In perhaps one of the very first instances of blockchain solving a real-world problem, and a little financial alchemy through the creation of additional value through the transformation of a standard financial asset, Permuto Capital has created the next big thing for equity investors.
Permuto Capital is launching a product to unbundle the dividend and capital components of common stock and by appealing to different investor groups the sum value of the two elements may be greater than the value of the underlying stock. Permuto filed a registration statement with the SEC, and upon approval, expects to launch with Microsoft (MSFT) as their first equity.
Separation of the economic components of financial instruments is not in itself a new idea. In the 1980s the government permitted coupon stripping of U.S. Treasury securities (notes and bonds), a process where the interest and principal components are partitioned into discrete securities and are termed “STRIPS” (Separate Trading of Registered Interest and Principal of Securities). The components appeal to different segments of investors, and the product thereby improves the efficiency of the overall market.
Dividends and Capital Appreciation
Similar in concept to Treasury stripping, the Permuto product cleaves a Microsoft common share into two: a “dividend certificate” and an “appreciation certificate.” The owner of the dividend certificate will be entitled to the dividends paid by Microsoft on the common share, and the appreciation certificate will represent entitlement to everything else.
The “secret sauce” for Permuto that makes their product viable whereas previous incarnations were considered too cumbersome and expensive for widespread distribution is twofold: the advantages of blockchain technology coupled with the use of single stock voting trusts to hold the shares and issue the certificates. The Voting Trust structure provides a regulatory compliant structure, and the blockchain reduces costs.
The idea is that investors that hold Microsoft common shares may deposit the shares with a designated custodian, and in return the investor receives one of each of the two certificates. Once the certificates are created, they will trade independently, and hence the investor that deposited the shares may sell one, or both, of the certificates, and other investors may purchase certificates without having owned the underlying shares. An investor who owns both types of certificates may return them to the trust and receive back a common share.
For an investor who wishes to use traditional platforms Permuto is seeking to have both types of certificates listed on a nationally recognized stock exchange, and the investor may elect for the Depository Trust Company (DTC) to hold their certificates.
Chia Blockchain
Alternatively, investors may choose to hold their certificates on the Chia blockchain as Chia Asset Tokens (CATs). One advantage of the CATs is that they will be able to be traded on decentralized marketplaces 24 hours a day, every day, and not be subject to exchange trading halts.
The key advantage of the blockchain technology is cost savings. In addition to the reduction in trading fees from decentralized marketplaces when compared to traditional stock exchanges, the blockchain provides a cost-efficient mechanism for distribution of the dividend payments.
Permuto charges for the processing of dividend payments, and there is a nominal fee for the creation or redemption of the certificates. When dividend certificates are held at the DTC Permuto pays the investor 80% of the dividend and retains 20% for processing costs. Better yet, given that costs are significantly lower on the Chia blockchain, an investor holding a CAT will receive 90% of the dividend payments. This difference implies that the dividend certificate should trade for a higher price as a CAT than on the traditional markets.
Sample Valuation Calculation
If the assumptions are simplified a quick valuation may be calculated. Using a Microsoft share price of $429 and an annual dividend of $3.32, and assuming that the dividend increases 5% per year of which 90% is returned to the investor, the investor in the dividend certificate will receive $198.50 over thirty years. That is not the price that investor will pay today, however, as money has a greater value today than if received some point in the future. By assuming that money is worth 8% less per year, that dividend certificate will have a value of $45.46. A dividend certificate with that value returns an annual yield of 6.6%. The appreciation certificate should therefore have the value of $429 – $45.46 = $383.23.
This simple calculation demonstrates how an investor may value the two elements of the common share. The benefit to investors is that they may allocate their investment capital directly according to their investment preferences, and may receive a string of dividend payments or no dividend payments and only the capital appreciation of the shares.
According to Trent Martensen, Co-CEO Permuto Capital, “The ability to choose and manipulate risk exposure assuming a given return requirement is an objective for all investors, and by partitioning common shares into dividends and capital appreciation we are providing investors tools to fine tune their portfolios.”
In finance grad school in the late 1980s and early 1990s discussions about financial engineering and structuring of risks often included dividends and how a given dividend stream may not be well priced for a given common stock. Only now are the tools available to deliver standardized products to investors, and Permuto certificates could be the answer to those questions from long ago.
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