The bonus issue denied investors a fair exit by blocking 83 percent of the share value, and disincentivising sales due to a higher tax rate. The Independent Directors are particularly culpable
Nykaa (FSN E-commerce Ventures) had lit up Dalal Street in a dazzling debut on November 10, 2021. Investors had given it a nearly 80 percent premium over its issue price of Rs 1,125. Exactly a year later, the stock made news for different reasons.
On November 10 this year, the lock-in period of the pre-IPO investors ended, and the company announced a bonus issue with November 11 as the record date. While the company had stated its intent was to increase retail participation in the scrip, some investors saw this as denying them a fair exit.
Here is a quick reckoned.
What is a bonus issue?
A company issues additional shares to their investors in a certain proportion. For example, if it is a 2:1 bonus issue, then the investor gets two shares for every one he / she holds. Therefore, he / she ends up with three shares.
The total value of the three shares will not change. It will be equal to the value of the original share. If the first share was trading at Rs 900, after the bonus issue, the shares will trade at Rs 300 each (Rs 900 divided by 3).
Why do companies do this?
A company may issue additional shares if it wants to increase the liquidity of its scrips in the market. If a stock is highly priced, then there will be less participation in it. To increase participation and trading volumes, a company may issue bonus shares and bring down the price.
A company also issues bonus shares (or stock dividend) when it has enough reserves but does not wish to issue cash dividends. “Payment of cash dividends alters a company’s capital structure, whereas payment of stock dividends does not,” said Gaurav Shetty, CFA (US).
“A company’s assets and shareholder equity both decrease whenever a cash dividend is paid. On the other hand, when a stock dividend is paid, a company’s assets and shareholder equity remain the same,” he added. Cash dividends can also lead to higher financial leverage ratios and lower liquidity ratios, he said.
What were the concerns around Nykaa’s bonus issue?
Nykaa’s lock-in period ended on November 10 and the record date for the bonus issue was set at November 11.
Some investors saw this —timing the bonus issue with the ending of the lock-in period — as a ploy by the management to stop investors from selling their holdings as the lock-in period ended. They saw this as denying investors, particularly retail investors who entered at a high IPO price, a fair exit.
Why wouldn’t they be able to exit? For one, investors may not have access to the additional shares — five-sixths of their holding — for a few days. The bonus shares do not have to be transferred immediately. The company can do that anytime within 15 days from the record date.
Experts also pointed out that the taxation structure could disincentivise some people from selling, while incentivising some to partially exit. “If an investor chooses to sell, then the majority of the holding would now attract a higher tax rate (15 per cent in short term capital gains tax),” said Shetty. Sans the bonus issue, the investor would have been able to sell his / her share at a long-term capital gains tax rate of 10 percent.
Who should have raised an alarm?
According to a corporate fraud investigator with over two decades of experience, Vidya Rajarao, independent directors should have seen through the management’s “ruse”. In an interview given to Moneycontrol, she said, “The Board of Directors, especially the independent directors, should have raised concerns about this issue. Their lapse is particularly galling because the independent directors have several years of experience in the corporate sector and serve on boards of several listed companies in India.” Rajarao, CEO and Founder of Fraudopedia, said that if the independent directors had dissented, they could have written to the market regulator Sebi (Securities & Exchange Board of India), or they could have made a public declaration about their difference of opinion.
What can the regulator do?
“Sebi’s powers to investigate are very wide. However, merely because a bonus issue has been announced is not sufficient reason for Sebi to investigate unless material information regarding financials have been hidden. A fall or rise in prices is a market function and Sebi usually doesn’t involve itself in it, except making sure that due disclosures are done,” said Sumit Agrawal, founder, Regstreet Law Advisors and former SEBI officer.