Reliance Power’s proposed bonus issue tries to mend fences with hurt investors

Reliance Power is attempting to win over dejected investors, who suffered losses after investing in the company’s public offer IPO, one which attracted unprecedented subscriptions. The company’s Board will meet next Sunday to decide on a proposal to issue bonus shares or otherwise compensate shareholders who applied in the IPO.

It has attributed the decline -11% for retail shareholders- in the share price to the global uncertainty in equity markets and rivalry. Whether a bonus will really lower the cost of acquisition is debatable, a cheque in the mail would have been more effective but would lead to a cash outgo. Investor sentiment though may get a small boost.

The proposal is to reduce the cost of ownership below the IPO price of Rs 430 for retail shareholders and Rs 450 for institutional investors. Now, the best way of doing that is to return money to shareholders, that is returning whatever investors have lost to them. Whether such a move would be legal and if regulators would approve it is one matter, but under a scheme of arrangement, such a plan should work. But that would mean foregoing money that Reliance Power has already raised, for its power projects.

So what is being proposed is a bonus issue, which will exclude promoters. But a bonus issue is just a book entry. From the existing reserves of the company, more shares will be issued, but it does not lower the cost of shares below the IPO price. Instead of holding 100 shares worth Rs 40,000 if a shareholder is left holding 200 shares worth Rs 40,000, except for the psychological satisfaction of holding more shares, nothing else changes.

In this case, the argument for a market premium after bonus too does not seem to hold water. The post-bonus premium works when the company’s near to medium term prospects are fantastic or when strong demand for the stock creates a liquidity premium. But none of these seem to exist in the current case where the company is in the initial stages of building power plants. Since promoters are being excluded from the issue, which is not normal under existing company law rules, the procedure may be through a scheme of arrangement, under Sec 391-394.

Most importantly, any bonus issue will increase the equity capital of the company and dilute EPS, so the net value of shares would remain the same. Getting more shares need not necessarily make the Reliance Power shareholder richer. Perhaps a more effective salve in the longer run will be timely completion of its projects, which could justify the price paid by its IPO investors. There can be no effective substitute for performance as a means of rewarding shareholders.

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