often not sufficient to fully absorb those previously accumulated accounting losses. This scenario is known as a “dividend trap” where a group is net cash and profit generative but cannot lawfully pay a dividend due to accumulated accounting losses.
Dividend traps impact a variety of stakeholders. Firstly it may be a source of frustration and confusion for shareholders - whether individuals, corporates, family businesses, private equity investors or governments. Having waited through the financial down turn they can now see positive cash and profits generation but they cannot directly access this value. Depending on their objectives, this may disrupt the shareholders ability to redeploy cash for other opportunities or requirements.
This scenario will also invariably place pressure on the group’s senior management team to turn profits into cash dividends and meet expectations of those shareholders on a timely basis. Additionally, deal makers may also have to think twice about entering a structure where dividend traps are presenting a medium to long term barrier to cash extraction.
Clearly dividend traps impact the ability of shareholders to realise value and require immediate attention. Fortunately there are a number of restructuring options that can unlock the value of a company and facilitate the payment of dividends. These include:
It is important to note that there is not a one size fits all solution to this issue. Some of the above mechanisms will potentially not be viable in specific circumstances – for example inserting a new parent company or undertaking shareholder loans may not be appropriate solutions for a listed group.
As a result, relevant options should be considered in the context of a groups specific fact pattern and include consideration of the related accounting, legal and tax (if relevant) implications.
As companies in the region continue to return to profitability we expect cash extraction to gain momentum and to see more groups implementing restructuring options to unlock trapped cash.
Otherwise, as seen in the past, the inability to address dividend traps can act as a deal breaker in financial transactions – reflecting both the critical requirement of some investors to extract cash on a timely basis as well as the clear value derived from developing solutions to address dividend traps.