Saturday, 20 August 2016

How Perpetual Securities affect Ordinary Shareholders

Perpetual Securities are a class of financial instrument and has in recent times gained popularity due to a low interest environment. Companies such as Ezion, Hyflux and even Mapletree Logistics Trust have issued such instruments to retail investors. This post seeks to cover the basic of Perpetual Securities and how it affects ordinary shareholders

Classifying Perpetual Holders

Perpetual Securities are bond like instruments which gives perpetual holders a fixed dividend payout at each time period. In addition, it has no maturity date to redeem and its dividends are either non-cumulative or cumulative (cumulative means the payment of dividends are accumulated and brought to the next payment date). It is classified under "Equity" in the balance sheet. Below is Hyflux's balance sheet which shows that perpetual securities are classified under the "Equity" section.


Hyflux Balance Sheet
So while Perpetuals do have bond-like payments, it is classified as "equity".

Perpetual Securities where do they rank?

In the event of a liquidation, the proceeds of the companies are distributed in this general order:

1) Secured Lenders
2) Unsecured Lenders
3) Perpetual Holders
4) Ordinary Shareholders

Perpetual holders are behind lenders but ahead of ordinary shareholders when receiving the leftover proceeds from the sale of a company assets.

What it means to Ordinary Shareholders?

As ordinary shareholders who own shares of a company, we are the last in line to: i) Receive dividends/payments or ii) Proceeds from a company's liquidation. Seems quite a lousy deal for us and this is precisely why we should always carefully assess the value of our shares! 

Therefore, while some companies may proclaim that they have a healthy leverage or debt servicing ratio; as investors, it is our due diligence to check the validity of their claims by analyzing for other obligations or preferred shareholders who are ranked ahead of us. Using Hyflux's balance sheet as an example, it can be seen that preference shares contribute to approximately half of the company's equity. 

Quiz time: Usng Hyflux as an example, if Hyflux is liquidated and instead of relaising its full equity value of 1.7 billion,  the company only receives 1 billion as leftover for its equity holders. How much does perpetual holders and ordinary shareholders receive separately? 

Answer: $964 million to perpetual holder & $36 million to ordinary shareholders

Yes, this how it works. Perpetual Holders receive proceeds before ordinary shareholders.


Profit effect to Ordinary Shareholders

That's not all. Let's look at Hyflux's latest profit & loss financial statement




Both snapshots are taken from the same financial document. However there is something strange. On the first page, Hyflux reports a net profit to the owner of the company; but digging deeper, Hyflux in fact made a loss for ordinary shareholders. How is it possible?

This is because the dividends paid to perpetual shareholders was factored. As a result, while Hyflux did report profits for the period, ordinary shareholders of the company faced with a loss. This also means the net asset value of their shares decreased. This is the effect of perpetual securities dividends to ordinary shareholders.


Company's net profit - dividends to perpetual holders =  Eventual Profit to Ordinary                                                                                                     Shareholders

Conclusion

As equity investors, it is important for us to check for the presence of such financial instruments in a company's balance sheet. It tells us a lot of information and will affect our valuation of a company's earnings, cash flow generation ability and proceeds available to ordinary shareholders in the event of a liquidation. 

< The author is neither vested nor shorting Hyflux Stocks, Hyflux is used because it is a good case study and a popular brand name people can associate with in Singapore>

2 comments:

  1. very good read, seems like hyflux is a very risky counter
    no wonder their perp bonds got sold down 5% below PAR

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