DVRs

A large number of people, especially retail investors, are unfamiliar with the term DVRs. Despite the fact that it has been in existence since nearly a decade now, DVRs offer more potential in terms of returns. In fact, since they are lesser known, DVRs of some of the companies are undervalued. Unlike their perception of being a complicated product, DVRs are simple to understand as well as invest.


IMPORTANCE OF DVRS
Every ordinary equity share and its owner have equal rights in a company. If a company wants to take a decision or take over another company, it will have to seek the approval of its owners or its shareholders, who in turn, will express their decision by exercising their voting rights. If companies do not get the requisite votes from their shareholders, then it cannot pass any resolution or take decisions on matters that require the approval of the shareholders. There are practical issues too. If you ask company managements what they prefer, they would say they much rather have institutional investors as shareholders of the company, but would also prefer them not interfering in the day to day running of the company. Many companies are known to have found it difficult to convince institutional shareholders or large shareholders while seeking their votes for particular decisions. Many a times institutional investors block certain resolutions and companies are forced to rollback resolutions in the event of opposition or the inability to obtain enough votes. There are circumstances when companies want to raise funds by issuing additional shares, but they fear they would lose control as issuance of additional shares could result in the dilution of voting rights. For instance, promoters of a company have a 51% stake. And following the issuance of additional shares, the same could fall to 40%. In such a situation, the company might fear losing control and also face difficulties in seeking approval. Moreover, a higher stake dilution could create the threat of a hostile takeover of the company. All these situations, particularly for family-run businesses, could have devastating effects on companies.


SOLUTION IN ITSELF
A DVR share, as the name suggests, has solutions to all these problems or the issues that companies and investors face. These shares carry differential voting rights. This means the shares will remain the same in all respects compared to the ordinary listed equity shares, but will carry differential voting rights. In this case, say a investor who holds 100 DVR shares, might be having voting rights equivalent of 10 or one-tenth of every DVR, whereas an ordinary equity shareholder who holds 100 shares could have voting rights equivalent to 100. Through the DVR route, the company may raise funds without diluting rights because they could carry lower voting rights. This might solve the company’s problem. But what about the problems of investors? Why would they have lesser voting rights even if they really do not exercise them? It is true in the Indian context that not many, especially retail investors, exercise their voting rights.


ADVANTAGE: DISCOUNTED PRICE WITH HIGHER DIVIDEND
Why should one shareholder (DVR) be deprived and the other be given more privilege (in terms of voting rights)? In view of these valid arguments, the need to compensate DVR holders with lower voting rights arises. This is why companies offer DVR shares at a lower price compared to their counterparts - ordinary equity shares. But what will the investor do if the markets closed for the next five years? Do not worry.
DVR holders are compensated with higher dividends. This means that if ordinary shareholders are issued 10% dividend, the DVR holders get an additional dividend of 15% or 5%. Let us now take actual examples to understand this better. In India, leading automobile company, Tata Motors, was the first to offer DVR shares. Its DVR shares have one voting right for every 10 DVR shares held by its owners.
So, in this case voting rights are almost one-tenth compared to voting rights enjoyed by ordinary equity shareholders. Therefore, if you buy Tata Motors DVR today, they will have lesser voting rights. However, for the lesser voting rights you are compensated by way of price. Today ordinary equity shares of Tata Motors are trading at around `279 per share (as on 9th March) whereas DVR shares are trading at around `155 per share (as on 9th March). This is almost a 45% discount compared to ordinary shares. That apart, Tata Motors pays a 5% additional dividend. So as the company is expected to declare per share dividend of `4 next year to its ordinary shareholders, the DVR holders will get 5% higher dividend, which will total to `4.2 per share.
In the first case, one is buying DVRs at 45% discount. Secondly, if today one invests in ordinary shares at `279, then the dividend earnings will be about 1.4%. And if the same money is invested in DVRs, then the dividend earnings next year will be almost 2.8% if we include the benefit of 5% higher divided for DVR holders.
HOW MUCH DISCOUNT ?
By now it must be clear as to why DVRs trade at a discount. However, the bigger question is at how much discount should DVRs trade at and how should we value them. The quantum of discount could depend on several factors. But in India, in general, the discount is observed to be much more compared to the discount in the global markets. Globally, the concept of DVRs is quite old and well understood by investors. Many global giants like Berkshire Hathaway, Google, News Corp, etc have issued DVR shares in the past. The global price pattern suggests that most of them typically trade at about 0-15% discount compared to ordinary shares. In India the discount is as high as 40% to 50%, which many believe is not justified.


PRICE: A REFLECTION OF LOW AWARENESS
Though this looks illogical, it is largely on account of the fact that despite having four listed DVRs at present, the awareness of the product is very low. This can be gauged from the fact that most DVRs have very low volumes or liquidity. Also, only institutional investors or large investors have invested in DVRs in India. The participation of retail investors is still very low. It is possible that in the long run as a result of increased awareness, participation could increase, leading to the discovery of the logical or reasonable price of DVRs. In such a situation, the current discount on DVRs could also narrow down to the global benchmark.


SHOULD YOU BUY DVRs
Given a chance what would you buy - ordinary shares of Tata Motors or its DVR, which are trading at 45% discount and offering a far higher dividend yield? If you are an investor who is not interested in voting rights, why not invest in DVRs, which for no major reason trades at much cheaper prices. The odds are in favour of DVRs as in the long run investors will not only gain on account of structural investment story but also on account of higher dividends. Imagine you have invested in the DVR of a company which is in the growth phase and is expected to increase its dividend payouts over the long term. In such a situation, the dividend income alone could be far more rewarding. Not to forget, if in the long run, the gap between DVR prices and ordinary shares gets narrower, then there will be an additional kicker to the overall returns, which could be very high if it happens at higher prices in the future. Hence, factors like DVR discount compared to ordinary shares, dividend yield, ratio of voting rights and size of the equity capital play a critical role while determining the price of DVRs. However, simply going by the discount on DVR shares may not work always as rules of investing in equity shares do not change for DVR shares. This is nothing but one more form of equity shares albeit with lesser voting rights. Investors need to carefully understand the prospects of the company, industry in which it is operating and the company management like we do before investing in equity shares of the company.
To conclude, DVRs could be a far better instrument for long-term investors who are not very enthusiastic about voting rights. However, in the short term, the only visible risk to these instruments is that they trade with very thin volumes, which is why they tend to fall higher in falling markets as investors tend to sell them at lower prices in a bid to exit them.
However, this particular risk will largely influence short-term investors; long-term investors can still leverage on them.


DETAILS OF LISTED DVRs

Tata Motors
Tata Motors issued DVRs in the year 2008 to fund its global acquisition. In that year, the company announced rights issue, which also comprised DVR shares offered at `295 a share compared to ordinary new shares offered at `330 a share. In the case of Tata Motors’ DVR, investors have voting rights of one-tenth with the privilege to get 5% additional dividend compared to ordinary shareholders of the company.

Pantaloon Retail
Pantaloon issued its DVRs in the year 2008 through the issuance of bonus shares to existing ordinary shareholders of the company. Its DVR has voting rights of one for every 10 DVRs held by its owner. However, its DVR investors enjoy 5% additional dividends compared to ordinary shareholders of the company. Currently, Pantaloon’s DVR at the current price of `102 (as on 13th March) is trading at 37% discount to its ordinary shares which are trading at `161 per share (as on 13th March).

Gujarat NRE Coke
The private sector coking coal supplier, Gujarat NRE issued DVRs in the year 2010. Its DVR carries a voting right of one for every 100 DVRs held by its investors. Its DVR at the current price of `15.3 per share is trading at a 40% discount. However, investors should be aware that the trading volumes in the case of Gujarat NRE’s DVR is very less. The average two-week trading volumes in the counter stood at just about 7,700 shares compared to 9.31 lakh shares in the case of ordinary shares.

Jain Irrigation DVR
Jain Irrigation, which is the leading player in micro irrigation system, issued DVR shares recently in November ’11 in the form of bonus to its existing shareholders. Its 10 DVRs carry voting rights equal to voting rights of one ordinary share. Relatively, in the case of DVRs’ of Jain Irrigation, the discount is larger as currently its DVR is trading at almost 50% discount at around `52 per share (as on 13th March) compared to `108 per share price (as on 13th March) in case of the ordinary shares of Jain Irrigation.