Bonus shares: no free lunches?

If there are two b-letter words that get investors all hyped up and frenzied, they are buybacks and bonus shares. 

In the case of buybacks, the investors wrongly imagine that the entire value of their shareholding has risen, even though only a miniscule portion may be eligible for the buyback and the hyped-up price may quickly correct back.

In the case of bonus, there is a perception that you are getting something for free. Even though the reasoning may well argue that there is nothing free; the emotions overrule and logic is swept aside.

Now let us look at bonus shares. Generally, upon issuance of bonus shares the market value reduces and the number of shares rises resulting in more or less the same total market value. Previously, the long term capital gains (LTCG) on shares were exempt. However, the Finance Act 2018 has removed this exemption and taxed the LTCG. Let us see how this will impact bonus shares.  

First we will look at the tax impact if bonus shares were issued prior to 31.01.2018 and next at the tax impact if bonus shares were issued after 31.01.2018. We will also look at the tax impact if no bonus shares were issued.

Prior to 31.01.2018, if you held the bonus shares for more than 1 year, they would be tax-exempt. But after 31.01.2018, the tax treatment has changed. Let us see how.

So as can be seen, bonus shares were not a very tax-efficient method of rewarding shareholders. Prior to 31.01.2018, the investor could atleast wait for a year and then sell his shares tax-free. However, after 31.01.2018, bonus shares have become even less tax friendly. Investors would well keep in mind that there are no free lunches. 

Notes:

1. The above calculation assumes there is no LTCG to set off against the LTCL.

2. LTCG below Rs. 1,00,000 is exempt.

3. Market value in case of no bonus shares is calculated by applying the bonus ratio.

Here's how to ensure multiple over-subscription for your IPO.

Polycab priced its IPO at Rs. 533 - Rs 538. A simple glance at the exchanges bid data will show how to create media frenzy and hype around the IPO. Simply put in bids at prices which were bound to be rejected such as 533, 534, 535, etc.

Another remarkable thing is the amount bid for is almost the same i.e. 3.40 crores across the various prices. Such media hype will prompt the retail investors into action and possibly losses.

Never mind that the DRHP contains this in the auditor's report:

"For the year ended March 31, 2017

Qualified Opinion
The Company’s internal financial control over cut-off procedures for recognition of revenue at the
year-end and review of invoices raised for certain category of customers were not operating
effectively which could have potentially resulted in under or over accrual of revenue and receivables
in the financial statements.

For the year ended March 31, 2016
Disclaimer of Opinion
During the year, the Company implemented a new ERP system. According to the information and
explanation provided to us, since the ERP system was under stabilization, the Company relied on its
legacy and manual controls."

As long as there is a quick buck to be made (or lost?) why bother with such trivial things as Auditors Reports?

Lyft: So did you make 8.74% or lost 11.64%?

Lyft (NYSE: LYFT) listed for trading this Friday. While the promoters and VCs made a killing, what if you were not allocated the shares and wanted to make a quick buck? You could buy shares when they listed at $87.24 or wait a bit while the shares climbed higher still to $88.60 and that's when you decided to buy the shares only to see you incur substantial losses. Lyft closed at $78.29 implying a loss of 11.64%. 

While the financial media will keep ranting and raving about $20 billion or $24 billion or $22 billion, the simple fact of the matter is you made losses in case you bought the shares to make a quick buck. It's of course quite possible that the share price will recover in subsequent days but now the share price will have to climb atleast 13% before you even break even. 

Just goes to show that there are no free rides for retail investors.

 

Shareholder Beware?

"The Shareholders hereby agree to pay management Rs. 14.86 crores in the 1^st year, Rs. 70.72 crores in the second year, Rs. 114.1 crores in the third year, Rs. 182.09 crores in the fourth year as franchisee fees when previously no such fees were being paid out"

Should such a resolution surprise and shock the shareholders or should they just willingly play along in the better interests of management?

Something like this is happening at Tide Water Oil (NSE: TIDEWATER) and the shareholders seem to be blissfully unaware.

Sometime in 2014, the brand ENEOS was transferred to a JV company, JX Nippon TWO Lubricants India Private Limited, with management affiliations. Prior to this no franchisee fees were being paid out on the ENEOS brand. However, after the brand was transferred out to this JV with management interests, franchisee fees started shooting the sky. 

Since 2015 franchisee fees are being paid in highly disproportionate amounts so much so that the cumulative franchisee fees paid out is roughly double the incremental sales.

 

  In 2018 for instance, compared to a sales growth of -2%, the franchisee fees grew 60%. From 1.6% in 2015, franchisee fees have skyrocketed to almost 16% of the sales without any tangible benefits accruing to the company or shareholders.Shareholders would be well advised to read the postal ballot notices and check for new fees or charges being paid out and try to understand the rationale behind the same before parting with their hard earned money.

Leveraged Buybacks

 
Home Depot ( NYSE: HD) has had a fantastic run so far on the exchanges. The stock is up 133% compared with a 52% return in the S&P 500 over the past 5 years.

One reason for this spectacular run could be the generous dividend and buyback program. But has it been a bit too generous?

As can be seen the past 4 years have generated $36.76 bn in FCF. However, stock repurchases and dividends amounted to almost $47.19 bn i.e. a shortfall of almost $10.43 bn. While the FCF grew 34%, the buybacks and dividends grew 46%. This was financed primarily by debt issuances of $10.57 bn. Already the buybacks have caused the stockholders equity to turn negative and raise the debt almost 100% over the past 4 years.

While this strategy may give a short term boost to the share price, its long term implications are quite detrimental to the company. Could there be another Macy's in the making?

IL&FS and the Rating agencies

Indian rating agencies have blamed the lack of timely default data for their delay in downgrading IL&FS.

How true are their claims?

As early as 2015, IL&FS had disclosed FD under lien of Rs. 161.7 crores in its Cash Flow statement.
This certainly should have been an eye-opener considering the company had disclosed cash of Rs. 6,419 crores in its Balance Sheet.

However, that's not all: it seems the cash disclosed under the Balance Sheet was not freely available to the company. The Cash Flow statement depicts a further bifurcation of this cash balance as balance under margin/ security/ lien and as per the cash flow statement.

 As seen the percent of free cash available to the total cash declined from 87% to 41%.

Meanwhile the current maturities of long-term borrowings and short-term borrowings increased from Rs. 10,610 crores to Rs. 25,797 crores.

The percent of free cash to short-term borrowings plunged from 26% in 2014 to 17% in 2018. In other words, to meet a rupee of the short term borrowings only 0.17 rupee was available in 2018 from 0.26 rupee in 2014.

 Coupled with the almost 100% increase in the Debt-equity ratio, the situation at IL&FS was screaming disaster and the only ones who couldn't listen were the ones who didn't want to listen.