Recently Syntel Inc., Michigan (USA) based IT organization, declared a $15 dividend for its shareholders. At prevailing stock price of approx. $41, it meant a dividend yield of 36%, not a small number.
It is not difficult to see how it would impact the finances when a $1 B organization, with its 101 Million outstanding shares, declares such a dividend. With this dividend payout of $ 1.5 Billion, Syntel would give up all of its cash reserve (approx. $ 1.1 Billion), and will also bring a senior debt of approx. 400 M.
This is one of those interesting corporate actions that tells you how organizations may use leverage to change the organization culture. It is one of the most risky initiative, but it exhibits the quantum of confidence management has in its strategy.
It may also be interpreted negatively when by paying equity in the form of dividends, managers might be emptying company’s coffers and later using leverage to run the shop. If this happens, it may create a question on corporate governance practice, the company is following, especially when 1-2 individuals are also majority shareholders, as is valid in this case as well.
Common understanding says, equity is a less expensive financial instrument and also has less risk, as there is no compulsion to have periodic payouts to equity shareholders. Then why an organization would borrow money from the market, to pay its shareholders, and also would pay approx. $250 M of dividend payout tax.
If we look at the performance of IT industry in few quarters, revenues are stagnating, while organizations are sitting on a war chest of cash. Whether it’s TCS, Infosys, OR Syntel all have more than $ 1 B of cash or equivalent in their reserve. They kept it for possible M&A targets. However, in this time of Unicorns, not many companies are available for acquisition at reasonable valuations. And therefore, despite trying for years, Syntel couldn’t find a right target for inorganic growth, which in turn might have compelled it to pay the cash in form of dividend.
But why debt? A potential explanation is that through leverage, board & management hopes to create following effects on the company:
– Increased Managerial Discipline at various levels in the organization
– Reduce Slack in the resource utilization
– Improve financial efficiencies of Employee Utilization, Revenue productivity, and offshore leverage
– Reduce Cash Conversion Cycle by creating a sense of urgency in collecting ARs
Moreover, when a company applies for debt, bankers and creditors ask tough questions which compels business to think hard of its strategy and business model.
Also by increasing leverage, organizations may create a sense of urgency because in the absence of this urgency, organizations become too comfortable in status quo which may make them complacent in decision making.
So now probably, you would understand why Syntel might have decided to bring creditors on the books to pay its equity shareholders.
[This article is purely based on the analysis of the information available in public domain]