How to benefit from shares with differential voting rights

The only thing most of us want from stocks is returns . That's why many companies nowadays offer investors the option to earn a little more from a stock in exchange for sacrificing a few rights they rarely exercise. These shares, called differential voting right, or DVR, shares are catching the fancy of more and more stock investors.

The list of companies that have issued DVR shares includes Tata Motors, Pantaloon Retail India, Gujarat NRE Coke and Jain Irrigation. DVR shares were allowed in India in 2000.

EXPLAINING DVR SHARES

DVR shares are like ordinary shares, but with fewer voting rights. These allow a company to dilute equity without a matching reduction in promoters' stake. The aim of limiting voting rights is preventing hostile takeovers by separating economic interests and voting rights.

DVR shares are ideal for small shareholders as they rarely exercise their voting rights. This is because only a few understand the company's affairs in such detail that they can influence its actions. They buy shares only to make money and so happily give away voting rights in favour of those who have management control.

DVR shares are priced lower at issuance and offer higher dividends; in return, the voting rights are limited. For instance, the holders of Tata Motors' DVR shares can cast one vote for every 10 shares held. However, they get 5% more dividend than ordinary shareholders. On 18 July 2012, the company gave Rs 4.10 a share as dividend to DVR holders and Rs 4 a share to ordinary shareholders.

At times, companies issue DVR shares to fund large projects. This is of special help to those who do not want control of the company but are looking to take part in its growth by making a big investment.

According to the Companies Act, only a company that has been profitable for three years preceding the year in which it has decided to issue DVR shares and which has not defaulted in filing annual accounts and returns for the period can issue such shares. However, a DVR issue cannot exceed 25% share capital.

FOR INVESTORS

The correlation between DVR and ordinary shares is high. "Prices of DVR shares move with those of ordinary shares," says Vishal Jajoo, senior research analyst (private clients group), Nirmal Bang Securities. For instance, in 2012, the Tata Motors' DVR shares rose over 95% as against 70% rise in ordinary shares. Similarly, Pantaloon Retail's DVR shares returned over 113% in 2012 compared to the 102% rise in ordinary shares.

DVR GAP

On January 25, Tata Motors' DVR shares were trading at a 42% discount to its ordinary shares. While the DVR shares were at Rs 173.95, the ordinary shares were at Rs 301.05.

"DVRs usually trade at a discount, largely due to fewer voting rights. Unless companies offer incentives, investors are reluctant to buy DVR shares," says Deepak Ladha, executive director, Ladderup Corporate Advisory.

"This discount is comparatively higher in India when compared with the developed markets. Low liquidity can also be behind this. A higher free float can reduce the gap," says Sony Mathews, investment advisory service, Geojit BNP Paribas Financial Services.

VOLUME GAME

Trading volumes also show that investor interest in DVR shares is comparatively low. Let's take the example of Pantaloon Retail and Jain Irrigation. The oneyear average trading volume of ordinary shares of Pantaloon Retail and Jain Irrigation was 10.8 lakh shares and 8.71 lakh shares, respectively, on 31 December 2012. In comparison, the one-year average trading volume of DVR shares of the two was 11,180 and 26,150, respectively.

"DVR shares have not gained wide acceptance due to lack of awareness. Globally also investors had taken time to understand and accept the instrument," says Ladha of Ladderup Corporate Advisory.

"DVR volumes are lower as there is always a class of investors which does not prefer to buy these shares. Also, many small investors are not able to appreciate the exact nature of these shares and so do not invest," says Dipen Shah, head, private client group research, Kotak Securities.

DVR BREAK-UP

Four Indian companies, Tata Motors, Pantaloons Retail India, Gujarat NRE Coke and Jain Irrigation Systems, have issued DVRs so far. The trading volume in these is 75-90% less than in ordinary shares.

Tata Motors:
In 2008, Tata Motors became the first company in India to issue DVR shares. To fund the acquisition of Jaguar Land Rover, it issued 6.4 crore DVR shares at Rs 305 a share when the ordinary shares were at Rs 340. These DVRs offer higher dividends but carry one-tenth the voting rights of ordinary shares. This means 10 DVR shares equal one ordinary share as far as voting rights are concerned

Pantaloon Retail India:
The company issued bonus shares that were DVRs in February 2009. These carry one-tenth voting rights of ordinary shares and pay 5% additional dividend.

Gujarat NRE Coke:
The company issued DVR shares in 2010. The investor has to hold 100 DVR shares for getting voting rights equal to one ordinary share. On January 25, the DVRs were trading at Rs 11, 45% less than the ordinary shares, which were at Rs 201. In 2012, the average trading volume was 7,870 for DVR shares and 4.63 lakh for ordinary shares.

Jain Irrigation:
Jain Irrigation is a leading player in the micro-irrigation system market. The company issued DVR shares in November 2011 in the form of bonus to its existing shareholders. Its 10 DVRs entitle investors to one vote in shareholder meetings.

WHY BUY?

DVRs mostly trade at a discount. However, at times, the gap between DVR and ordinary shares is big, providing investment opportunities. Experts say the discount between DVR and ordinary shares in foreign markets is about 10%.

Devang Mehta, head, equity advisory & sales, AnandRathi Financial Services, says, "An investor stands to gain from capital appreciation in a scenario where the price difference between ordinary and DVR shares falls as a result of rising awareness about the product. This comes with the additional benefit of higher dividends."

Mathews of Geojit BNP Paribas Financial Services seconds Mehta and says, "If an investor is bullish on a stock's long-term prospects, he may look at investing in its DVR shares as it offers an opportunity to receive higher dividends and take part in the company's growth through capital appreciation."