Dividend Re-investment Scheme (DRS), is it worth it?

I'm not sure which company start introducing the Dividend Re-investment Scheme (DRS), but it had been popular by most of the banks in Malaysia when paying out the dividend to their shareholder. In short, a DRS allow shareholder to re-invest part of the dividend received into new share of particular company, often at a discount below the market price for existing share of the company. Banks like to do this to increase their capital to comply with future regulatory requirement, while keeping their promise with shareholder on stable dividend payout. Shareholder will then need to make a choice on whether he will like to keep the dividend as cash or re-invest as per term and condition of DRS. 

There are potentially three situations the shareholders will be facing:

Situation 1 : The shareholder is in need of cash

Situation 2 : The shareholder is not in need of cash, and the price for DRS is below the current Net Asset Value (NAV) per share. 

Situation 3 : The shareholder is not in need of cash, and the price for DRS is above the current Net Asset Value (NAV) per share. 

For situation 1, since the shareholder need cash, there is really no choice but to forgo the DRS option. 

For situation 2, the advice is to always re-invest. This is because if you don't re-invest and others do, the NAV per share of your original share will be decrease due to diluting effect, and you loose the NAV without reason. To illustrate, for a company with 100,000,000 shares outstanding and NAV per share of RM 10, if the company decide to give dividend of RM 1 and DRS price is RM 5, a total of 20,000,000 shares will be issued. The NAV after DRS will be around RM 8.33. Now , if  you choose to keep dividend as cash instead of going for DRS, your total asset will be RM 8.33 + RM 1.00 = RM 9.33, compared with RM 8.33*1.2 = RM 10 that you have. A loss of RM 0.67 per share!

For situation 3, it is a bit complicated. 

To summarize, even though your NAV per share will increase, because of the diluting effect of new share issuance, your share on the company future earnings will be decrease. Further more, a company with market price higher than NAV usually has high Return on Equity (ROE), thus, the benefit of keeping cash (and invest elsewhere) need to compare with the loss in opportunity of additional investment of the company. There will be a rate of return of other investment that make the two choices equal which serve as an determining benchmark. That if the shareholder is optimistic of getting return above benchmark, he shall keep the cash from dividend and invest elsewhere, but if he is pessimistic of getting return below the benchmark, he shall opt for the DRS. 

Which lead to the question, how do we calculate this reference benchmark?

Let use an example to see. A company has the following characteristic

Current market price : RM 11

DRS price : RM 10

Earning per Share (EPS) = Dividend declare : RM 1 (thus a person holding 10 shares will get 1 share if opt for DRS)

Current shares outstanding, 100,000,000 shares

NAV (before/immediately after dividend) : RM 6/ RM 5. 

The NAV after DRS will be RM 5.4545, total number of shares will be 110,000,000, if all dividend reinvested in DRS. 

Now , regarding the potential change to share of future earning, there is 4 cases. In all cases below we assume the shareholder had 10,000 shares in the company. 

Cases one, regardless of the total capital employed, the total future earning for the company remain constant. 

This mean, the total earning next year will still be RM 100,000,000. 

But as total number of share had increased to 110,000,000. 

EPS will dilute to RM 0.909. 

If you opt for keeping dividend as cash, your share of company's earning will amount to RM0.909 * 10,000 shares = RM 9,090. 

If you opt for DRS, your share of company's earning will amount to RM0.909 * (10,000+ 1,000) shares = RM 10,000. 

The difference of RM 910, is what you required to earn with the dividend hold as cash. As the amount of dividend hold as cash is RM 10,000, the equivalent rate of return that make two options equal will be 9.1%. This mean that, if you confident that you can earn rate of return more than 9.1% in other place, you shall keep the dividend as cash (and invest elsewhere), else, you shall opt for DRS.

(one might also notice that the difference is due to additional shares invested X new EPS. )

Case two, regardless of the total capital employed, the Return on Equity (ROE) for the company remain constant. 

This mean, if the ROE for this year is 20% (EPS/Capital employed the year before)

The next year ROE will still be 20%. 

The difference between keep as cash and opt for DRS will then be 20% * RM 5.4545 * 1,000 shares = RM 1091. 

The equivalent rate of return that make two options equal will be RM 1,091/RM 10,000 = 10.91%. 

Case three, regardless of the total capital employed, the Return on Equity (ROE) for the company remain constant, but the Equity included tangible and intangible asset, and the amount of intangible asset remain the same before/after the DRS.

Tangible asset means the NAV that we can measured. 

Intangible asset usually can only be estimated and consisted of the skill of employees in the organization, the current marketing and distribution network, and also the value of the brand name. 

As the total amount of intangible asset assume to remain constant, but total outstanding shares increased after DRS, the intangible asset per share will decrease. Table below illustrate the cases with different amount of total intangible asset, and their resulted equivalent return requirement. For the trend, one can safely say that as long as the total intangible asset remain constant, the equivalent return required will range from 9.10 % (case where infinite intangible asset that change in NAV no longer relevant) to 10.91% (case where zero intangible asset that change in NAV will be dominant). 

Case four, the ROE for capital employed is not constant, and it will increase/decrease after DRS. 

In this case, since we already know the new NAV per share (equity) and additional number of shares invested (1,000), we just need to estimate the new ROE and multiply by new shares and equity per share. 

Conclusion?

We take Maybank (1155) recent DRS for example. (all data taken from bursa website, Maybank June quarterly financial statement, here)

Total number of shares = 9,117,393,000

NAV per share (before/after dividend) = RM 5.3653/RM 5.1253
ROE(annualized) = 14.67%
EPS (annualized) = RM 0.735
Dividend declared = RM 0.24
Electable portion of dividend for DRS = RM 0.20
Share price during ex-date = RM 9.88
DRS price for new share = RM 9.30
Total new shares if all opt for DRS = 196,072,968
New NAV per share ( if all opt for DRS) = RM 5.213

Assuming one shareholder holding 10,000 Maybank shares. The equivalent rate of return, for constant return case to constant ROE case, are shown in table below

This mean that, if you are confidence in getting rate of return higher than 8.23% in other investment, you should keep the Maybank dividend as cash. Else, elect for the DRS. 

Now, one would question what happen to the discount you receive by invest in DRS price lower than market price. Well, if you choose to invest in long term, the discount doesn't really matter as the ultimate price of maybank share will be determined by its EPS in the future and rate of return required by the market. 

There is one other option, to opt for DRS, then immediately sell the new shares obtain under DRS in higher market price to reap the price difference (RM 0.58 per new share). However, due to minimum selling lot restriction, one need to have at least 4,650 Maybank shares to enjoy the instant profit. The commission fee will likely reduce the profit further by about RM 12 (estimated commission fee incurred) if you sell 100 shares. But it is still profitable, and this explain why after the DRS period, large institution investor like Employee Pension Fund (EPF) will have immediate selling activities.