Friday, 12 July 2013

Debt for Dividends

Christchurch City Council refuses to sell Council-owned assets to help pay for the earthquake rebuild. They should sell some of those assets, so long as it's to pay for roads and sewers rather than for stadiums. But, a lot of folks just hate the idea of selling off the assets, and so it isn't happening.

Instead, Council-owned companies look like they'll be taking on debt to pay a higher dividend to Council.
The Christchurch City Council's investment arm may have to borrow to meet higher dividend commitments of $140 million over three years to the council.
Christchurch City Holdings (CCHL), which oversees the council's trading companies such as Orion and Christchurch Airport, promised to step up dividends after the earthquakes.
Its new statement of intent for the next three years from July 1 this year to June 30, 2016, forecasts dividends of $46m, $46m and $48m to the council.
It is a significantly higher level of ordinary dividends than before the quakes, when dividends ranged from about $30m to $35m each year.
CCHL's profits for the three years are forecast to be $33.1 m, $37.6m and $43.1m. CCHL will need to borrow $26.2m to meet its commitment to the council, unless it receives more dividends from the council's seven trading companies, increasing its profits.
CCHL chairman Bruce Irvine confirmed CCHL would borrow to meet the gap between its forecast profits and the dividends if needed.
I'm not a corporate finance guy, but it seems a bit odd to be borrowing to pay dividends to current shareholders. It's not something I'd expect would typically be recommended. Borrowing money to finance projects that yield a longer term rate of return in excess of the borrowing costs - that tends to be recommended. If firm shareholders have short term financial issues that mean they've a strong preference for having cash now, sensible Boards, I'd have thought, would have reminded those shareholders that they could divest themselves of a few shares if they needed a short-term cash hit.

When companies instead are borrowing to make their big shareholder happy about the current dividend flows, I start worrying about a whole pile of other ugliness that could be going on. Like, whether the company is making adequate investments in the maintenance of its physical assets or whether it's deferring maintenance to make the dividend payments. But again, I'm not an accountant or a corporate finance guy, and I've certainly not cracked open the CCHL books. It just smells a bit off. When a company is taking the dividend as a constraint against which to optimise instead of as the residual of what's left over after they've paid the bills, I wonder whether they really ought to have different owners.

But maybe a finance type who reads the blog can set my mind at ease here. Or maybe this is just standard practice when the government owns NZ companies. I remember something about something involving Solid Energy doing something like this.


  • Apple has borrowed to cover dividends and share buyback. Borrowing for a share buyback is different: the firm gets to own more of itself. And Apple had tax reasons to borrow rather than to bring its overseas cash back to the US.
  • Weird stuff can happen such that companies can't make a scheduled dividend payment while all is fine, or where a profitable company hits a liquidity constraint and so has to borrow despite profits in excess of the dividend payment. But here CCHL deliberately lifted the dividend payment to transfer more money to Council post quake. If they're doing that, why not just sell some shares in it instead?


  1. I think they call it asset stripping, tranz rail is a good local example, gear up the balance sheet and under no circumstances re invest in maintaining your capital investment. Doesn't really square up with city care employing ex mainzeal staff to have a crack at becoming a building company which I am sure will end really well.
    One would imagine that the Port and Airport need as much capital as they possibly can while they both expand ?
    Partial asset sales despite all the pundits saying were wildly unpopular has been an incredibly good way of Labour to soar in the polls and Key to be smashed, Oh wait. I don't think ratepayers care who owns the port etc and is not something they mull over while waiting to get the cars suspension fixed again

  2. Had a quick look at the Fy12 AR for CHHL... seems its has debt of $667m and equity of $1.3 billion.... so a D/E ratio of around 50% - this could be pushed a bit higher - but it also depends on the existing debt in place and the terms of new borrowings - the risk is that a lender to CHHL wants to get some form of 'revenue bond' security to enhance their position...

    Not good.

  3. In the Press piece Bruce Irvine is quoted as saying CCHL will only borrow if it has to implying that he is confident they can make the payments. Given that CCHL is invested in monopolies its not too hard to join the dots. After all CIAL could contribute the increased dividend by itself from its parking charges.

  4. But they Council do want to build stadiums and convention centres. 150,000 ratepayers and one $150 million stadium thats $1000 each. Add in a convention centre, thats another $1000 each. And it is something I would consider while the car's suspension is getting fixed again, I think the Council may possibly collapse and be taken over by Government . The sickness is just too too deep and longstanding.

  5. Can anyone remember whether the Council's original recovery plan (the one that had all the public input) included the covered stadium and convention centre? I think they may have only turned up once the government usurped the process.

  6. The first question to ask is: what are these increased dividends going to be used for? There are two possibilities - greater council spending or lower rates. It's hard to believe it couldn't be anything but the former.

    That being the case, what really matters is the quality of the intended spending, i.e., is it covering its cost of capital? (which is more than just the cost of the borrowing used to finance the spending) Since we don't know what the increased spending is going to be on, it's impossible to say anything definite about this. But the quality of council spending over recent years, and the quality of the 'analysis' underpinning it (e.g., the $70m cycleway), means the most plausible assumption is to place 0% probability on these borrowed funds being spent wisely.

    There are other interesting undercurrents in all this though. First, by getting CCHL to do the borrowing, the council is avoiding the need to reveal it on its own books, i.e., it's cunningly 'hiding' the extent of its indebtedness. Second, and more importantly, the council is effectively saying it can invest new capital more productively than CCHL. This is intriguing, given that we're repeatedly told what great investments the CCHL assets are, that they return 15% per annum, and how rates would be so much higher if we didn't have them. If all this were true, then the best strategy available to the council would be to reinvest the borrowed funds in the CCHL assets to provide for further growth. By implicitly saying it could do better than this, the council clearly doesn't believe its own spin.

    This is hardly surprising. The arguments trotted out to justify the 'keep-the-CCHL-assets' line are so transparently flawed that the only plausible explanation for the council's behaviour is good old fashioned empire building (something that those of us who work at the University of Canterbury are familiar with).

    But now the chickens are coming home to roost. As well as the disturbing announcement identified by Eric, this week we've also learnt that (i) Red Bus earned basically zero profit in the last financial year and will pay no dividend, and (ii) the council has sold one asset (Jet Engine Facility - what on earth was it doing owning it in the first place?) in order to prop up another loss-making subsidiary (VBase).

    It's like living in an episode of Mad Men (without the fun parts).

  7. Nothing inherently wrong with borrowing to pay dividends. Usually it's a way for a company to lever up to a lower weighted average cost of capital. Other reasons to do it are to reconfigure agency issues (debt holders keep firmer eyes on companies than equity holders in many cases). This can in fact be the cause of lower WACC.

  8. So the CCC want CCHL to increase its dividend. One of the best performing businesses owned by CCHL is Orion. Orion wants special permission to charge its customers more ( to rebuild its damaged network (all the while paying more money to its shareholders). This is looking increasingly like a rates rise by stealth.

  9. I can hardly believe, and I do not understand the simpleton argument that if i borrow money from you and I need to pay you back that I should borrow from another person. And you know i do not think Eric or Matt can explain this, and if you can Eric, do so now or be silent forever, , it is a fundamental equation, give away your words Eric, Christchurch University is closed,