Corporate Actions — dividends, bonuses, splits, mergers and buybacks

Where this chapter sits

Chapter 9 carries 5% of the paper. For a research analyst it matters beyond its weight, because almost every per-share number in Chapters 3, 8 and 10 — EPS, book value per share, market price per share — is disturbed by these events.

The exam: 120 minutes, 100 marks, 60% to pass, 25% negative marking.

The single most useful idea in the chapter: some corporate actions change the economics of the business, and some only change the arithmetic. Bonus issues, splits and consolidations are in the second group, and the workbook says so repeatedly.

What governs corporate actions

A company initiates several actions, apart from those related to its business, that have a direct implication for its stakeholders. These include sharing of surplus with the shareholders in the form of dividend, changes in the capital structure through further issue of shares, buy backs, mergers and acquisitions, corporate restructuring, and delisting, raising debt.

In a company that has made a public issue of shares, the interest of the minority investors must be protected. So corporate actions are regulated by:

• Provisions of the Companies Act, 2013
• Relevant regulations of SEBI
• Terms of the listing agreement entered into with the stock exchange

This includes giving notice to the regulators, stakeholders and following the disclosure norms.

Who is entitled. Corporate benefits and actions apply to all investors who appear in the register of members, if the shares are held in physical form, or investors whose names appear in the register of beneficial owners maintained by the depository, in case of dematerialized shares.

To determine this, the company announces a record date or book closure period, and investors whose names appear on the records on this date become eligible shareholders to receive notice of the relevant corporate action and benefit.

Dividend

Post-tax profits in a business belong to the shareholders and a company can broadly do two things with those profits — retain them for investment in the business or return to the shareholders.

In practice, companies distribute part of the profits and retain part. The proportion of distribution and retention will depend upon the opportunities available for ploughing back the profits into the business, nature of management, expectation of shareholders and ultimately the availability of cash in the business.

A company may declare "interim dividends" during the financial year and a "final dividend" at the end of the year. A company has to pay dividends within 30 days of its declaration.

The rupee-terms rule. SEBI has mandated that listed companies shall declare dividends (if any) in rupees terms on per share basis as against the earlier practice of declaring dividends as a percentage of the face value.

Why: this is to avoid confusion among investors while comparing dividend on various shares of different face values. The workbook's illustration: if 50% dividend is declared by two companies with different face values of ₹2 and ₹10 respectively, an investor in company A will receive ₹1 as dividend as against ₹5 in the case of company B. In the interest of the investors, company A is now required to declare the dividend as ₹1 per share while company B will declare the dividend payable as ₹5 per share.

Reading the history: historical dividend track record of a company may be seen from the Payout ratio, which is calculated by dividing the company's dividend per share by earnings per share.

Taxation: in India, the entire dividend is now taxable in the hands of the shareholders. The company deducts 10% tax (u/s 194 of the IT Act) on dividend income more than ₹5000 while crediting the dividend in the shareholders account. And the domestic company is not required to pay dividend distribution tax.

Rights issue

When a company needs additional equity capital, it has two choices — ask more money from existing shareholders or go for a fresh set of investors.

The dilution problem, worked: a company may have 10 lakh shares of ₹10 each, amounting to an issued and paid-up capital of ₹1 crore. If it issues another 10 lakh shares to a fresh set of investors, the proportion held by existing shareholders will come down by half.

To prevent this, the Companies Act requires that a company which wants to raise more capital through an issue of shares must first offer them to the existing shareholders, and such an offer of shares is called a rights issue.

It is a choice, not a compulsion. A shareholder may buy shares offered to them under the rights issue, let the choice expire without any action, or transfer their rights/entitlement to another person for consideration (sell) or without consideration (under love and affection) — this is called renunciation of rights. Rights entitlements also get traded on the stock exchange for a defined period.

Why the price is discounted: shares under rights issues are generally offered at a discount to the prevailing market prices. The logic is unanswerable — if price under a rights issue is higher than market price of stock, investors would be better off buying shares from the market without subscribing to the issue.

Worked: a shareholder with 10 shares of a ₹100 stock, offered a 1-for-2 rights issue at ₹70, will have right to buy one share for every two shares held by him at ₹70 — so he can buy 5 more shares at ₹70.

And a practical addition: in practice, companies allow shareholders to apply for additional shares beyond their entitlement, because some shareholders may neither apply for shares under their entitlement nor transfer their rights to others, and those shares may be available for issuance.

The process requirements:

• A listed company making a rights issue shall fix a record date to determine the eligibility to the rights
• The company must issue a letter of offer giving details of the issue including the purpose for which funds are being raised. The draft letter of offer must be filed with SEBI
• An abridged letter of offer must be dispatched to all investors at least three days before the issue opens
• Investors can also apply on a plain paper if they do not receive the application form
• A rights issue is open for subscription for a minimum period of 15 days and a maximum period of 30 days

The balance sheet effect: total number of outstanding shares goes up with a corresponding increase in the cash in the asset side of the balance sheet. If all shareholders subscribe to their full entitlements, their proportionate ownership remains unchanged and the number of shares held by them goes up.

Bonus issue

A bonus issue, also known as equity dividend, is an alternative to cash dividend. Bonus shares are issued to the existing shareholders by the company without any consideration from them.

What actually moves: the reserves lying in the books of the company (shareholders' money) gets transferred to another head, i.e. paid-up/subscribed capital. Issuance of bonus shares is termed as capitalization of reserves.

And the workbook is blunt about what it achieves: the shareholders do not pay anything for these shares and there is no change in the value of their holdings in the pre and post-bonus stages. The issuance of bonus shares is more to influence the psychology of investors without any economic impact.

The ratio: a bonus issue in the ratio of 1:3 entitles a shareholder to 1 bonus share for every 3 shares held.

Two eligibility restrictions:

• The company makes the bonus issue out of its free reserves built from genuine profits. Reserves built from revaluation of assets are not allowed to be considered for making a bonus issue
• A company cannot make a bonus issue if it has defaulted on payment of interest and/or principal on any debt security issued or any fixed deposit raised

The effect on per-share data: as total number of shares go up without any economic change in the profit and loss statement or balance sheet, per share data (earning per share, book value per share, market price per share) witnesses immediate deterioration. However, as shareholders' proportionate ownership remains unchanged and the number of shares held by them go up, at overall ownership level, there is no negative impact.

Worked: if shares were trading at ₹1,000 prior to bonus, post bonus on a 1:1 basis, fair price is likely to come down to ₹500. The value of the investor's holding pre-bonus at ₹1,00,000 (100 shares × ₹1,000) remains the same ₹1,00,000 (200 shares × ₹500) post bonus.

With a realistic caveat: actual market price of share post bonus will be around ₹500 (not exactly ₹500) as it will depend on market factors of demand and supply.

Stock split

A stock split is a corporate action where the face value of the existing shares is reduced in a defined ratio. A stock split of 1:5 means split of an existing share into 5 shares. Accordingly, face value of shares will go down to 1/5th of the original face value.

Worked: if an investor holds 100 shares with a face value of ₹10 each, a stock split in the ratio of 1:5 will increase the number of shares held to 500 but the face value of each share will go down to ₹2.

And from the company's side nothing changes: there is no change in its share capital since an increase in the number of shares is offset by a fall in the face value and the resultant multiplier of face value and outstanding number of shares remains the same.

Why companies do it: companies consider splitting their shares if prices of their shares in the secondary market are seen to be very high, restricting the participation by investors. As price per share comes down post-split, share split leads to greater liquidity in the market.

But the workbook keeps its scepticism: similar to bonus, split is also a book entry resulting in increased number of outstanding shares in the books of company with reduced face value without any economic benefit whatsoever to the shareholders. We may say that share split is also to influence the psychology of investors (of reduced market price per share) and to impact liquidity in the marketplace without any economic benefit.

The real example given: SBI initiated a stock split of its equity shares from a face value of ₹10 to ₹1. A shareholder holding 1 share of a face value of ₹10 will now hold 10 shares each with a face value of ₹1. The stock that was trading in the markets at over ₹2700 at the time of the announcement traded post-split at around ₹295.

Share consolidation

Share consolidation is the reverse of stock split. The company changes the structure of its share capital by increasing the par value of its shares in a defined ratio and correspondingly reducing the number of shares outstanding to maintain the paid up/subscribed capital.

A stock consolidation of 5:1 means consolidation of 5 existing shares into 1 share. Accordingly, face value of shares will go up 5 times and the number of outstanding shares will become one fifth.

Worked: if an investor holds 500 shares of face value ₹2 each, a stock consolidation in the ratio of 5:1 will reduce the number of shares held to 100 but the face value of each share will go up to ₹10.

Why companies do it: companies consider consolidating their shares if prices of their shares in the secondary market are seen to be very low, affecting the perception of investors. An increase in the price per share post-consolidation leads to better perception among the market participants about the company's prospects.

And the mirror-image effect on per-share data: as total number of shares goes down without any economic change in the Profit and Loss account or Balance Sheet, per share data witnesses immediate improvement. However, as shareholders' proportionate ownership remains unchanged and number of shares held by them go down, at overall ownership level, there is no positive impact.

Worked: if shares were trading at ₹5 prior to consolidation, post-consolidation on a 5:1 basis, fair price is likely to become ₹25. Value of the investor's holding pre-consolidation ₹2,500 (500 shares × ₹5) remains the same at ₹2,500 (100 shares × ₹25) post-consolidation.

Mergers and acquisitions

Mergers, acquisitions and consolidations are corporate actions which result in a change in the ownership structure of the companies involved.

The four motives:

• Synergy — each company may have distinct efficiencies that when combined together may result in greater economic benefits. The combined entity can benefit from economies of scale, forward and backward integration and expanding the market for their products and services
• Increased revenue and market share — if two competitors go through M&A, it would result in increased revenue and market share for the acquiring entity
• Geographical or other diversification — acquiring a company in a different geography or complementary business space may offer significant competitive advantage
• Taxation — a profitable company can buy a loss making company to enjoy tax shield against the losses of the target company

And the protection for public shareholders: the shareholding pattern of a listed company may change due to a substantial acquisition of shares and voting rights by an acquirer and persons acting in concert with the acquirer. SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997 provide relevant triggers and requirements for an acquirer and offer an opportunity to public shareholders to exit from the company in such situations, if they choose to do so.

Demerger and spin-off

A spin-off occurs when a company carves one or more of its existing businesses on to a separate company. In case of a spin-off, the shareholders on the record date will be eligible to receive shares in the new company in proportion to the shares they held in the parent company.

The workbook's examples: in April 2018, Adani Enterprise spun-off its renewable energy business to a new company Adani Green Energy Limited. Shareholders of Adani Enterprises were given shares in the new company in the ratio of 761:1000. Earlier, in June 2015, Adani Enterprise spun-off its ports, and power and transmission businesses into two separate companies: Adani Ports and Adani Transmission.

Scheme of arrangement

Some companies may fail to fulfil their obligation to their creditors or to a certain class of shareholders — example: failure to redeem preference shareholders. Under such conditions, the company and the creditors or members may enter into a scheme of arrangement to settle the issue.

A scheme of arrangement is a court monitored settlement process between the company and its creditors or members. It typically involves reorganization of the share capital of the company. It may involve the existing shareholders relinquishing part of their ownership in favour of the creditors, or consolidation or division of class of shares.

Under section 230 of the Companies Act 2013, a scheme of arrangement can be sought by the company or its creditors/members.

A point worth noting on scope: the term Scheme of Arrangement refers to all types of corporate restructuring, including Mergers and Acquisition. Invoking this under bankruptcy conditions is just one of the ways.

The process: the person claiming the scheme of arrangement shall approach the National Company Law Tribunal (NCLT). The tribunal then orders the meeting between the company, its creditors and/or members to arrive at a compromise or arrangement.

Loan restructuring

Loan or debt restructuring is a mechanism available to companies in financial distress who are unable to meet their obligations to their lenders, to restructure their debt by modifying one or more of the terms of the loans.

What may be modified: the amount of loan, rate of interest, the mode of repayment — funds and/or equity in the company — and the term of the loan, so that the repayment obligation is within the payment capacity of the borrower.

Why both sides gain: the borrower is given a way to repay the loan that is feasible given the current state of the business and not be declared a defaulter. The company is now able to focus on building back its business and repairing the balance sheet. The lender can expect some repayment from a loan that would otherwise have to be written off as a bad debt.

The process: analysing the debt position of the company, meeting with the lenders, providing information on the current and future financial position, and coming up with a workable repayment plan. The lenders have to be provided a concrete business plan on how the company plans to generate the revenues required to meet its obligations under the new terms as well as meet the financial needs of the business.

Buyback of shares

A company may deploy excess cash on the balance sheet in various ways. It may expand business and grow, reduce its liability by paying back its borrowings, or distribute to the shareholders.

If it chooses the third option, management needs to choose between homogenous distribution of this money among all shareholders through dividend, or offering a choice to the shareholders to have the money through selling their shares back to the business, or in kind in terms of enhanced value of each share in terms of EPS and Book Value per share.

The six motives:

• To give a value boost to the stock if it is seen as undervalued
• Excess cash and lack of profitable investment opportunities
• Buyback as a confidence building measure
• Buyback as a defensive strategy against a potential takeover
• Buyback to reduce equity and resultantly increase the leverage in the company
• Buyback to diffuse the impact of dilution in promoters' holding on account of, say, Employee Stock Option Plans

And a caution for the analyst: while every management talks about the positive impact of buyback on minority shareholders, it is very difficult to ascertain management intention on buyback of shares.

The rules:

• Buyback of shares can be done only out of the reserves and surplus available with the company
• The shares bought back are extinguished by the company within a stipulated time frame and that leads to a reduction in its share capital
• To be eligible, a company should not have defaulted on its payment of interest or principal on debentures/fixed deposits/any other borrowings, redemption of preference shares or payment of dividend declared
• The company needs to pass a special resolution specifying the timeframe for buy back and maximum price at which the buyback will be made

The four routes: the tender method by making an offer to existing shareholders on a proportionate basis · from the open market through a book building process · through the stock exchange · from odd lot holders.

The effect — and this one is economically real, unlike a bonus: as buyback of shares results in the reduction of outstanding shares, even if there is no change in the P/L, it would result in increased EPS for post buyback shareholders. These shareholders may also enjoy higher dividend on each of their shares. Assuming the market value of shares based on earnings remains same pre and post buyback, as it is to be spread over a smaller lot now, market value per share goes up.

Delisting and relisting

Delisting of shares refers to the permanent removal of the shares of a company from being listed on a stock exchange.

Two kinds: in a compulsory delisting, the shares are delisted on account of non-compliance to regulations and the clauses of the listing agreement by the company. In a voluntary delisting, the company chooses to get the shares delisted and go private — motives ranging from regulatory reporting complexities and compliance, due to mergers and acquisitions, and sometimes to have freedom to execute a changed strategy.

The exit mechanism. SEBI regulation requires that the promoter group provide an exit opportunity to all shareholders. The promoter or promoter group should invite bids to acquire the shares through a reverse book building process. Under this system, the promoter needs to specify the floor price. Shareholders then specify the price at which they are willing to sell the shares.

The promoters can accept the bid price, reject the bid price (cancel the delisting plan) or provide a counteroffer to the public.

The two thresholds:

• Voluntary delisting can go through only if the promoter holding in the entity crosses 90%. If that is not possible, then the company cannot delist
• At least 25% of public shareholders should participate in the reverse book building

After delisting: if a company is delisted with some shares still held by the public, then such shareholders should have the right to sell their shares to the promoters. Promoters offer to buy those shares at the exit price within one year.

And the protection that overrides everything: no minority shareholder can be forced to exit at the time of delisting of shares from the stock exchanges.

Relisting. As per SEBI (Delisting of Equity Shares) Regulation of 2009, a company can apply for relisting (i) five years after delisting in the case of voluntary delisting and (ii) ten years after delisting in the case of compulsory delisting.

Stale reference in the workbook. The workbook cites the SEBI (Delisting of Equity Shares) Regulations, 2009 and the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. Both have since been replaced — by the Delisting Regulations of 2021 and the Takeover Regulations of 2011. The paper is set from the workbook, so learn the workbook's rules and names, but know that the current regulations carry different years.

The asymmetry is deliberate — a company thrown off the exchange waits twice as long as one that chose to leave.

Share swap

Swap simply means exchange of something. Accordingly, share swap means exchanging one set of shares with another set of shares.

The term share swap is often used during a merger or acquisition of a company when the acquiring company uses its own stock as cash to purchase the business. Each shareholder of the acquired company receives a pre-determined amount of shares from the acquiring company.

And the valuation step that makes it fair: before the swap occurs, each party must accurately value its company so that a fair swap ratio can be calculated.