Lecture 4: Capital Allocation, Financing, and Value Creation
Dr. Chen Liu, Ph.D.
Director of MBA Programs
Associate Professor of Finance
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1. Dividends vs. Stock Repurchase
CF in Investing
(Sale / Purchase asset)
CF in Operating
(Revenue, Cost, Profit)
CF in Financing
(Equity & Debt)
Free Cash Flow
Retain
Distribute
Organic Growth
M&A
Dividend
Share Buyback
Growth potentials
Will the expansion be fast enough?
Do we have the capabilities?
Can I integrate?Will synergies materialize?
Is this safer or riskier?
Free CF
= Operating CF – Capex
Not much Growth Potentials
a company that is generating more cash than it needs to fund its own operations and investments might choose to return that excess cash to its shareholders.
Top 5 US Dividend Payers
Increase investor loyalty
Boost stock price
Good use of extra cash
Dividends give predictable income and profit without selling stocks
Reduce risk (Bird-in-the-hand) less risky than future potential capital gains.
Signaling: Dividends as a signal about firm’s future performance
Dividend as a disciplining mechanism: reduce wasteful spending of free cash flows
6
Benefits of Dividends
For the Investor
For the Company
Dividends vs. Share Buybacks
Dividend is paying cash directly to shareholders on a per share basis
Distribute
Shareholders are invited to sell their shares at a specific price and within a certain time frame (min. 20 days).
Company wants to use $36 mil to repurchase stock from shareholders at $12 per share, retiring 3 mil of shares (leaving 7 mil shares)
Until: 20 business days, or use up $36 mil.
Tender Offer
Our company has a stock price of $10 per share, and 10 mil shares of stock
So total market capitalization: $10 per share * 10 mil shares = 100 Mil USD.
Shareholders are invited to sell their shares at a specific price and within a certain time frame (min. 20 days).
Company wants to use $36 mil to repurchase stock from shareholders at $12 per share, retiring 3 mil of shares (leaving 7 mil shares)
Until: 20 business days, or use up $36 mil.
Tender Offer
Our company has a stock price of $10 per share, and 10 mil shares of stock
So total market capitalization: $10 per share * 10 mil shares = 100 Mil USD.
What would you do as a shareholder to respond to the tender offer?
Sell your stock to the company right away at the announcement.
Sell your stock at the market within the 20 business days.
Buy more stock in the market immediately and sell to the company immediately.
Buy more stock in the market immediately and hold the stock (do not sell to the company immediately).
Think and decide to do nothing.
Company repurchases its shares directly from the market, usually over a period of 3-6 months.
Company wants to use $36 mil to repurchase stock from shareholders at market price.
Until: 3 months, or use up $36 mil.
Shareholders are invited to sell their shares at a specific price and within a certain time frame (min. 20 bus days).
Company wants to use $36 mil to repurchase stock from shareholders at $12 per share, retiring 3 mil of shares (leaving 7 mil shares)
Until: 20 business days, or use up $36 mil.
Tender Offer
Open Market Repurchase
Our company has a stock price of $10 per share, and 10 mil shares of stock
So total market capitalization: $10 per share * 10 mil shares = 100 Mil USD.
Company repurchases its shares directly from the market, usually over a period of 3-6 months.
Company wants to use $36 mil to repurchase stock from shareholders at market price.
Until: 3 months, or use up $36 mil.
Shareholders are invited to sell their shares at a specific price and within a certain time frame (min. 20 bus days).
Company wants to use $36 mil to repurchase stock from shareholders at $12 per share, retiring 3 mil of shares (leaving 7 mil of shares)
Until: 20 business days, or use up $36 mil.
Tender Offer
Open Market Repurchase
Our company has a stock price of $10 per share, and 10 mil shares of stock
So total market capitalization: $10 per share * 10 mil shares = 100 Mil USD.
What would you do as a shareholder to respond to open market repurchase?
Sell your stock to the company right away at the announcement.
Sell your stock at the market within the 3 months.
Buy more stock in the market immediately and sell to the company immediately.
Buy more stock in the market immediately and hold the stock (do not sell to the company immediately).
Think and decide to do nothing.
Alibaba Group said it will hike its share repurchase program from $15 billion USD to $25 billion USD, the largest ever buyback undertaken of a Chinese internet stock.
The buyback will run for two years through March 2024.
The move sent Alibaba’s shares over 11% higher in Hong Kong trading to close at HK$110.20.
Alibaba Group’s Deputy CFO, Toby Xu said:
“The upsized share buyback underscores our confidence in Alibaba’s long-term, sustainable growth potential and value creation.”
“Alibaba’s stock price does not fairly reflect the company’s value given our robust financial health and expansion plans”.
Share Buyback: What Signal Does It Send?
If the people with all the information about a company are buying back shares, they must think the company is undervalued！
Announcements about stock repurchases result in a stock price increase.
1. Signaling
3. Flexibility
2. Tax
Shareholders have no choice about dividend, but need to pay tax.
Shareholders pay taxes only if (1) they choose to sell the stock, and (2) they have capital gain.
Capital gain tax is lower than dividend tax
Dividend is sticky
A firm with a permanent cash flow increase may increase dividend.
Repurchase is not commitment.
A firm with a temporary cash flow increase is likely to repurchase stock.
4. Consolidate ownership
Repurchase consolidates ownership
5. Preferred by top executives
Executives are frequently given stock options as part of their overall compensation and they do not receive dividends.
Existing stock price is higher in repurchase than in dividend.
No
Likely not
Neutral
Stock is undervalued
After announcement, price increase
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After Trump signed the Tax Cuts, companies repatriated $2.6 Trillion USD held in foreign cash stockpiles.
The extra capital is largely being used for corporate buybacks.
In the past 10 years, the top 20 companies in the S&P has spent this much on stock buybacks…
2. Raising Equity & Start-Up Financing
CF in Investing
(Sale / Purchase asset)
CF in Operating
(Revenue, Cost, Profit)
CF in Financing
(Equity & Debt)
Seasoned Equity Offering (SEO)
Personal Savings
Family & Friends
Angel Investors
Venture Capital Firm
(General Partner, GP)
Investors (Limited Partners, LP)
Corporate & Public Pension Funds, Insurance Companies, Family Offices, Endowments, High net-worth individuals.
Venture Capital Fund
(the pool of money)
Company A
$
$$$
$$$
$$$
1. Fundraising
2. Evaluate & Invest
3. Manage & Monitor
Another VC
Company B
Company C
Company A
IPO: 20 X return
Company C
Sold 10 X to Google
Fail!
$2 Billion
$200 Million
VC Compensation 2+ 20
2% Management Fee (annual)
= 2% * 200mil = $4 mil
4. Exit: IPO or Sale
20% Carried Interest (one-time)
= 20% *(2 bil – 200 mil) = $360 mil
What is a unicorn?
Privately held startup company
valued at over $1 billion.
| Global Unicorn Companies Valued at $1B+ (as of November, 2020) | |||
| Company | Valuation | Country | Category |
| ByteDance | $140.00 Bil | China | Artificial intelligence |
| Didi Chuxing | $62.00 Bil | China | Auto & transportation |
| SpaceX | $46.00 Bil | US | Other |
| Stripe | $36.00 Bil | US | Fintech |
| Airbnb | $18.00 Bil | US | Travel |
| Kuaishou | $18.00 Bil | China | Mobile & telecommunications |
| Instacart | $17.70 Bil | US | Supply chain, logistics, & delivery |
| Epic Games | $17.30 Bil | US | Other |
| One97 Communications | $16.00 Bil | India | Fintech |
| DoorDash | $16.00 Bil | US | Supply chain, logistics, & delivery |
| Yuanfudao | $15.50 Bil | China | Edtech |
| DJI Innovations | $15.00 Bil | China | Hardware |
IPO Dec 10, 2020
Price = $68,
Valuation = $47 Bil
IPO Dec 9, 2020
Price = $102,
Valuation = $72 Bil
June 10, 2021
| Global Unicorn Private Companies Valued at $1B+ (as of January 2023) | |||
| Company | Valuation | Country | Category |
| ByteDance | $140 Bil | China | Artificial intelligence |
| SpaceX | $127 Bil | US | Other |
| SHEIN | $100 Bil | China | E-commerce & direct-to-consumer |
| Stripe | $95 Bil | US | Fintech |
| Canva | $40 Bil | Australia | Internet software & services |
| Checkout.com | $40 Bil | UK | Fintech |
| Instacart | $39 Bil | US | Supply chain, logistics, & delivery |
| Databricks | $38 Bil | US | Data management & analytics |
| Revolut | $33 Bil | UK | Fintech |
| Epic Games | $31.50 Bil | US | Other |
| BYJU’s | $22 Bil | India | Edtech |
| Xiaohongshu | $20 Bil | China | E-commerce & direct-to-consumer |
Going Public
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