Monday, December 28, 2009

The Premium On Shareholder Friendly

In theory, there is no value created or destroyed as a firm issues a dividend. This is because the shareholder owns a portion of the company's cash; if he were to receive that cash, it's as if money is being moved from his right hand to his left, i.e. there is no net change (ignoring taxes). In practice, however, companies that pay out funds to shareholders enjoy higher valuations.

Nowhere is this more evident than at Acorn International (ATV), a company we discussed a few months ago as a potential value investment. For much of this year, the company has traded for not much more than its cash on hand (with negligible debt), despite the fact that it currently breaks even.

But on one day last week, the stock price soared 15+% as the company announced a special dividend that will see it pay out about 1/5 of its cash on hand (almost $1 per depository share). This clearly illustrates the premium shareholders place on companies that pay out. But it also illustrates the importance of control.

Together, management/directors/founders own about 40% of the company, not quite enough for control of the company. This is important because of the large number of options the company has doled out. In the past, management has also downwardly revised exercise prices for their options after the fact, so they have not been shy about transferring wealth from minority shareholders to themselves.

But the fact that they did not have control has likely kept them honest. Comments from a recent conference call made it clear that shareholders wanted a payout, and the threat that shareholders would exercise their rights probably forced management into doing something they did not want to do. If management had control of the company, this dividend may not have happened. The lesson here is that shareholders should be wary of companies where a minority of insiders own control, and at the same time have the incentives to benefit at the expense of shareholders.

Disclosure: None

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