Dividend Distribution-In-Kind
Commentary
Dividends represent a commitment of a Company to sharing their profits with shareholders, representing value creation and augmenting investor confidence. Companies typically pay dividends in cash, however, sometimes companies may alternatively choose to pay dividends in assets other than cash. These non-cash distributions known as “in-kind dividends” are strategic choices that reflect a variety of corporate objectives and financial considerations, offering both opportunities and challenges to both the company and its shareholder.
Reasons for dividend distribution-in-kind
A key driver for companies’ issuance of non-cash dividends is to conserve their cash reserves, as a strategic imperative. Instead of distributing cash to shareholders, they may provide other assets to provide financial flexibility. By distributing non-cash assets to shareholders, businesses can safeguard their liquidity, equipping themselves to navigate unexpected challenges, capitalize on emerging opportunities, and reinforce their long-term growth strategies. Preserving cash allows companies to explore new growth opportunities without relying on external funding, which can be costly, time-consuming, or involve issuing new shares that reduce existing shareholders’ ownership stakes. By distributing assets other than cash as dividends, a company avoids increasing its debt or altering its ownership structure, ensuring it remains well-positioned for strategic moves like acquisitions.
During economic downturns or uncertain periods, cash reserves act as a safety net, enabling businesses to operate without severe cost-cutting. This resilience provides a competitive edge by allowing continued investment in crucial areas such as research and development (R&D) as a key driver to innovation, efficiency and future profitability.
In industries characterized by seasonal demand, managing inventory effectively is vital. As an alternative to holding unsold products, companies can distribute them as dividends, reducing storage costs, clearing inventory, and minimizing the risk of goods becoming obsolete.
Avoiding cash outflows also lets businesses reinvest in transformative initiatives such as infrastructure, technology advancements, or facility expansion, all of which support future growth and profitability.
When facing temporary cash flow constraints, dividends-in-kind offer a practical solution to uphold shareholder relations without jeopardizing financial stability. By rewarding investors with non-cash assets, firms can demonstrate their commitment to shareholders even during challenging periods. Multinational companies (MNCs), operating across diverse markets, often prefer distributing dividends-in-kind instead of cash. Since each country has its own currency, fluctuations in exchange rates can make paying cash dividends in foreign currencies expensive. By distributing assets such as shares or physical goods, MNCs can bypass unfavourable exchange rates and save on transaction costs, ensuring a more efficient way to reward their shareholders.
Types of dividend distribution-in-kind
When a firm decides to pay dividend distribution-in-kind, it may take various forms. One form is the payment of stock dividends. A stock dividend is a type of dividend payment where a company distributes additional shares of its stock to shareholders instead of cash. Essentially, when a company issues a stock dividend, shareholders receive a certain percentage of additional shares based on the number of shares they already own. For example, if a company declares a 10% stock dividend, a shareholder who owns 100 shares will receive 10 additional shares (100 * 10%), increasing their total ownership to 110 shares.
Dividends-in-kind can also be distributed as other financial assets, such as bonds or mutual funds. These assets are typically already owned by the company. For instance, when distributing bonds, the company may transfer a bond to a shareholder, which can be redeemed for cash at a future date. Similarly, mutual funds can be used as a non-cash dividend, where the value of the mutual fund shares is distributed to investors, equivalent to the dividend amount they are entitled to receive. This approach provides flexibility while preserving the company’s cash reserves.
Instead of cash, companies can also choose to distribute its own products or services as dividends to shareholders. When a company issues a product dividend, shareholders receive physical goods, services, or access to the company’s offerings instead of a cash payout. The type of product distributed varies depending on the nature of the company’s business. For example, if a beverage company issues product dividends, shareholders may receive cases of drinks or food items. Similarly, a cinema company might distribute tickets which was the case for Cinemaone which gave each shareholder a voucher redeemable in movie tickets, food and beverage services, theatre facility use, screen advertising valued at TTD 0.13 per share.
Advantages and disadvantages of distributions-in-kind
Companies that distribute dividends in kind can preserve their cash resources, enabling them to reinvest in growth initiatives and strengthen their financial position. This is especially beneficial during periods of economic uncertainty, as it provides flexibility to adapt to challenges and pursue opportunities. For shareholders, this approach supports the business’s long-term growth, potentially increasing the value of their shares over time.
Dividends-in-kind also offer shareholders an opportunity to diversify their investment portfolios. By receiving assets such as stocks or products, investors gain exposure to new industries or asset classes. For example, a shareholder who primarily holds the company’s stock could benefit from an in-kind dividend that includes shares of a subsidiary or assets in a different sector. Diversification helps manage risk by spreading investments across different areas, reducing the impact of a downturn in any single asset or industry.
From a tax perspective, dividends-in-kind can offer advantages in certain countries. Capital gains from the sale of these assets are often taxed at a lower rate than ordinary income. Additionally, shareholders can defer taxes until they sell the distributed assets, potentially benefiting from more favourable tax rates and timing.
However, there are also notable drawbacks. One major disadvantage of dividends-in-kind is illiquidity. Unlike cash, assets such as products or shares may not be easily or quickly sold, which can be a challenge for investors who rely on dividends as a source of income.
Share dilution can happen when companies issue additional shares to shareholders as dividends-in-kind. This means instead of paying cash, the company gives shareholders more of its own stock. While this increases the number of shares each investor owns, it also increases the total number of shares available in the market. As a result, each individual share represents a smaller percentage of ownership in the company. This can reduce the value of existing shares and the voting power of shareholders, as their stake in the company becomes diluted among a larger pool of shares.
Issuing extra shares as dividends also impacts the stock price, which adjusts to reflect the increased number of shares. This adjustment ensures that the company’s total market value remains the same immediately after the dividend is issued. For example, if a company with 1 million shares trading at $50 each (valued at $50 million) issues a 10% stock dividend, it would have 1.1 million shares after the dividend. The stock price would then adjust to approximately $45.45, keeping the total market capitalization unchanged at $50 million.
In addition, these assets can be difficult to value. Unlike cash, which has a fixed and universally recognized worth, the value of in-kind dividends is often subjective and influenced by variables such as market conditions, demand, and consumer preferences. This inherent volatility can make it hard to determine the true financial benefit of the dividend at the time of distribution.
In some cases, the practicality of the distributed assets may also be limited. For example, if a company distributes its products as dividends, some shareholders may have little use for them, diminishing the value and appeal of the distribution.
Dividends-in-kind provide a unique way for companies to reward shareholders, offering benefits beyond traditional cash dividends. While they allow companies to conserve cash and manage resources efficiently, they also provide investors with tangible assets or shares that could hold long-term value. However, investors must carefully consider factors such as liquidity, valuation, and tax implications, as these dividends are less straightforward to monetize compared to cash. For those willing to explore the broader potential of these distributions, dividends in kind can be a strategic and rewarding form of investment return.
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