@jiantan86 and @LifeUniEvery42, I'm not sure why there is all...

@jiantan86 and @LifeUniEvery42,

I'm not sure why there is all the apparent concern and consternation about the special dividend that has been declared.

All that is happening is that the business has capital that is surplus to its requirements and the board is - quite rightly - saying the following:

"This capital belongs to shareholders, and we, the managers of the business, have no use for it; so we should simply let the owners of the business have it. Otherwise it will just lie there in the bank and dilute the overall returns being generated by the business."

It is a perfectly appropriate thing to do, with one important proviso: that it doesn't put the company is a position of financial risk.

On that score, it is instructive to look at how capital flows through TME, and the extent to which the financial risk of the company will be altered as a result of this special dividend.

And, given the prolific cash generation of this company, coupled with its limited capital requirements, this special dividend will leave it a very long way from being in anything that remotely resembles financial risk.

Here's the math:

Starting with FY2018's EBITDA of $164m and the year-end Net Debt position of $64m.
(That equates to Net Debt-to-EBITDA of 0.4x, and Net Debt-to-Equity of 9%.)

This reflects a very inefficient capital structure.

For context, most companies that are commercially self-sustaining - even ones with business models that aren't nearly of the durability and quality of TME's - will operate with Net Debt-to-EBITDA somewhere between 1.0x and 2.0x, and companies with TME's free cash generating capacity, will easily be able to run with 2.5x Net Debt-to-EBITDA for extended periods at a time.

With that backdrop, let's look at how TME's Net Debt-to-EBITDA metric will flex in the periods ahead:

In FY2019, the company will generate EBITDA of some $175m (FY2018: $165m).

Because it is a negative working capital business, and movements in provision are zero, at least all of that EBITDA will convert to Net Receipts in the Cash Flow Statement.

From this $175m of Net Receipts, deduct the following:

- $9m in Net Interest payments (up from $5.2m in FY2018, due to the higher level of borrowings due to the special dividend), and

- $39m of tax (assuming that the tax expense in the P&L all gets paid out as cash, which is a conservative assumption given that, historically the company has over-provided for tax by almost one-third, i.e, actual tax payments have averaged 75% of the tax expense recognised in the P&L),

...which gives Operating Cash Flow of $127m

Investing Cash Flow has been guided to $30m in terms of capex and development expenditure [*], and no acquisitions are on the cards.

So that means some $95m in Cash Flow available for financing purposes.

In terms of cash outflows due to dividends over the next 12 months, there will be a total of $170m paid out, represented by:

- 10.5cps FY2018 final dividend to be paid in the current half which will consume $42m,
- the 22.0cps special dividend ($87m), and
- I expect a FY2019 interim dividend of 10.0cps will be declared and paid in JH2019, which will equate to $40m.

This means that the company will have a FY2019 capital deficit of $95m less $170m, i.e., $75m, which will need to be sourced from a combination of borrowings or the company's current cash holdings, but probably a combination of these.

In other words, Net Debt will rise by $75m during FY2019, to around $140m.

So, for FY2019, that will leave the company with a Net Debt-to-EBITDA metric of $140m / $175m, i.e., around 0.80x.

On any objective view, that is a very conservative level of gearing, an one that does not even warrant the raising of an eyebrow, let alone coming even close to being cause for concern.

And then, to take the exercise one step further, by the end of FY2020 - even without any hairy-chested assumptions, and assuming the world doesn't implode - EBITDA be somewhere between $180m and $190m and Net Debt will be around $120m, so Net Debt-to-EBITDA of 0.65x, which gives an indication of how rapidly this company's balance sheet is able to repair it self, because it is such a prolific free cash flow generator.


So, to conclude: what TME's board is doing in terms of declaring this special dividend is not only fiscally prudent, but it is exactly what shareholders should expect them to do.

In fact, they are even being quite conservative, because a 25cps special dividend would eminently manageable; heck, even a 30cps special dividend would only get Net Debt-to-EBITDA to a mere 1.0x.

This is a cash generating machine, and if it generates more cash than the business needs, then they will continue to give the surpluses back to shareholders.

So, expect more special dividends in the years ahead, because in about 3 years' time, the Net Debt-to-EBITDA will be at the same level as it finished the FY2018 year, despite the special dividend being paid between now and then.


[*] Free Cash Flow-minded investors will become alerted to the fact that TME's Operating Cash Flow covers its Capex requirements by a factor of four times, which is a feature of the company's financial pedigree that will position it in the top 5% of 10% of companies on that measure. (In fact, while the ratio is expected to be four times for FY2019, over the longer-term it has averaged in excess of six times).