Pacific Century Regional Developments (SGX:P15) – Dividend Recapitalization… a nicer term for cashing out

Pacific Century Regional Developments (SGX:P15) reported their FY19 results on 21 Feb 2020 yesterday. Revenue increased 12% due to higher dividends received from their stake in HKT and profit fell due to higher expenses and lower share of profits from their associate PCCW.

For more information on their business model, you may refer to my previous writeup here. https://themosspiglets.com/2019/10/26/pacific-century-regional-developments-sgxp15-the-peculiar-case-of-pcrd/

Mo Money Mo Problems

Investors in PCRD should know that revenue and profits do not really matter as it will be stable as long as PCCW and HKT pays their dividends on time. What matters the most is their dividend payout.

For the past 2 years, shareholders of PCRD have been very happy with their dividends. In FY18, they received 8.7cts per share ( 25% yield as compared to current share price of $0.35) and this year, PCRD rewarded their shareholders with 6.26cts per share. In total, that is a whopping 43% return in dividends in just 2 years.

Where did the money come from? The dividends received from HKT and PCCW were only about $110mil/year and total dividends paid since last year were almost $400mil. Well unfortunately, money does not fall from the sky and instead, most of the dividends came from borrowings aka debt.

Dividend Recapitalization

The person who benefits the most from the dividends would be the largest shareholder, Mr Richard Li, and he owns 89.32% of the company. Hence, my guess is that the special dividends paid out were part of his plans to cash out of this investment, or using the correct term, dividend recapitalization.

Before we go any further, let’s clear up the definition of a dividend recapitalization (recap). It results from using borrowed money to issue a special dividend to the company’s shareholders. A dividend recap is an alternative to way of realizing cash, other than selling the company or a portion of it.

Motivations

So why did Mr Richard Li chose to do a dividend recap? Here are some of the probable reasons

1. Undervalued stock price – Selling the company or a portion of PCRD right now may not be the best way to cash out of his investment. As per my calculations in my previous writeup, PCRD’s indirect and direct interest in HKT should be worth about S$0.845 per share, representing a huge upside from its current share price of S$0.35.
2. Low cost of borrowing – Similar to what Apple (NASDAQ:AAPL) is doing, the company is likely looking to take advantage of low-interest rates and use this debt to increase shareholder returns.
3. Lack of alternative exit option – A secondary listing or issuance of new shares could help to recoup Mr Richard Li’s investment. However, in the current market, an IPO or issuing more shares could seem rather risky and unpredictable.
4. Retains ownership – A dividend recap allows shareholders to pull money out of the company while retaining the same ownership. In addition, with PCRD trading at such low multiples, any rerating would actually help to decrease the leverage on the company.

The table below is quite informative on how business owners can raise more cash.

Risk

The main risk is that the company could load up with too much debt that they are unable to satisfy its obligations. That could lead to insolvency.

The current debt level is about $343mil and dividends received from HKT and PCCW is about $110mil. Assuming that PCRD continues to pay out their ordinary dividends (2.76cts per share or $73mil in total) and use the rest to repay the debt, they would need about 7-8 years. It should take longer as I did not take into account all the other expenses (eg finance cost, director fees, etc etc).

However, a point to take note is that dividends from HKT and PCCW have been increasing for 3 consecutive years. I also think that management would have taken this into account when they did this dividend recap.

So What Now?

Fundamentally, the company has changed as it has loaded up with too much debt (debt to equity 0.32) and it is worse when you are loading up debt just to pay dividends which brings no value creation whatsoever to the company.

However, don’t forget that Mr Richard Li still retains his shareholdings in the company. In my opinion, the management would not attempt a dividend recap unless they were confident that the company could manage its debt levels.

That also means that privatization would not happen in the near future as it would make more sense to just buy the remaining 10+% before the dividend recap (why share when you can have it all?)

Hence, PCRD remains a dividend play. Even without the special dividends, PCRD’s dividend yield is still very attractive at around 7%. However, with a higher debt load, investors should take note of any deterioration of the performace of PCCW and HKT which could lead to decrease in cashflow to finance PCRD’s debt and also future dividends.

Cheers