Financial Analysis Of Mark And Spencers And Vodafone Finance Essay

Financial Analysis Of Mark And Spencers And Vodafone Finance Essay

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In 2002 Mark & Spencer restructured its capital through the creation of a new holding company called Mark & Spencer Group plc. In addition, in the same year Mark & Spencer also reduced its capital by 19% through the court-approved Scheme of Arrangement. Mark & Spencer decreased the nominal value of each of its New Ordinary Share from 245 pence to 25 pence. The capital restructuring is done because return on equity and assets was low for Mark & Spencer for so many years. Therefore, Mark & Spencer underwent a capital re-structuring by a proposal to return approximately £2 billion to its shareholders. Mark & Spencer generates £2 billion cash from different sources like cash raised from its recent business activities but the main source was disposal of its non-core operating assets, for example, property. Mark & Spencer hold large proportional of properties in UK and outside UK and the return on property was lower than the return in retailing. So, Mark & Spencer return the £2 billion cash to shareholders after selling non-core operating assets which they really don't need. So in order to return the £2 billion to shareholder and to maintain the sufficient distributable reserve, Mark & Spencer underwent through a scheme of arrangement and a capital reduction process. The scheme of arrangement includes the creation of a new holding company and also in Mark & Spencer Group capital reduction, allows Mark & Spencer more financial flexibility. Therefore, the £2 billion is returned to shareholders without using the existing distributable reserve of Mark & Spencer's (Mark & Spencer, 2002).

Under Mark & Spencer scheme, the return of £2 billion to shareholders has been done through the issue of "B redeemable share" and its subsequent redemption by shareholders. Shareholders were given "B redeemable share" value of 70 pence, for every ordinary share they hold, at the time of capital re-structuring process and also company issued 17 New Ordinary Shares for every 21 ordinary shares in Mark & Spencer Plc. According to www.nortonrose.com (2010) once the "B shares are issued by the company, shareholders are often given two options. First, an Immediate Capital Option and second a Deferred Capital Option. However, Immediate Capital Option means, where shareholders redeem their "B share" immediately at a specified rate and the company will transfer the entire redemption money to shareholders. Likewise, Mark & Spencer gave the first choice to their shareholder to redeem the "B shares" immediately at 70 pence per share. And, if not, then the second option given to shareholder is called Deferred Capital Option.

Deferred Capital Option means where shareholders keep "B shares" with them for the future and receive income, as dividend, is usually declared on the "B shares". In this method, shareholders have the right to redeem its "B share" whenever they want, subject to companies rule of redemption. Similarly, Mark & Spencer offer their shareholders to keep "B shares" and give non-cumulative dividend of 75% semi-annually. According to Mark & Spencer rule, the shareholders can redeem "B shares" at least twice a year at 70 pence per share. The remaining "B shares" were redeemed in May 2006. The table in the appendix will gives an idea of how each of the choices affects the shareholders.

According to Connon, H (2002), the advantage of this method, from a shareholders perspective, is that redeeming the "B Share" has been treated as a partial sale of shareholder investments, so the gain is subjected to capital gain tax instead of income tax gain, which has been paid by the Mark & Spencer through the dividend on the "B Share". So for the investors, who were coming under the capital tax allowance for that year, was the right time for them to sell the "B share". While Mark & Spencer paid the interest on the "B share" and shareholders got better return elsewhere. According to Straighter (2002), the main objective of Mark & Spencer behind this mechanism, was to treat all the shareholders in the same way. Moreover, from Mark & Spencer prospective, the return on capital made its financial structure more efficient and flexible. They have £2 billion less capital on return and their earning was divided through a small number of shares. If Mark & spencer could have done through its traditional stock repurchase method or by paying higher dividends method then Mark & Spencer and shareholders both will be liable for tax bill like, stamp duty, income tax etc. then it would be harder for the private investors to participate in a buy back scheme.

According to BBC News (2002) Mark & Spencer opted above mention mechanism rather than a tradition stock repurchase in order to avoid a sudden hike in its share price. Moreover, if Mark & Spencer had chosen traditional stock method, then they would have paid all the money in one-go to shareholders, while with this method they were liable to return cash in according to the shareholder's demand for cash. Also traditional share repurchase can be done all at one-go or could be stretched over a period for unloading the equity capital of a company. Moreover, traditional stock repurchases has some signaling theory, according to which market reacts positive on the decision as this takes off extra cash flow from managers ensuring that they don't overinvest. But returning capital generally means that the company doesn't have any profitable investment in their portfolio but in Mark & Spencer case the source of the cash and the aim of the company to re-organize its capital. So along with the method used for restructuring the capital, a lot depends on the way the managers communicate information's to the market. The repurchase of shares increase the level of profitability in near future as more profit is shared by less number of shareholders but this was also achieved by the Mark & Spencer court-approved Scheme of Arrangement method.

There was another method also for Mark & Spencer to use the excess free cash flows use by distributing i.e. Special Dividend Payment. But using special dividend payment would have led the Mark & Spencer to use all the distributable reserve in one-go which was not the aim of the Mark & Spencer. Different investors have different requirements, and keeping the same thing in the mind Mark & Spencer used above mention method as to what shareholders would prefer. Distributing the dividend give the signal in the market that company is expecting higher growth with higher profits or may be a firm shifting from growth to value stock. But according to the Mark & Spencer method it is clear that the company wants to follow a dividend reinvestment plan, from which investors can buy shares in the market in every six months using these dividends, this result to the reduction of shares. While Special Dividend Payment method might lead to the addition of shares instead of reduction. Lastly, the tax rate for different methods is also determines that which method to follow, because historically capital gain tax has been less than the dividend tax on share repurchase, but now most of the countries either made it equal or may be in the process of doing that. So after critically analyses the decision of Mark & Spencer, it seems that they have followed the right method to achieve the set goal for returning the £2 billion cash to shareholder and capital-restructuring.

VODAFONE

Managers are not the real owners of the companies and owners are not the real managers of the companies. However, Managers are appointed by the owners i.e. by the shareholders to take care of company's performance for the owner's benefit, but sometimes managers take some decisions for their own sake without having light on the owner's value. This concept is called an 'Agency Problem'. This problem is generally faced by all the companies these days. Executive compensations packages attract the public attention and media interest. The major event was when Vodafone declare in its annual report in 2000 and 2001 that Vodafone's CEO Chris Gent, awarded with £8 million as a salary package (Vodafone Group Plc., 2000). This all happens after firm Vodafone takeover German mobile phone group Mannesmann and Air Touch. After such takeovers and mergers Vodafone underwent some major managerial changes; this mainly because according to Guest, P (2006) "correlation between the compensation and size imply that making a firm larger by acquisition could only increase the compensation of an existing managers, regardless of whether the acquisition creates value or not". Therefore majority of acquisition, mergers do not benefit to shareholders but these acquisition and mergers are basically carried out to increase the size of the firm in an attempt to increase executive compensation (Guest, P 2006).

There is significant relationship between firm performance and the level of executive cash compensation. In Vodafone, CEO compensation consist of cash- based compensation, which is the sum of base salary and bonus and equity-based compensation, that is the sum of stock options and long term/short term incentives plans (Ozken, N 2007). According to the Vodafone annual report of 2000, the short term incentive plans is provided in form of shares, after attaining performance criteria for the year as set by the remuneration committee. This provisional award of share is in two parts: "an original award of "Initial Shares" worth up to 25% of salary and an additional award of "Enhancement Shares", worth 50% of the value of the original award" (Vodafone Group Plc., 2000). But if executives do not want to go for provisional awards then, the company may pay a cash bonus of 25% of salary. While in Long Term incentive plan shares will be transferred to the executive directors and senior executives at nil consideration after attaining three years performance criteria, set by the remuneration committee. That is the reason why sometime companies inflated their profits without writing down its goodwill and impairment assets.

The size of the Vodafone has no doubt increased by the Acquisition of Air Touch and Mannesmann, but this acquisition didn't benefit any Vodafone shareholder. Vodafone increased its size by $184 billion but because of acquisitions and mergers it destroyed almost $105 billion wealth of an investors (Balls, A 2002). So it is correctly said "Company had vastly overpaid for the many acquisitions it had made in prior years, many with inflated stock" (PR Newswire, 2002). There were two occasions where company awarded special bonus to executives. Firstly when company merged with the Air Touch in 1999 and secondly when company acquired Mannesmann AG in 2000. Company policy does not allow for the payment of special bonuses to executives but these bonuses are paid, on the other hand it paid for acquisitions, which actually reduce the value of shareholders money (Vodafone Group Plc., 2000).

 

After taking above mentioned agency problem into consideration, the main focus of Vodafone's is on the interest of executive & managers and simultaneously with the interest of shareholders. For this purpose, company having a policy where they offer compensation to executives in form of stock option on the basis of achieving performance target which basically improve the shareholder value. "Share Ownership guidelines require ownership levels of four and three times salary respectively for the Chief Executive and other executive directors" (Vodafone Group Plc, 2001). Moreover, out of total remuneration, 80% are performance based remuneration. The above mention issue explains that the shareholders always in benefit with the performance based remuneration. To claim more remuneration, the executives would have to increase the performance. But, the main thing is that which performance we have to consider. Either simple performance or risk based performance. Performance can be increase by using different methods. To increase the performance, low cost debt is the simple solution. Also, the risk of the company increases with the increase in leverage. Moreover, as higher the debt the lower will be the equity of the company.

In 2000 and 2001 there was no indebtedness in the Vodafone because of mergers and acquisitions of Air touch and Mannesmann AG, which increased the value of equity capital. Vodafone's 31 March 2001 balance sheet shows net debt at 5.4% of the Group market capitalization (Vodafone Group Plc, 2001). Generally when a new CEO's join the company, the first step a CEO took is to write off all the assets, to take care of future profits. But, in case of Vodafone, there was a case of performance based remuneration, so purposely the CEO and executives not writing off its company's assets as because writing off assets would reduce the future profits and CEO's and executives are paid on performance based remuneration. But this give a questions in shareholders eyes that the company might be overvalued. The reason of overvalued is the assets might not be worth enough that what they are showing in the balance sheet. Moreover, in the year 2000 and 2001 Vodafone Group amortised £1.72 and £11.9 billion of goodwill respectively. This amorisation amount is all part of the goodwill amount which has been created at the time of the merger of Air Touch. At the time Air Touch merger £41 billion of goodwill has been created. However, amortization of goodwill results in the reduction of assets of the company which contrary means reduction in owner's equity.

Due to write down of assets i.e. goodwill there is decrease in assets and with an increase in a liability, will definitely reduce the value of shareholders money, in general reduce owner's equity. Same thing was there in the Vodafone case. Valuation purpose also affects the value of the company. But, the actual valuation of the company would be reduced by the write down off assets and also because of heavy indebtedness. In the case of Vodafone, the heavy indebtedness can't be measure but yes, write off of assets i.e. write off of goodwill would definitely affect the valuation of the company. This will not only affect the valuation of the company but it also gives an idea that the company over paid for the acquisition. And these all give rise in all the agency problems as because executives and managers are highly rewarded at the time of these deals.