Sunday, February 12, 2012

Loss of my favourite dividend child - Nera Telecommunications

I like to own companies that pay good dividends. I view them as my children. These children pay me annual allowance for my living expenses.

The best children are those with growing income and pay me a reasonable percentage of their income as dividends. This percentage should not be so high until their own growth is stunted because they are not reinvesting enough of their profits back into the business. This percentage should also not be so low until I have problems paying for my living expenses. No parents like children who are stingy with their allowance despite earning fat salaries. A fast-growing income means that the children can afford to pay me rising, comfortable allowance without holding back their own wealth accumulation or even putting themselves into hardship. These are the best sort of companies to buy for dividends. They are very hard to find but if you can find them, they will not only deliver consistent dividends but good capital gains as well.

I do not like children who pay me generous allowance when times are good and ask for the money back (and more) from Papa when bad times hit. These children share a common name. Not all of them behaved this way but quite a number of them did in the credit crisis of 2008. The name of these children is REIT. I forgave them because the law stipulates that they have to pay at least 90% of their income as dividends which means they may not have enough internal cash to put back into the business. It is not their fault but this defining characteristic means the sustainability of dividends paid by REITs is questionable. I will consider buying REITs on a depressed basis when bad times hit and after they have raised money from other people.

One of my favourite child is Nera Telecommunications. Although this child does not enjoy growing profits, it has been able to pay out very generous dividends because of its strong, consistent cashflow. See the table below to judge how filial this child has been to me for the past 8 years.

Dividends per share (cts)
Dividend yield based on price at beginning of year(%)
Stock price at beginning of year when dividend is paid

For the past 8 years, Nera Telecommunications have been paying dividends with yields ranging from 7.65% to 47.37% (yes it's 47%, no typo error). On a growth basis, NeraTel is not impressive. In fact, the book value has been sliding down since 2003. Its earnings has been quite flat over the years too with earnings per share hovering at around 3cts per share. PE ratio is not impressive at an average of 17 for the past 4 years. So, one way to interpret this is that NeraTel has been sacrificing growth to pay generous dividends to its shareholders. So shareholder-friendly. Such a filial child.

A good question to ask at this point is whether the dividends are sustainable. Since dividends are paid from hard cash and not accounting profits, it is better to look to the cashflow statement rather than the income statement for the answer. NeraTel's operating cashflow grew 15% in 2010, 16% in 2009 and a whooping 80% in 2008. The absolute amount of the operating cashflow is comfortable enough to cover the generous dividends. Based on the cashflow numbers, there is good reason to believe that the generous dividends are sustainable in the years ahead. There must be something about the business being a cash gusher that enables it to have a consistent track record of paying generous dividends for 8 years throughout good and bad times.

On 10 Feb 2012, ST Electronics made an announcement to buy my favorite child away. The price offered is $0.45 cents per share. The actual price paid by the Acquiror is only $0.39 excluding 6cts of dividends that will be paid by NeraTel.

Is the offered price $0.39 too cheap? If the worth of a company is the sum of its future cashflows, then NeraTel is surely worth more than $0.39 based on its strong, consistent, stable dividends in the past decade. In fact, the dividends that NeraTel paid in the past 7 years alone already exceeds $0.39 which is the offered price today. ( I hope any potential acquirer will take note of this point) Now, ST Electronics wants to pay only $0.39 to swallow up all the future dividends for decades to come.

This cheap $0.39 offer comes at a time when the no-growth baby is starting to show some growth after expanding their Telecom business to new markets in Middle East and North Africa. In the latest announcement for FY2011, NeraTel net profits grew 23.9% and increased its already high dividends by 50% to 6cts per share.

Some may ask, if NeraTel is really worth that much, why is its biggest shareholder Eltek selling it so cheap? The answer is found in their balance sheet for FY2010. Eltek has NOK600m debt versus NOK6.8m cash. With the ongoing European sovereign crisis, it is not surprising Eltek is hard up for cash and has to sell its assets cheap to raise cash.

It is very hard for me to find a better child than NeraTel. Nera Telecom has been a good child to many minority shareholders. Don't insult me with a cheap price tag. I will vote no! How about the rest? What say you?

Disclosure: This post has been written with vested interest.