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Monday, March 29, 2010

Bonus issues/Stock-split/Preferential issues/QIP/ADS and GDR

The stock market is driven by sentiments. Is there any way by which sentiments can be influenced or rather created? There are five ways companies can boost prices of their stocks: By announcing a bonus issue, stock-split, preferential issue, qualified institutional placement (QIP), and fund raising through issue of GDRs or ADRs.Though these corporate actions generate a lot of heat, the hype lasts only for a short term.Ultimately, it boils down to the financial track record of the company. Hence, what matters is the company's business operations, management credentials and future outlook.

Bonus issues:This is a wealth-neutral corporate action.The best part about this is that it has worked, though for short term, in most cases in boosting stock prices.Additional bonus shares issued are perceived as a big gain for the shareholders.It is, however, not a gain at all.A company issues bonus shares to the shareholder by transferring its accumulated profit or reserves to the equity capital. Thus, it is a cashless transaction. Equity shareholders receive additional shares as per the approved bonus ratio. Suppose a company ABC declares 1:1 bonus. This means each shareholder will receive one share for one share owned by them.Hence, if the shareholder owns 100 shares, he will receive another 100 shares and his total holding will be 200 shares. Assume the equity capital of the company is Rs 100 crore (face value of Rs 10 and paid-up outstanding equity shares of 10 crore) and it has reserves of Rs 500 crore. After the bonus issue in the 1:1 ratio, the equity capital will increase to Rs 200 crore (face value of Rs 10 and paid up outstanding equity shares of 20 crore) and reserves will go down by Rs 100 crore to Rs 400 crore.The market price of a stock after the bonus issue is adjusted in such a way that the overall market capitalization remains the same. Suppose prior to the bonus issue the market capitalisation was Rs 10000 crore (share price of Rs 1000). Post bonus issue, the theoretical share price would be Rs 500. The overall market capitalisation will, thus, remain the same: Rs 10000 crore (20 crore shares x Rs 500). The simple formula for arriving at adjusted theoretical market price is market capitalisation divided by outstanding number of equity shares post bonus issue.The market price will be adjusted to Rs 500 and considered as the previous day's price when the stock goes ex-bonus. Shareholders of ABC, who were earlier holding 100 shares worth Rs 1000 a share will now hold 200 shares at Rs 500 a piece. Where are the gains?

Stock-split:This is another way to boost market sentiment.A stock-split reduces the face value of the stock. This increases the number of outstanding shares in the market. The basic objective of a stock-split is to improve liquidity by increasing affordability for investors. For instance, if a stock with a face value of Rs 10 is trading at Rs 2000 a piece, it makes sense for the company to go for a stock-split.Assuming the company goes for a 10:1 stock-split, 10 shares of face value Re 1 each would be issued for every single share of face value Rs 10 held. The stock price would come down to Rs 200 so that more investors can afford this stock. This also helps price discovery as more investors would start trading in the stock.As is the case with bonus issues, the stock price is adjusted in such a way that the market capitalization of the stock before and after the stock-split remains the same. Hence, a stock-split does not yield any material benefit to the shareholders.Companies going for stock-splits or bonus issues could genuinely want to increase the market liquidity of stocks. However, this is true when share prices are in of three digits, four digits or five digits.Ironically, many penny stocks announce bonus shares and stock-splits. Penny stocks are defined as stocks that are trading below Rs 10 or below their par value. The primary objective of bonus issues or stock-splits is to improve the liquidity profile of the stocks. If penny stocks are already trading at lower levels, what is the reason for them to opt for stock-splits or bonus issues? The simple answer is to prop up prices by trying to improve market sentiments.Finding the real reasons for bonus issues is not so difficult. These companies should have healthy reserves to issue bonus shares. The stock price should be high to act as a deterrent for small investors fro a company to go for a stock-split. Otherwise, beaware of the efforts of promoters of ‘penny' stocks to boost prices.

Preferential issues: Of late, many companies have announced their intention to allot shares on a preferential basis. It is actually issuance of shares to promoters and non-promoters. To make preferential allotment more expensive for promoters, the Securities and Exchange Board of India recently hiked upfront the margin requirement from 10% of the allotment size to a hefty 25% for convertible instruments such as warrants. If promoters fail to converts the warrants into shares during the stipulated period, the upfront margin is forfeited by the company. Further, the capital market regulator has put up another condition to safeguard the interest of small investors: a lock-in of three years from the date of allotment.Generally, allocation of shares on preferential basis to promoters and institutional investors is perceived by investors as a sign of revival in market fortunes. Promoters opting for preferential allotment mean they are optimistic about the prospects of the company and think valuations at the current level are fair. Besides acquisition of equity shares under preferential allotment by institutional investors is also considered a positive development as these institutions supposedly do cherry-picking.However, the rise in stock prices on the announcement of a preferential issue could be short-lived and even promoters and high-profile institutional shareholders could go wrong with their bets as timing the market is difficult. For instance, in the last one year or so, many promoters and non-promoter have lost the upfront margin paid for convertible instruments on not exercising the option of converting the warrants into equity.Small investors are better off relying on industry- and company-specific performance rather than chasing stocks favoured by promoters and institutional investors.

Qualified Institutional Placement (QIP):In the last 12 months, a slew of companies has been placing shares with qualified institutional buyers (QIBs). The announcement of QIP provides strength to some stocks on the trading floor. Under the QIP route, companies can issue equity shares and other securities such as fully or partly convertible debentures to QIBs.QIP was introduced in 2006 to encourage companies to raise money from the domestic market rather than going overseas to raise funds. QIBs include mutual funds, foreign institutional investors, banks, venture capital funds, provident funds, and pension funds. A QIP is considered as positive development for the stock as QIBs are supposedly expert in picking stocks and the price paid by QIBs is considered as benchmark for the stock by market participants.

Issue of global depository receipts (GDRs)or American depository shares (ADS):It is not only the recovery in the domestic and international equity markets but also the rise in the risk appetite of investors that have encouraged many domestic companies to raise funds in the international markets. For instance, Tata Steel and Suzlon Energy.One of the reasons for this euphoria, particularly in these two cases, is that these companies can retire their debt by utilising the proceeds raised from the overseas market. This way Tata Steel and Suzlon Energy can reduce their interest burden and also look at funding their business plans.In July 209, Tata Steel, one of the world's largest producers of steel, raised US$ 500 million on the London Stock Exchange. This is the largest-ever GDR offering of an Indian company in London.Similarly, Suzlon Energy raised US$ 202 million through issue of global depositary receipts (US$ 108 million) and zero coupon convertible bonds (US$ 93.87 million). Mid July 2009, Sterlite Industries successfully raised US$ 1.5 billion through issue of ADS.Fund-raising plans are seen as a positive sign as many companies are in the process of restructuring their debts and reshaping their balance sheet. In the present market, driven by liquidity, successful equity offerings are a boon for companies and, in turn, to their shareholders.

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