Big ‘B’ Bombs in Box Office !!

Can Independent Directors stand up and be counted?

The recent ‘B’onus issue of five shares for each share held in a company that prides itself on being “in the spotlight every day” has raised concerns on corporate governance and the role of the independent directors.

The company went public just over a year ago when its Re1 face value shares were offered at a premium of Rs1124. The issue was an offer for sale, raising Rs 4720crs for the selling shareholders, combined with a fresh issue of Rs630crs. It cumulatively put 47.4mn shares of Re1each in the market which constituted 10% of its capital of 474mn shares. The promoters hold 52.43% post the IPO.

It is to be noted that the share capital changed in a significant way before the public issue and a sizeable quantum was held in a physical mode which is quite unusual for the times. Even post the public issue about 12mn shares are so held.

Preparatory to the public float the company made a bonus issue, the proportion being not very easy to compute. There was a split of the Rs10 face value into 10 shares of Re1 each. To understand the metamorphosis of the capital structure in just the year before the public issue, a lay person would need the assistance of a forensic auditor!

Recently the one-year lock in for the investors, who were issued the shares before the IPO, ended. The bonus was timed to coincide with this.

Why did the company wish to be “in the spotlight” with a rather unusual and abnormal ratio of 5:1?

Typically, bonus issue and share split happen when the share price reach unaffordable levels taking it out of reach of the common investors. This was a real problem in the dog days of physical lots being traded on the exchange.

If a share quoted at say Rs1000 and had a market lot of even 50shares, the minimum investment needed was Rs50000. Rs1200 which the price of the company been for some time is actually a very low figure as our markets have witnessed share prices in five digits like the case of MRF and Shree Cements, to just name two.

With the electronic trading doing away with market lot, even a single share can be traded. And in the case of the company the price has been hovering between Rs1220 and Rs 2580 and was never within the reach of five digits. Considering its present performance, it may not possibly in some years!

So, what prompted this step? One can only take an intelligent guess.

The issue of bonus shares carries a peculiar tax treatment whereby, the cost of the original shares is left undisturbed, and the bonus shares are imputed ‘zero cost’. This is completely alien to logic, as well as to the accounting treatment where the total cost of acquisition of the original shares are pro rata allocated across the total holdings, inclusive of the bonus shares.

However, the same tax law applies the principle of apportioning the cost when shares are split. In a manner of speaking, share split and bonus are little different, especially when bonus is issued out of share premium which is the case with the company where the share premium was Rs 1415cr and the retained earnings Rs75cr as at 31/3/2022.

It is quite possible and may be checked with reference to the offer documents, that the shares issued to the investors before the IPO were at a deep discount to the IPO price. The lock in on these shares was expiring. Those investors must have been anxious to sell when the lock in expired.

Though the current market price is not significantly higher than the IPO price, it would be higher than the preferential price adopted for the shares issued pre-IPO. These investors would accrue significant capital gains on the sale as it is.

Given the quirk in the tax law that does not disturb the original cost on the issue of bonus shares, the sale of the original shares is most likely to result in a loss or a much lower capital gains once the market price falls proportionate to the bonus issue.

In the company’ case the share that was hovering in the Rs1000-Rs1200 range pre bonus issue, dropped to sub Rs200 on the 5:1 issue.

Unless the pre-IPO issues were below the new market price of approximately Rs200, the sales will only result in booking losses for tax purposes. Whenever, the bonus shares are sold, the cost for tax purpose will be reckoned as ‘zero’, and the sales will result in gains. Since the loss arises before the gains, the shareholder can plan to match the profit with the loss suitably and not pay any tax!

The capital loss can also be carried forward to the future years. Thus, there is an inbuilt tax bonanza for the big shareholders and the promoters, who must have been issued their shares at abysmal prices, to either use the tax losses artificially generated to set off against other gains or carry forward to future years to set off against the future gains.

There have been rumours of the government wanting to change the capital gain tax regime. Quite likely the highly beneficial tax regime for the equity shares may change for the future period. In the case of the shareholders who accrue losses in the current year and carry it forward, the same will be a handy shield against the higher taxes that may arise in the future years.

Isn’t it a unique case of insider trading?!!

Is there any benefit to the common shareholders who bought in the IPO? Clearly, none! If at all, the market prices will drop due to the bloated capital and due to the selling pressure from the big holders. The small holders will curse their luck for holding these shares to complete the 12-month period to qualify for the lower tax rates!!  

Worse still is the tax consequences for those who bought in the IPO or later in the market. For those with a holding period in excess of twelve months on such purchases, the sale of the original shares will result in a long-term capital loss and the sale of the bonus shares, in short term capital gains. With no set off allowed between these two, the cost of this exercise to all these cases is doubly adverse; both on the price fall and on the tax out flow!

Can the board and especially the independent directors stand up and claim that they have done this in the larger interest of the public shareholders? Can those three independent directors who hold shares valued in the region of Rs 8cr to Rs 18cr, depending on the market price, confirm that they did not benefit out of this decision?  

Most certainly not!

What is the loco standi of the independent directors, who possibly obtained these shares at a significant discount before the IPO, though the basis of valuation would have followed the valuation principles to be adopted for private unlisted companies, to approve a resolution that directly benefits them?

A 5:1 bonus issue is quite weird in any situation and especially in a company that had made an IPO just a year ago and had created a share split of 1:10 just prior to the IPO and has hardly shown any recognizable operating profits.

It is a case where the Board must explain the rationale. The audit committee should be asked to explain the logic that influenced this outrageous outcome, and the external experts’ inputs received, if any.

The SEBI should initiate a probe into the entire history of how the shares were issued and changed at different points in time and quickly give its report if the decision was taken on logical grounds and in the larger interest.

The union budget being just a couple of months away, the CBDT should grasp the anomaly caused by the tax provisions and amend the law in such a way that and the distorted way of computing the tax is corrected for the previous year 2022-23, if not the years preceding. Alternatively, bonus shares issued from share premium account should be retrospectively clarified to qualify as a split of shares and not as bonus.      

There is, however, a contrasting case of how the issue of bonus shares benefited the common shareholders and the precedent comes from an unlikely source, and from relatively a distant past!

Reliance Power Ltd, is one of the three businesses that Anil Ambani secured in the split with his elder brother, and the company went public in 2008.

The issue was a giant one by the then prevailing standards. The issue which was of the size of Rs 11000cr attracted bids for almost 75times!

When the shares issued at Rs 430 dropped about 20% on listing due to the overall global melt down that reflected in the sensex dropping about 16%, there was a great deal of criticism from the market players on the pricing adopted for the issue.

Though the reason for the collapse in the share price was more external, the promoter announced a 3:5 bonus shares only for the non-promoter shareholders. This step brought down the average acquisition cost to Rs281 per share and Rs269 per share to the institutional and the non-institutional category, respectively.

This was an unprecedented investor friendly move when the vigilance of SEBI and public awareness on the role of the independent directors was much lower and corporate governance was more a topic in seminars!

The trajectory the group and the individual companies took in the later years is a contrast to the action taken in 2008, but quite outside the scope of this analysis.

If the company under scanner had made a bonus issue only for the benefit of the shareholders who got the shares in the IPO to give them a cushion against the fall in the market price triggered by the lock in on the pre-IPO shares expiring, the gesture would have been most genuine and applauded.

The company, much admired for its innovative business model and the promoter often cited for great enterprise, has much to explain for in its recent conduct.

The recent issues where there has been much consternation about the pricing should adopt R Power as an example if they wish to compensate the small investors for the high pithed IPO pricing, but never go this company’ way!

Unfortunately, the company has come into “the spotlight every minute” for the wrong reason!!  

If the identity is yet unrevealed , do check the QR code below!!!