Tesco paid out nearly £5 bn to shareholders through a special dividend last month, around 50p per share which gave around a 21% return (the share was around £2.40 per share when they did this in February 2021). Tesco also consolidated shareholders holdings on a 15 shares for 19 shares basis, which was around a 21% reduction in value. Tesco’s circular laid out the details for this transaction and the financial media covered it as well. The share consolidation was supposed to negate any potential fall in the share price after the share went ex-dividend. The puzzle is, why on earth the company thought that this was a good idea?
The background of the special dividend is that Tesco bought into a chain of Asian grocery stores after the 1997 Asian financial crisis and then agreed to sell their Asian holdings in March 2020 for around £8 bn. Tesco paid down some debt and put money into their employee pension fund, and decided to return the rest (nearly £5 bn) to shareholders. So far, so good.
But why consolidate shares? In their circular and other statements, the company says that they did this in order to avoid a fall in the price of their shares. However, a fall in the price of a share after a share goes ex-dividend is actually part and parcel of investing in shares and investors (especially fund managers) should be used to this. By consolidating the shares, the action ‘stole’ 21% of shareholder wealth. The company will argue that if they didn’t consolidate shares, the market would have repriced the shares lower, potentially by over 21%. The 21% special dividend leaves the shareholder ‘all-square’ as far as Tesco is concerned. The general meeting saw over 99% of voters approve the special dividend and share consolidation, so who am I to complain?
Well, any drop in price after the share went ex-dividend could have offered long-term believers in Tesco the chance to buy more shares at a lower price (especially with a cash return coming soon in the post). The consolidation of the shares locked in a 21% loss, in a manner that many investors can’t use to lower their taxes. The special dividend (21% gain) however could create a tax obligation for many shareholders. If the company had simply paid the dividend, they would be heroes. The history of making an investment, growing the business, selling it for a profit, and then returning a lumpy sum to the company owners is a nice one. There was no need, in my opinion, to consolidate the shares as this ‘killed’ the profit from the special dividend.
The math is simple. If you bought 19 shares at £2.40 you had £45.60 invested in Tesco. By consolidating your 19 shares into 15 shares at £2.40, this reduced your investment to £36.00. The £0.5093 special dividend times 19 shares gives you £9.68, and ignoring tax implications (if any) you are left with around £45.68 (£36+£9.68) after the consolidation.
The company will argue that this a job well done of returning cash to the owners, but somehow one feels that something is missing. The reality of the market is that Tesco shares fell the day after the share consolidation despite the company action.
Put it this way- would anyone ever buy a share that pays a dividend if every time the company issued a dividend it took active measures to ensure that the shareholder was left ‘even’ by reducing their shareholding? No. People buy shares on the expectation that the company will grow and profits will rise. The share price may go up, and dividends may be paid out. The investor does not expect the company to consolidate shares every time a dividend is paid out in order to make sure that they are ‘even’.
Over 99% of the votes at the meeting were in favour of paying the dividend and consolidating the shares. The idea that the consolidation was not necessary and was detrimental to the shareholders interest is a lonely view. John Calverley, our Chief Economist, takes the view that on balance there is not a lot of difference to the investor. James Chu, our Head of Investment Solutions, can see all sides of this and suspects that Tesco may have done this as a cheap share buyback. The FT, in their initial coverage of this event labelled it as a share buyback as well, but had to correct the story later on.
From a simple perspective, the fact that Tesco consolidated the shares and ‘locked in’ the losses instead of letting the share price fall where it may, is not ideal. Next time please keep it simple, pay the money back to the company owners and don’t try and be too clever by consolidating their shareholdings. Remember, share prices can run higher in anticipation of a dividend as well, this should come out in the wash for long-term investors. If this was a private company would they consolidate shares after paying money back to the owners from a disposal of company assets? Probably not. Are the Tesco board and top management taking a 21% pay cut as this is now a smaller company? Hmmm….