dealtn wrote:Gengulphus wrote:Given that you're talking about selling off part of the company (i.e. some of its assets), how do you know what what the market values that part at? It's not tradable on the open market (other than in a few special cases), so the only real guide you have is that what someone is willing to pay for it...
Well that's not strictly true either (although I agree with much of what you say, but for brevity won't quote all of it).
If you have a market valuation for the entirety of your company, and you also have a good idea of what some part of your company would be worth by way of market value, if it was a regulated utility with a number of quoted alternatives priced by the market, the Directors are able to derive the market valuation of the remainder.
That's rather circular, isn't it? The company is made up of the part you're selling and the part you're keeping: you're trying to deal with the fact that there's no market value available for the former by assuming that there is one available for the latter... But there isn't - having an
idea what the market value of something is isn't the same thing as having its market value available. In addition, and probably more importantly, you're making the assumption that the market value of the whole is the sum of the market values of the parts - and that assumption isn't justified: synergies between businesses do happen, and so do their opposites. (And the history of company mergers is littered with examples of directors failing to have a good idea of what those synergies/anti-synergies are...)
dealtn wrote:As a Director you will also have an idea, as an insider, of what the relevant future cash flows etc are likely to be for that part of the business.
Agreed that the directors are in a better position to forecast those future cashflows than outsiders are - but they're still only forecasts, subject to steadily greater possible errors the further they try to look into the future. At some point in the future, they become so subject to error that the 'forecasts' are better not even described as informed guesses, but as pure guesses. That point will be further into the future for the directors, but not necessarily enough further to greatly improve the reliability of a calculated total present value of those future cashflows. E.g. even for directors of a regulated utility such as what will be left of Pennon once Viridor has gone - a type of company that is generally regarded as having some of the more reliable cashflows - I wouldn't expect directors' forecasts of future cashflows to be anything other than guesswork beyond the maximum time to the next election plus maybe a year for an incoming government to actually bring its plans into effect. That's a maximum of about 6 years of reasonably reliably forecastable cashflows, which on reasonable discount rates and assumptions about inflation will make up less than half of those cashflows' net present value.
Basically, I do expect directors and other insiders to have a considerably better idea of the next few years' cashflows than outsiders do, and that's very useful for their actual role, i.e.
managing the company. It's considerably less useful for the investor's role of
valuing the company because most of a company's value usually lies beyond even insiders' foreseeable-future horizons.
dealtn wrote:Again this is all hypothetical, and not about Pennon (I haven't yet done any analysis on the company or this transaction in particular). This was all in response to an enquiry of "...why companies sell off "good bits" of themselves..."
Understood and basically agreed - though on a wording point, I would probably say "theoretical" rather than "hypothetical". (I.e. it's general theorising about companies selling off parts of themselves, not making a hypothesis that a particular company will sell off a particular part of itself and trying to work out what the consequences of that hypothesis are.)
And I've no problem with that: although this is a board about practical matters, having a good understanding of the theory
and of its limitations is helpful when trying to make the practical decisions this board is supposed to be about. But we should also keep in mind the question of what those practical decisions actually are... With regard to decisions related to companies selling off parts of themselves, they're usually limited to:
* when such a sale is major enough to require shareholder approval, a decision whether to vote about it, and if so, in which direction - in this particular case, it was major enough, but the boat has sailed as regards voting;
* generally assessing the company with regard to whether to buy it (or more of it) for one's HYP;
* for tinkerers, generally assessing the company with regard to whether to sell part or all of it from one's HYP.
On those last two, Pennon has made it clear that they intend to use some of the Viridor sale proceeds to make a return to shareholders, but have not yet said how, how much or when (I would guess because they probably haven't yet made all the decisions and almost certainly haven't yet got all of the details). As far as buying is concerned, I would regard Pennon as being in a bit of a limbo at present, with an unknown-but-probably-large proportion of the current value of my holding essentially locked up in the anticipated Viridor sale proceeds. It seems likely that I'll want to reinvest the returned capital to restore the value of my holding, but trying to do so before I know how much to reinvest isn't really possible! And as far as selling is concerned, I'm a tinkerer but I think it unlikely I will sell. That's because I think Pennon unlikely to meet any of my main criteria for selling, which are (a) to trim an overweight holding; (b) the dividend looking unsustainable; (c) the company becoming very different from the company I bought, in a way I don't like, e.g. by moving into a different sector that I've already got enough of or by moving abroad. (That last one is a strong personal preference, especially not to have to deal with foreign dividend income in my tax returns - I don't expect other HYPers to share it!) Of those reasons, (a) and (c) are very unlikely to apply - my current holding is only about 2.7% of my HYP and can be expected to reduce when the return of capital goes 'ex', and while the company's sector is shifting from water utilities plus waste services to only water utilities, under 5% of my HYP is currently in water utilities.
That leaves reason (b) - the dividend looking unsustainable. That's relevant both to why I think I'm quite likely I'll want to reinvest the returned capital to restore the value of my holding and why I think it unlikely that I'll want to sell because of an unsustainable dividend. That might seem odd in view of the statement in the results that "
Pennon's dividend policy for 2020-25 for the re-based Continuing Group will be growth of CPIH + 2% per annum, from an implied Continuing Group dividend for 2019/20 of 21.11p per share." The reason is that I think it pretty likely that the return of capital will be pretty large and done by a special dividend plus a share consolidation, or something with similar effects such as a B share scheme (capital only for tax purposes, not the old type that offered shareholders a choice between income and capital) plus a share consolidation. The company has form for doing capital returns by special dividends plus share consolidations, albeit quite a long time ago (two of them, in 2003 and 2006), and if they follow suit this time, I would expect that "implied Continuing Group dividend for 2019/20" to be adjusted as normal for the consolidation and in line with the reduction in the company's market cap as a result of the special dividend (or whatever) going 'ex'. A rough halving of the company's market cap doesn't look implausible to me, which would make the consolidation be in the region of 2-for-1, which would adjust that 21.11p per current share to around 42.22p per consolidated share, i.e. in the region of the current dividend. If those things were to happen, the effect on shareholders would be roughly equivalent (other than possibly for tax purposes) to a compulsory sale of half of their holding, with the special dividend (or whatever) being equivalent to the sales proceeds and their dividend income from the holding being roughly halved, but that halving being due to the reduced number of shares rather than to any significant dividend cut.
I'm not by any means saying that's what the company will do - it appears quite plausible to me that the company will do something reasonably close to it, but 'quite likely' falls a long way short of 'certain'! But the wording does indicate to me that the 21.11p figure takes the sale of Viridor into account but not the implications of the return of capital. It's certainly not impossible that the return of capital will be significantly smaller than I'm thinking likely, which would result in those implications being smaller and so not enough to prevent there being a significant dividend cut.
So basically, I'm not trying to give any sort of definite verdict about the dividend being cut or not - just saying that I think the jury is still out about that, and will remain out until the company gives details of how much it plans to return to shareholders and how it plans to do the return. My guess is that that will happen when or shortly after the sale finally completes and the company actually has the cash...
Gengulphus