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'R' for magic-II - Views on News from Equitymaster

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'R' for magic-II

Feb 25, 2008

The magic does not seem to die down! First it was the magic created by India's largest IPO that was absorbed in a minute's time. Now, it is an unprecedented bonus issue in the Indian capital market history, where the said company is 'rewarding' shareholders within just 14 days of its stock market existence.Reliance Power has announced a 3:5 bonus issue (3 bonus shares for every 5 shares held) for non-promoters, i.e., those currently holding around 10% of its issued capital. In all, the company will be issuing around 137 m shares to non-promoter shareholders, which shall lead to a dilution of 6% in the current equity base of 2,260 m shares.

This bonus issue shall reduce the cost price for those retail shareholders who were allotted shares in the company as part of the IPO process, from Rs 430 to Rs 269. For institutional investors, who were issued shares at Rs 450, the effective cost price now stands at Rs 281. Thus, from a retail applicant's perspective, at the current market price of Rs 426, a loss of 1% (from the original cost of Rs 430) has suddenly transformed to a gain of 59% (over the adjusted cost of Rs 269). Now, isn't that magic!

What is more, the promoter company - AAA Ventures, controlled by Anil Ambani - has shown its 'gratitude' by not issuing bonus shares to itself and rather diluting its shareholding to reward non-promoter shareholders. AAA Ventures has also simultaneously announced a voluntary contribution of 2.6% of its shareholding in Reliance Power to Reliance Energy (the other promoter), to protect the company from any dilution of its existing 45% stake in Reliance Power, as a result of the bonus proposal. Accordingly, Reliance Energy's stake in Reliance Power will be maintained at the existing level of 45%.

Overall, it seems nothing more than a face-saving exercise from the promoter consequent to the stock's poor performance after its listing since a couple of weeks ago. Bonus shares from a company that will still have zero operating revenues for the next three years are not really bonus in their true sense! In effect, it has purely corrected the overpricing (though only to a certain extent) that was a result of the greed (call it mis-calculation) of the issue's promoters and investment bankers. As such, terming this bonus exercise as a show of concern and gratitude towards non-promoter investors is nothing more than a pretense from their side. And retail investors need to take this with a pinch of salt. After all, they were initially sold a piece of paper worth nothing for a price as high as Rs 430.

The issue had a list of well-known investment bankers, some of whom were even predicting a 'four figure' mark for the stock on the day of listing! Should investment bankers be making those sorts of claims and statements on future share prices? But that is the nature of the investment banking business. They work for companies. Their fees are a function of how much money they raise for the company. And they (the bankers) have already made their money, and loads of it, bonus or no bonus.

The IPO, in its first place, was a bad deal for investors. It remains so, especially with the intrinsic value of the company still way below the current market price. Power is definitely in short supply - no one can argue with that. Consequently, there is tremendous potential for power companies to grow their businesses in the future. But there are risks, and many of these - land and rehabilitation, fuel, equipments and overall execution of plans. Also, one needs to understand that growth in businesses does not necessarily translate into higher returns for shareholders, especially when the return for companies itself is capped (return on equity for power generation companies is capped at 14%). With power sector valuations remaining at high levels, despite correcting a lot during the past few weeks, we would advise you to tread with utmost caution. After all, not all mistakes in investing are corrected by bonuses.


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