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Monday, 4 May 2009

First Ship Lease Trust's Distribution Reinvestment Scheme (DRS)

DRS Summary

In short, DRS is a scrip dividend scheme for FSLT to make payments through issuing new shares in place of cash. FSLT had 2 strategies to reduce cash payout in terms of dividend, one is via direct reduction in distribution (from almost 100% to 75%) and second is via DRS. While a 25% cut in direct distribution conserve about USD 4m, how much DRS can conserve depends on the take up rate, up to a potential conservation of about USD 12m. To entice shareholders to take shares instead of cash, the shares are offered at a discount of about 5%.

Shares or Cash dividend?

I had an enjoyable discussion on the topic with a reader and the our correspondences (via comments on one article) can be found here. After the fruitful exchange with better insight, I summarise the key points and add a few more.

Qualitatively, if the market ultimately recover (before 2012 when the first bullet payment is due), choosing shares might seems a better option. But in current market sentiment where cash is king, many might choose cash that is immediately tangible. If the shares crash further, the cash can buy more units than those offered at a discount under DRS.

Those who should know better

Is there other hints for a better decision? The management and the sponsor should hold the key to the answer, if they don't know, who would know better? Along with the annoucement on the discounted price of the new shares under DRS, the take up rate of the key directors and sponsors are disclosed as well. If all of them subscribe 100% to new shares, I would almost do the same without much thought. In contrast, if the unamious choice is cash, I'll take cash and run fast. However, shareholders looking for a mark of confidence is still disappointed. The key directors take up 100% while the sponsor choose only to take up the 25% of the distribution in shares. 'Insiders' show their confidence, sponsors shows their reservations.

Quantitative Analysis

So qualitative analysis doesn't help here. How about quantitative analysis? The following is table tested the outcome if I choose shares entirely while 25% of other shareholders choose shares.

Under this scenario, my dividend entitlement for the next distribution will rise by about 7.2% to compensate me for taking shares instead of cash now. This compensation will fall to a meagre 2% if all shareholders take up distribution in shares. (Note that the actual DPU falls by 2.5%. The fall is even larger at 7.2% if all choose shares).

Over a longer period, until 1Q 2012 when the first bullet payment is due, the comparison for taking shares all the way versus taking cash all the way is illustrated:

Here, I assume the DRS only applies until 3Q 2010 when the USD 65m tranche is due for first installment (the distribution cut to 75% should be enought to service this installment) and dividend continues until 1Q 2012 when the 1st bullet payment is due. It is quite clear that taking shares might be a more worthwhile option, provided the shares are still worth something by 1Q 2012.

Benefits to FSLT

I've been talking from common shareholder's point of view. How about from FSLT? Cutting distribution to 75% generated about USD 4m and assuming all shareholders take up shares, will yield another USD 10m (the sponsor already pledge to take up 25% distribution in shares). But against the loan of some USD 500m, it might seems meagre. Noting that one of the value-to-loan covenant is 145%, a USD 10m reduction in debt will improve value-to-loan ratio by about 3.5%. But the expected reduction will be much lower since I don't think most shareholders will opt for shares.


I'll take up shares for now and see how other shareholders react. In the long run, I'm still confident that if the management can make use of the (slightly) better financial position to improve distribution in the future (via more distribution accretive acquitisions), it is still better to take up more shares.



Blogger dsea said...

Hello MU,

Indeed, the single act says a thousand word.

with regard to the directors opting for DRS, sometimes its implied. Actually,its very common overseas. director receive their fees (proportion varies) in form of shares. and they not allowed to dispose till they leave the board.


BTW, it just dawned upon me that the discount is to ensure that round lot of shares is issued, rather than to entice anyone to subscribe for DRS

5 May 2009 at 22:31  
Blogger Market Uncle said...

Hmm, I think there is still some discount for encouragement, but with rounding in mind.

6 May 2009 at 22:35  

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