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Rightmove: Should investors prefer special dividends to share buybacks?

Rightmove is a big fan of using share buybacks. I take a closer look at the company to see if shareholders would have been better off with a special dividend instead.
April 14, 2020

Share buybacks are a controversial topic at the best of times. In theory, they seem to make sense and for some companies they can work well. However, too often it is company management that benefits the most from them and shareholders may well have been better served with a bigger dividend instead.

Share buybacks describe the process when a company buys its own shares. These shares are either cancelled or held in treasury and reduce the number of shares outstanding. This is often seen as a positive thing to do as it means that the company’s profits are spread over a fewer number of shares and earnings per share (EPS) and any dividend per share can increase. The remaining shareholders’ ownership stake in the business also increases.

Another reason why buybacks are popular is because they can sometimes be seen as a sign that a company’s management views its shares as being undervalued. It can also ease the worries of some shareholders who are concerned that the company might waste its money by buying a bad business.

But buybacks are not always a good thing. I wrote an article in March last year about how buying shares at too high a price can deliver very poor returns to shareholders. There’s also a view that buybacks are just a form of financial engineering. After all, the value of its operating profits and its assets do not change at all.

Buybacks also don’t treat all shareholders equally. Whereas every shareholder receives a dividend, the cash spent on buybacks only goes to shareholders who sell their shares to the company and who could have raised the cash by selling their shares to anyone.

Academics have long argued that borrowing money to buy shares can increase the value of a business. This is because interest on borrowed money is a tax-deductible expense for businesses. By swapping equity (shares) for debt the company pays less tax and the cash flows to it actually increase because of these savings.

I used to believe this when I was a young analyst, but now I no longer do. Any increase in theoretical value is offset by an increased risk to shareholders from the extra debt. At times like this, those risks are very relevant. 

It may be a bit old fashioned and prudent, but in my view there is no optimal level of debt for most companies (network utilities with very predictable cash flows are an exception here) and that companies with very low or no debt on their balance sheets are more valuable because they are less risky.

Why don’t more companies pay special dividends instead of buying back shares?

Some companies do pay special dividends, which is a good thing in my view. I’ve always been a fan of dividends because once they have been paid, they cannot be taken away. They also represent a tangible and less volatile return from owning a share about which there’s a lot to like. As we have seen in recent weeks, share price gains can disappear very quickly.

Special dividends on their own don’t increase EPS and therefore don’t boost management bonuses, which are often linked to it. They also don’t pay commissions to stockbrokers who buy them back on behalf of companies. It’s therefore no surprise that buybacks are popular with companies and their advisers.

I am now going to look at a company and see how its shareholders would have fared if it had used the same amount of cash to pay them a special dividend instead of buying back shares.

This requires a few adjustments to the shares in issue, the share price and the dividends received. It takes a bit of time and is a bit fiddly, but afterwards we will be able to compare the total shareholder returns (the change in share price plus dividends received) between the two different ways of returning cash to shareholders.

 

Rightmove: Share buybacks versus special dividends

From a financial performance point of view, Rightmove (RMV) is one of the most impressive companies listed on the London Stock Exchange. It is highly profitable and has very small ongoing business investment requirements, which means it has been generating huge amounts of free cash flow in recent years.

Most of this free cash flow has been used to buy back its own shares. Since it started buying back shares at the end of 2007, it has repurchased nearly 433m shares and currently has just over 873m in issue. 

 

Rightmove: Free cash flow, dividends and buybacks (£m)

Year

FCF

Dividends

Buybacks

Surplus

2015

114.5

36.5

76.1

1.9

2016

139.6

43.2

88.1

8.3

2017

148.4

49.6

90.8

8.0

2018

165.8

55.0

113.5

-2.7

2019

183.7

59.9

88.6

35.3

Source: Annual Reports/Investors Chronicle

 

Out of interest, the senior management have a long-term incentive plan that is heavily weighted towards increases in underlying EPS and total shareholder returns. This would seem to favour share buybacks over special dividends.

I am going to compare total shareholder returns between special dividends and buybacks from the start of 2015 until Thursday 9 April, 2020. The share prices and shares in issue have been adjusted for the 10-for-one share split that occurred in 2018.

Since 2015, Rightmove has repurchased 108.5m shares at an average price of £4.19 per share for a total cost of £455m. The closing share price on Thursday, 9 April was 507p.

 

Rightmove: Share buybacks since 2015

Year

Shares bought

Cost 

Avg price paid per share

2015

22,513,400

£76,071,000

£3.38

2016

22,517,100

£88,083,000

£3.91

2017

22,240,590

£90,809,000

£4.08

2018

24,977,740

£113,528,000

£4.55

2019

16,268,322

£86,583,000

£5.32

2020

5,028,392

£30,124,783

£5.99

Cumulative

108,517,152

£455,074,000

£4.19

Source: Annual report

 

During this time, Rightmove has been very profitable and has been growing its profits at a healthy rate. Its diluted EPS (which is based on net income that deducts the cost of share-based payments and takes into account shares that are likely to be issued in the future) has increased from 11.27p in 2015 to 19.49p in 2019.

 

Rightmove: Buyback means EPS increases faster than net income (£m)

Year

Op profit

Net income

Diluted WANS (m)

Diluted EPS (p)

Change in NI

Change in EPS

2015

137.2

109.5

971.0

11.27

  

2016

167.6

129.5

949.7

13.64

18.3%

21.0%

2017

178.3

144.1

928.8

15.51

11.2%

13.7%

2018

198.6

160.5

906.8

17.69

11.4%

14.1%

2019

213.7

173.1

888.0

19.49

7.9%

10.2%

Source: Annual reports/Investors Chronicle

 

What we can see is that the buyback and the reduction in the diluted number of shares has meant that Rightmove’s diluted EPS has increased at a faster rate than its net income (its after-tax profits that belong to shareholders). 

The increase in profitability and free cash flow has seen Rightmove deliver some impressive returns to its shareholders. Since the start of January 2015 until 9 April 2020, its share price has increased by 282p and 26.4p of cumulative dividends have been paid. This gives a total shareholder return for the period of 137.3 per cent. Over the same period, the FTSE All-Share Index has delivered total returns of just 11.8 per cent.

 

Rightmove: Total shareholder returns

Year

Starting SP (p)

Closing SP (p)

Change (p)

DPS (p)

Total return (p)

Total return

2015

224.8

412.5

187.7

3.8

191.5

85.2%

2016

412.5

390.3

-22.2

4.3

-17.9

-4.3%

2017

390.3

450

59.7

5.4

65.1

16.7%

2018

450

432.25

-17.75

6.1

-11.7

-2.6%

2019

432.25

633.6

201.35

6.8

208.2

48.2%

TTM

633.6

507

-126.6

0

-126.6

-20.0%

       

Change in share price

282.2 (p)

91.4%

    

Dividends received

26.4 (p)

8.6%

    

Total return

308.6 (p)

100.0%

    

Total return %

137.3%

     

Source: Annual reports/SharePad/Investors Chronicle

 

What’s interesting to note is that over 91 per cent of the total return has come from a rising share price. Less than 9 per cent has come from dividends as the company has favoured buybacks.

What if Rightmove had paid a special dividend instead?

Now, I assume that no shares were repurchased since the start of 2015. There has been a very minimal increase in shares issued for rolled-up dividends on the shares in employee share plans. In all purposes, the amount of total shares in issue would have stayed at around 1bn.

I have adjusted the diluted weighted average number of shares (WANS) for the effect of shares held in treasury, the impact of employee share plans and the dilution that was recorded at the time.

Note that the company’s operating profit and net income do not change at all. The same amount of cash paid in buybacks is assumed to be paid as a special dividend. I also assume that the same amount of cash spent on regular annual dividends was the same but is obviously shared out amongst a greater number of shares.

 

Rightmove: Shares in issue and diluted EPS with a special dividend

Year

Op profit (£m)

Net income (£m)

Adj WANS (m)

Adj Dil EPS (p)

Rep Dil EPS (p)

Difference

2015

137.2

109.5

984.9

11.11

11.27

-1.41%

2016

167.6

129.5

983.7

13.16

13.64

-3.53%

2017

178.3

144.1

988.6

14.58

15.51

-6.05%

2018

198.6

160.5

989.8

16.21

17.69

-8.39%

2019

213.7

173.1

987.9

17.52

19.49

-10.11%

Source: Annual report/Investors Chronicle

 

Unsurprisingly, we can see that with a greater number of shares in issue, the EPS under a special dividend is lower than with a buyback. By 2019, EPS was more than 10 per cent higher than with a special dividend. 

 

Now let’s look at dividends

Rightmove: Dividend per share and special dividends

Year

2015

2016

2017

2018

2019

2020

Shares ranking for dividend (m)

972.5

973.3

977.7

982.1

983.6

983.6

Buyback cash spent (£m)

76.1

88.1

90.8

113.5

88.6

30.1

Equivalent Special DPS (p)

7.8

9.1

9.3

11.6

9.0

3.1

       

Cash spent on regular dividends (£m)

36.5

43.2

49.6

54.9

59.9

 

Shares ranking for dividend (m)

972.5

973.3

977.7

982.1

983.6

 

Dividends received per share (p)

3.75

4.44

5.07

5.59

6.09

 

Dividends actually received (p)

3.80

4.60

5.40

6.10

6.80

 

Difference

-1.3%

-3.5%

-6.0%

-8.3%

-10.5%

 

Source: Annual reports/Investors Chronicle

 

Having estimated the shares' ranking for a dividend, I have simply divided those into the cash spent on buybacks to get an estimate for the equivalent special dividends per share. Between 2015 and April 2020, the equivalent of 74.8p per share of special dividends would have been paid.

I have then estimated what the annual dividends per share received would have been by using the cash spent by the company on regular dividends during the year and dividing it by the number of shares.

We can see here that as with EPS, the buyback has resulted in a higher regular dividend per share to be paid to shareholders and can be seen as a clear benefit of reducing the number of shares. By 2019 the regular dividend received was 10.5 per cent higher under a buyback.

 

The valuation of the business does not change - just the number of shares

All we need to know now is what Rightmove’s share price would have been without the share buybacks. This is easier to calculate than it seems.

The reason I say this is because in both scenarios, the company’s operating profits are exactly the same, as are its cash balances. This means that the market value of the business – its enterprise value (EV) – is assumed to be exactly the same as well. The value of cash is then added to the EV to get the market capitalisation, which is then divided by the number of shares to get a share price.

I have taken Rightmove’s EV at the end of each year between 2015 and 2019 as well as on 9 April 2020. I have estimated the company’s cash balance in April 2020 to be £20m.

 

Rightmove: Adjusted share price for special dividends

Year

EV (£m)

Cash (£m)

Market cap (£m)

Shares (m)

Share Price (p)

2015

4,023

8

4,032

1,000.0

403.2

2016

3,715

12

3,727

1,000.0

372.7

2017

4,178

19

4,197

1,000.0

419.7

2018

3,909

14

3,923

1,000.2

392.3

2019

5,616

32

5,648

1,000.2

564.7

TTM

4,407

20

4,427

1,000.2

442.6

Source:SharePad/Annual reports/Investors Chronicle

 

The higher number of shares in issue gives a share price of 442.6p per share on the same EV on 9 April 2020 compared with the actual 507p.

Now we can look at what the total shareholder returns would have been with a special dividend instead of a buyback.

 

Rightmove: Total Shareholder return with special dividend instead of a share buyback

Year

Starting SP (p)

Closing SP (p)

Change (p)

Dividends received (p)

Special div (p)

Total return (p)

Total return 

2015

225

403

178

3.8

7.8

190.0

84.5%

2016

403

373

-30

4.4

9.1

-17.0

-4.2%

2017

373

420

47

5.1

9.3

61.3

16.5%

2018

420

392

-27

5.6

11.6

-10.3

-2.4%

2019

392

565

172

6.1

9.0

187.5

47.8%

TTM

565

443

-122

0.0

3.1

-119.0

-21.1%

    

24.9

   

Change in share price

218 (p)

74.4%

     

Cumulative Dividends

74.8 (p)

25.6%

     

Total Return

293 (p)

      

Total Return 

130.1%

      

Source: Investors Chronicle

 

What we can see is that the total return since 2015 would have been 130.1 per cent compared with 137.3 per cent from the returns with share buyback. There’s not that much difference at all.

The key difference is how the returns are made up. Over a quarter comes from dividends under the special dividend scenario, compared with less than 9 per cent under the share buyback. These dividend returns would have been pocketed by shareholders and could not have been taken away from them. They could have also been reinvested over the years in order to boost returns.

 

Future returns for Rightmove shareholders

Since 2015 the buyback has delivered the best returns to shareholders – just. But what about long-term returns from Rightmove from here?

Its estate agent customers are currently not selling houses and have little cash flow. Rightmove has given them big discounts on their monthly bills, which in turn means that its revenues and profits will be lower and that it will not be paying dividends or buying back shares for a while.

The real risk to Rightmove is that its customer base takes time to recover and so do its profits. At 507p, Rightmove shares still trade on a very expensive 26 times last year’s fully diluted EPS and therefore a much higher valuation of likely profits in 2020. 

There has to be some risk that its share price falls further, which means that the 108.5m shares bought at an average of 419p each over the past five and a bit years would begin to look more and more questionable as a good way of delivering long-term value for its shareholders.

 

Rightmove: PE multiple for share buybacks

Year

Average price paid

Dil EPS for year

PE

2015

£3.38

11.27

30.0

2016

£3.91

13.64

28.7

2017

£4.08

15.51

26.3

2018

£4.55

17.69

25.7

2019

£5.32

19.49

27.3

Source: Investors Chronicle

 

We can see that the average price paid by the company for its shares in recent years has equated to a very high valuation based on its EPS for the year concerned. If future valuations of its shares are much lower then investors could quite reasonably say that Rightmove overpaid for its own shares. 

When trading conditions get somewhere back towards normal again, perhaps a special dividend rather than a buyback will be a better and fairer way to pay shareholders their share of Rightmove’s impressive cash flows.