I got this question from one of the readers yesterday. The State Bank of India’s Chairperson recently announced, that they were going to look at issuing shares with differential voting rights (hence the name DVR) to raise funds to meet the Basel-III capital adequacy norms.
Government has also clearly indicated that it won’t continue to fund Public Sector Banksindefinitely. And these banks now need to look after their own needs. I believe that it is easier said than done because any problem, which these banks face will eventually become the problem of the government – reason being that these banks are deeply woven into the fabric of Indian economy, and hence the government cannot have a hands-off approach with them. But nevertheless let’s believe the government for the time being. 🙂
The government has allowed these banks to raise up to Rs 1.60 lakh crore from markets by diluting government holding to 52% in phases – so as to meet Basel III norms, which come into effect from March 31, 2019. The norms are aimed at improving risk management and governance while raising the banking sector’s ability to absorb financial and economic stress. So what exactly is this DVR creature?
What are DVRs?
Differential Voting Rights shares or as popularly known as DVRs, are a special category of shares issued by an already listed company to raise funds, with lower dilution of ownership when compared with issuance of normal shares.
Like ordinary shares, DVRs are also listed and traded on stock exchanges.
How are DVRs different from ordinary shares?
A DVR provides fewer voting rights to the shareholder than a normal share. While a normal shareholder generally has one vote per share held, a DVR shareholder needs to hold many more shares to get the right to ‘one’ vote.
One example of an Indian company having DVRs is Tata Motors. A normal shareholder of Tata Motors gets one vote for every share, whereas a holder of DVR shares gets one vote for every 10 shares held.
Companies generally compensate DVR shareholders with a higher dividend. A Tata Motors DVR has 5% extra dividend than normal shareholders as compensation for lower voting rights.
DVR generally trade at a discount to ordinary shares and Tata Motors has seen its DVRs historically quote at more than 30% discount to normal shares. I have written about the dual categories of shares of Tata Motors – Ordinary and DVR earlier too.
Is issuing DVR a common practice? Haven’t seen many in India.
Indian companies have somehow been averse to issuing DVRs. Apart from Tata Motors, very few have gone on to issue DVRs of their own – namely Gujarat NRE Coke, Jain Irrigation, etc. World over its a much more common practice and well known companies like Google, Berkshire Hathaway have dual categories of shares listed on exchanges.
Recently there has been a lot of noise about reduction in percentage difference (discount) between ordinary shares of Tata Motors and its DVRs.
For those who don’t know, Tata Motors has two kinds of shares listed on exchanges.
Ordinary shares (TTM) …and the DVR shares.
What is a DVR share?
DVRs are a completely different class of shares of a company whose ordinary shares are already listed on exchanges. DVR stands for Differential Voting Rights. It means that when compared to ordinary shares, a DVR carries different voting rights.
In India, it all started in 2008 when Tata Motors became the first Indian company to issue DVRs. The company came out with a Rights Issue where existing investors of TTM, were offered 1 DVR share for every 6 ordinary share held by them. As for the voting rights, one DVR share of Tata Motors has only 10% voting rights of an ordinary share, i.e. you get only one vote for every 10 DVR shares.
Apart from Voting Rights, is there any other difference between a DVR and an Ordinary share?
When you buy DVRs, you have lesser voting rights. And this needs to be compensated for. The shareholders of DVR are entitled to an extra 5% dividend compared to ones given to ordinary shareholders.
Unlike India, DVRs are used extensively in other countries to prevent hostile takeovers. At times these are used to bring money into the company without significant dilution of promoter’s voting rights. On an average, DVRs trade at a 10%-15% discount to ordinary shares.
Tata Motors – DVR Discount Trend Analysis
Like global peers, TTM-DVR also trades at a discount to ordinary TTM shares. But there is something interesting about this discount. I plotted this discount and found that in past 4 years, this discount has oscillated between 30% to 50%. And this is nowhere close to global average of 10-15%.
As of now, its quite close to its 4 year lows. And this has happened because share prices of DVRs have outpaced that of ordinary shares since start of 2014.
Discount at which DVR has traded in last 4 years
Now in 2008, when DVR was originally offered, the discount was a reasonable 10%. But over time, this discount kept widening until it reached almost 60% in mid-2013!
And this seems to be against common sense. That is because both DVRs and ordinary shares are based on the same business. Only difference is of the voting rights. And that anyways has been compensated for by a higher dividend promise to DVR holders. Ideally, discount should not be so large.
But in past few weeks, this discount has reduced to 33%. And many market participants now believe that this trend will continue and eventually, discount will settle at levels of 10%-15%. But we must remember that this is not the first time discount has come down. Few years back in 2010, discount had narrowed down to levels below 30%. Even at that time, experts felt that time had come for markets to give more respect to DVRs and that discounts will stabilize at 10-15%. But markets have this uncanny knack of surprising…And it did surprise once again by proving the experts wrong.
Price of DVRs fell and once again, it was available at huge discounts to ordinary shares. As mentioned above, discount almost touched 60%.
This time too, I am not sure if experts have any idea what they are talking about when they say that discounts would further reduce. 🙂
Beware – Controversial Idea Ahead
The last traded price for TTM was Rs 468 and that for DVR was Rs 312. Now simple calculation tells that for gaining ‘a’ vote in Tata Motors’ votings, you will have to shell out Rs 156 extra (468-312). I personally don’t think this makes sense for small investors. It might make some if you have substantial stake in Tata Motors and want to affect company’s decision making. But since you are reading this post on this small website, I assume you don’t have a very big stake in Tata Motors. 😉
I agree that its very important to exercise voting rights if the company is not being managed properly or its taking certain decisions which are not in best interest of minority shareholders. But broadly speaking, Tata Motors is managed decently if not brilliantly. And hence a small investor should not worry too much about his voting rights and consider DVRs as long term bets (if convinced about Tata Motors business).
One is getting the same business at 30% discount with assured higher dividends.
And if the DVR discount was to reduce further, a DVR investor stands to gain further as he will also be earning higher dividends in addition to capital appreciation. And if discount does eventually become insignificant, one can always sell DVRs and buy ordinary shares.
But having said that, please understand that we are not valuing DVR here. We are just discussing the discount at which DVR shares are available. It is very much possible that ordinary shares are over-valued and consequently, DVR may themselves be overvalued.
Why Did DVR Rise Much Faster Than Ordinary Shares in 2014?
The DVR shares have outperformed ordinary shares in last 6 months as evident from graph below:
Price Appreciation in last 6 months – TTM and DVR
Now the text that follows can be speculative and you should take it with a pinch of salt.
In last week of June 2014, a UK based fund house Knight Assets came out with a recommendation for Tata Motors. It advised the company to list its (planned) new DVR shares on New York Stock Exchange. But it asked Tata Motors to add the words ‘Jaguar Land Rover’ to the name of the DVR before listing. This according to fund would help it correct the big discount which DVR trades at and bring it in line with global averages of 10-15%. And since US markets are more familiar with JLR brands and with the dual-class shares, it would help listing the DVR in US markets.
This possibility of international listing might not be the only reason, but possibly one of the main reasons why DVR prices were running way ahead of ordinary shares.
Another possible reason can be that markets and analysts in general had ignored this stock completely in past few years. And because of this absence from analyst’s radars, it kept going down without any logical reason. Another evidence that markets can be irrational at times.:-)
What do you think? What are your thoughts about DVR shares of Tata Motors?
Disclosure: No positions in both the shares discussed above.