India Inc must stop playing Scrooge

Ajay Piramal is definitely a brilliant dealmaker, going by the cool 50 per cent gain that Piramal Enterprises will be pocketing from the sale of its strategic equity stake in Vodafone India to Prime Metals. Most professional investors in India would give an arm and a leg to see an investment pay off so handsomely in just two years.

This deal, coming on top of the milestone payments that Abbott Labs makes to it every year, would make Piramal Enterprises one of the most cash-rich companies in India Inc; its coffers are likely to top ₹10,000 crore this year. But just to clarify, this isn’t likely to make much difference to the public investors in Piramal Enterprises.

Note how all the news reports go on and on about the new ventures that Piramal is now ‘eyeing’ with this huge cash kitty. None have raised the critical question: How much of this windfall does the company plan to distribute to its shareholders?

Maybe they already know the answer – not very much. After all, the cash distributed to investors from Piramal’s earlier coup, the sale of the formulations business to Abbott, was quite underwhelming. From a deal valued at ₹17,000 crore (including staggered milestone payments), all that investors received was a stock buyback worth ₹2500 crore and annual dividends for three years amounting to about ₹300 crore each. Nor has Piramal Enterprises’ venture capital-like avatar helped it deliver great financial performance or stock price gains to its investors. The company’s latest financial results show that it reported losses for the nine months ended December 2013. This Friday, after news of the Vodafone sale was out, the stock spiked to about ₹575, exactly the same level at which it traded four years ago in May 2010, after the Abbott deal became public.

In this context, it is hard not to compare the Indian attitude to cash-rich companies, with that in the US. As recently as last month, activist investor Carl Icahn was holding a gun to the head of tech giant Apple, asking it to deploy $50 billion of its cash hoard in buying back stock from investors. Remember, this was for a tech company which is in an aggressive growth phase, after it had already put through buybacks amounting to $40 billion in the preceding year.

But to single out Piramal Enterprises for its not-so-liberal dividend policy would be quite unfair. For long, institutional investors in Infosys have been tussling with its management to get it to pay out some of its mounting cash pile as a special dividend. But the tech major has stonewalled such suggestions, citing reasons ranging from the need to tide over ‘volatility’ and emergencies, to being on the lookout for acquisitions.

In fact, an analysis of the balance sheets of the top 500 members of India Inc shows that this malaise is quite widespread. Most Indian companies love to amass cash, but are strangely reluctant to part with it by way of share buybacks or dividend payouts. While Indian companies certainly don’t lag their global peers on profitability, they tend to be stingy with their dividend payouts. Dividend payout ratios (the portion of annual profits that companies distribute) for Indian companies has hovered at 20-22 per cent in the last five years, far lower than levels in most developed markets. This essentially means that for every ₹5 that a company earns as profit, only ₹1 goes back to the shareholder as dividend.

This is also why the Indian stock market offers one of the lowest dividend yields in the world. The Nifty’s dividend yield of 1.3 per cent is far below that for emerging markets as a class (2.7 per cent) as well as developed markets such as the US (2.5 per cent). This tendency of Indian companies to hold on to cash like a limpet has many negative implications for investors, and for the market as a whole. For one, it makes equities a riskier proposition for Indian investors.

If one has to rely on capital appreciation, which depends mainly on the mad swings of the market, foreign institutional investors and so on, for much of one’s returns, how would they perceive stocks as a long-term investment vehicle? Now, if the companies you owned were to consistently pay out a 3-4 per cent dividend every year, this would give you some regular cash flows as long as the company remains profitable, shielding you from the vicissitudes of the Sensex.

Two, when companies sit on large piles of cash with no obligation to share it with investors, they are often tempted to make foolish decisions which they would not easily make with borrowed money. Idle cash is an open invitation to an empire-building promoter, to build a risky mega-project or rush headlong into an over-priced acquisition.

A final strike against this low-dividend policy of India Inc came from valuation guru Aswath Damodaran. During an interaction with this paper a few months ago, the professor pointed out that poor dividend payouts stand in the way of efficient resource allocation in the markets and in the economy.

His concern was that if the big daddies of business simply hoard their cash, how will that capital find its way to a Flipkart or a Redbus which badly needs it to scale up in size? And if all the cash remains locked up in mature sectors and companies, how will capital-starved new businesses get access to the money they need to drive growth? By paying out excess cash as dividends, companies can put this capital back in circulation. Investors can redeploy the money in avenues where they see better payoffs.

If anything, these Scrooge-like tendencies of India Inc have been heightened by the recent downturn. Companies, reluctant to initiate new investment projects, have simply added to their coffers waiting for better times, but not materially raising their dividend payouts.

CNX 500 companies together held cash and bank balances alone amounting to ₹3,60,000 crore as of end-March 2013. Imagine what a difference even a part of this money could make to India’s stalled infrastructure projects, tech startups and its under-capitalised banks.