HGS Interim Dividend: How Companies Fail Shareholders When Cash Comes In
It is not often that companies sell their key business segments. When they do, they have to do it with shareholder permission. Often, shareholders are then disappointed by companies that prefer to retain the cash without bothering to disclose what it will be used for and why that's a better option than distributing it to shareholders.
Few companies have succeeded in communicating clearly to shareholders why they prefer to keep the cash rather than distribute it. It is a different matter if the sale of the profitable division is undertaken to repay debt, but those are one-off cases. In many, it has been seen the sale leads to windfall gains, and companies then sit on the cash. The loss of 'governance premium' or impact on stock price as a business exits a segment serves a double whammy to shareholders.
What companies often forget is that while promoters have long-term vision and strategies, shareholders tend to have a shorter-term view, and that's bound to be unless promoters and management articulate their long-term plans well.
The HGS Math: Deal Proceeds, Payout, Residual Value
Let us take the current case of Hinduja Global Solutions Ltd. The business process outsourcing firm of the Hinduja Group sold its profitable healthcare services business to an arm of Barings Private Equity Asia. The transaction was based on an enterprise value of $1.20 billion, subject to closing adjustments, and resulted in inflows of $1.088 billion. The transaction was undertaken in a tax-efficient manner so that maximum proceeds could come to the company or so it said. The company paid 10-12% in taxes on a transaction that brought it over Rs 8,000 crore.
It then announced a third interim dividend of Rs 150 per share and a bonus of 1:1. The entire dividend payout will involve an outgo of Rs 313.2 crore. The bonus shares will consume Rs 21 crore, a piffling of the asset sale proceeds. They are not eligible for dividend as the share issue will take two months to get shareholder approval, and the shares are expected to be dispatched by March 5, while the record date for the dividend is Jan. 27.
Most of the dividend payment will go to the promoters. They own 67.2% of the company and the public shareholders own 32.8%. This translates to the promoter getting over Rs 200 crore as part of the interim dividend payment.
To be clear, HGS is a quarterly dividend-paying company and so far this financial year, it has paid Rs 39 per share in dividends (interim, final, and special). The company has made no mention of a buyback, nor does it plan to delist.
The healthcare segment that has been sold accounted for half the revenue and nearly 30% of the profit for HGS. Post the sale, the company has guided for a revenue run-rate of Rs 780-815 crore for the fourth quarter from continuing operations. This compares to consolidated revenue of Rs 1,600 crore it earned in the third quarter.
In the absence of a business plan that articulates the use of the cash proceeds from the transaction, should shareholders expect to be compensated for the expected drop in the share price that would result from the reduction in business activity?
The Promise… Not Kept
Paying dividend from operational earnings and paying a dividend to distribute windfall gains are separate issues. If a company does not have any immediate use for the proceeds earned from the sale of an asset, good governance would be to share that with shareholders, either as a dividend or through share buyback... especially if a management assured its investors that it would.
On being asked about such a payout in an investor call after the second quarter, HGS Executive Director and Global CEO Partha DeSarkar said, “Yes, so this is actively being deliberated with the board,” and added that, “the consideration is to return back to the shareholders, but we want to do it in a tax-efficient manner. So, all of these things are being deliberated in the board obviously.”
But the company disappointed its investors, and the board has failed to articulate a cash distribution policy.
DeSarkar told analysts that the company decided to sell the healthcare business as it was not able to attract the value that it deserves from the Indian stock market.
"It is a U.S.-centered business, with all its revenues from the U.S. and therefore we were always finding the gap in people's ability to understand what this business is and what its inherent worth is. The healthcare businesses were loss-making when acquired, the company turned it around and found investors who would value this business."
It is true HGS struggled to get the value for its operation from the Indian stock market. The stock had touched an all-time high of Rs 3,948 per share in anticipation of a significant shareholder reward. At the all-time high for the stock, the market cap was Rs 8,244 crore. The asset sale yielded it as much and more.
What may irk shareholders further is that the company has announced it will be seeking shareholder approval to enhance the limits applicable for extending loans, making investments, and providing guarantees or security under Section 186 of the Companies Act, 2013 to Rs 3,500 crore. Currently, HGS has inter-corporate deposits to Hinduja Group companies but that has been capped at Rs 500 crore.
Is it the company's intent now to raise that limit and use the cash to fund group companies? Or do they intend to invest it elsewhere – nothing is clear yet.
What Others Have Done With Their Cash
Within the Indian IT services space, Infosys, Tata Consultancy Services, and Wipro have all gone through a phase where they had billions in cash reserves before shareholder pressure forced the companies to distribute excess cash and articulate a cash distribution policy. Infosys, TCS, and Wipro, to name a few, have now cash distribution linked to free cash flow and profits, most have an 85-100% surplus cash distribution policy. In fact, TCS just announced a buyback programme which will be considered by the board at its Jan. 12 board meet.
HGS is not the only company to go this route. There are others like Elder Pharma, which adjusted sundry debts accumulated in the balance sheet against the proceeds of the sale of its branded domestic formulation business. Eris Lifesciences and Prabhat Dairy disappointed their shareholders too, by retaining significant asset sale proceeds without articulating future plans. Then, there are some like Majesco, which sold its majority business and returned cash to the shareholders before entering the real estate business – but those are a few.
If you look closely, there is a lacuna in regulations. Proceeds from the sale of significant business segments should require an articulation of the use of proceeds before shareholders approve the transaction. Unless that is well-articulated, shareholders could be left holding less value than they thought they would, after stock prices initially run-up in anticipation of significant shareholder payout.
Sajeet Manghat is Executive Editor at BloombergQuint.