When is it okay for a company director to bet against his own stock?

On Wednesday, Dis-Chem prompted lively criticism on social media when it announced that chief financial officer Rui Morais had used slightly more than 4.1-million of his shares to enter into an off-market hedge. Responding to the news, RECM chairman Piet Viljoen tweeted: "Directors of Dis-Chem hedging exposure to their own shares. Not a good sign for this highly priced market darling."

In the case of Morais, who in a second leg of the deal bought almost R50m worth of Dis-Chem stock, the answer may be: sometimes. He defended his decision as a "really positive" step that reaffirmed his commitment to the company.

Representing just more than a third of his shareholding in the company, the structure has a put strike price of R27.01 and a call strike price of between R38.29 and R39.25 a share, and expires between May and September 2021.

Essentially, it is a mechanism to raise capital: a director gives shares as collateral in return for money. The "put strike" means that in the event that the company’s shares fall below a certain level, that director is protected against losses. At the same time, the "call strike" means a director forfeits their right to any growth in the share price above a certain level — in this case, R39.25.

Morais has both hedged his downside risk — anything below R27.01 and he is "in the money" — and given away any gains the share price might make at more than R39.25.

When people start to diversify, it means you’ve got more faith in other businesses than your own.
David Shapiro

Collar structures are often frowned upon as they are complicated and at times unethical as directors no longer have downside risk in their own firm. "Why the hell would an ethical director bet against his own shareholders?" an analyst, who asked not to be named, said.

Sasfin securities’ David Shapiro said that "buying the put costs money — he has to pay a premium — so how do you offset that? By selling the call. If you want to diversify, rather just sell some of your shares.

"When people start to diversify, it means you’ve got more faith in other businesses than your own." But Morais said: "I don’t think people have understood the nature of the structure."

Having worked for the company for the past nine years, Morais said his entire wealth was tied up in Dis-Chem stock, which was "almost irresponsible", with the collar a means to diversify some money away from a purely rand-based asset.

"I could have just sold shares, but I’ve done it this way, which I think is better. I’ve used the same structure to buy into further upside in the group. I’m aligning myself further in the business," he said.

Traders Corner founder and market investor Garth Mackenzie agreed. "He’s actually increasing his exposure to the company, but doing it in a way that he’s protected, so if the share price falls he’s covered. It’s a smart thing to do and I don’t know it’s right to say that you’re betting against the company."

Executive director Stan Goetsch also hedged 1.818- million of his shares in a similar vehicle.

Dis-Chem stock has come under significant pressure since the release of its results for the year to end-February, in which headline earnings grew a less-than expected 19.7%. After peaking at R39.01 in January, its shares have slid 27% year-to-date, although they rallied 2.32% on Thursday to close at R26.50.