Why the share cap option?
Apparent contradiction explained
SHAREHOLDERS MUST BE delighted with the generous dividends they’re receiving from short-term insurer Mutual & Federal. In the financial year to end-December 2006 the company paid out a whopping R2,66bn in dividends, including a special dividend of roughly R2bn compared with R416m in the previous financial year.
There’s method behind this apparent dividend madness. MD Bruce Campbell explains that in light of M&F’s strong capital position the distributions, though they reduce investments, boost shareholder returns and reduce the insurer’s solvency margin towards the targeted 40%.
Accordingly, by year-end shareholder returns were marginally up to 27,5% and the solvency margin had reduced from 74% to just over 49%. That takes M&F some way towards its aim of better capital efficiency.
But then one has to ask: If distributing cash is the objective, why does M&F offer shareholders the choice between cash or a capitalisation award, essentially new fully paid ordinary shares distributed in a ratio based on the cash value per share? It seems contradictory if the aim is to reduce capital; and while the shares on the current rating are an attractive option there will be longer-term share dilution.
Initially, we suspected when cash or shares were offered at the interim, that it might be a ploy by Old Mutual, which holds a hefty 77% or so of M&F, to gradually build up its stake and quietly take over the insurer. That followed its clumsy, defeated attempt to take out M&F minorities early in 2004. But then Old Mutual confounded us and elected to take cash from M&F. Back to square one.
The answer is apparently very simple. M&F’s Brian Laird-Smith says the share option was introduced specifically in terms of the company’s empowerment scheme to allow black partners to take shares instead of cash. “If the empowerment partners took cash it could be construed as a contravention of Section 38 of the Companies Act,” he says.
That section deals with companies providing assistance to buy shares. However, the Act is up for review and Section 38 could change.
Meanwhile, it seems as if M&F has no option but to provide a choice between shares and cash in its distributions. It also means the dividend policy won’t necessarily remain so generous – there could be future volatility in dividend payments.
Chris Naidoo, insurance analyst and portfolio manager at Metropolitan Asset Management, points out that should there be a sharp downturn in financial markets it would affect insurers’ solvency margins and investment income. Dividends may well have to be cut should that happen in the future.
Indulging shareholders with cash and shares. Bruce Campbell