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The magic formula

By Devangshu Datta     November 30, 2006

Can you create genuine wealth with a few accounting entries? Indeed you can—it’s called financial engineering. Consider the situation when a company splits its shares. Let’s say, it decides on a 5:1 share split when it has a total of 1.24 crore outstanding shares, each trading at Rs Y. Post-split there are 6.2 crore shares, and each should trade at roughly one-fifth the earlier price.

Then, our company decides to offer a bonus of 12 shares for every share held post-split. Again, this makes no difference to the cash position. In a bonus, the ownership of reserves is transferred to the shareholders. But the money remains invested in the business. Prices should drop to 1/13th, as a result. The only apparent gain is liquidity—a market lot should now cost 1/65th of the price before the whole split and bonus act. Just how much premium can you place on liquidity? Quite a lot, it appears. When Unitech trotted out this split and bonus combo in May, it hit the sweet spot. Each original Unitech shareholder has received a bewildering 4000% return since the “great divide”.

Perhaps the inordinate reward occurs since a restructuring of these dimensions is seen as the prelude to something bigger—a public issue?

That is the case with DLF, which has performed a far more complex restructuring. It delisted in September 2003, (paying a Rs 5 lakh fine for breach of the Sebi takeover code) and offering Rs 320 per share. In 2005-6, it offered a rights issue of one Rs 100 debenture per share held.

Each debenture was then converted into 10 shares. Then, DLF made a bonus issue of 7:1. And a 5:1 share split is on the agenda at a November 14 EGM, where minority shareholders who claim to have been deprived of the rights offer are also expected to be accommodated.

A single share circa October 2005 will thus soon be the equivalent of 440 shares. If the anticipated IPO goes through at a likely price of Rs 600 per share, the returns could be in the region of 82400%. Splits, bonuses and rights offer are not new tools. A company may offer a bonus as a prelude to hiking future dividends payouts. Or a company, which feels that shares are uncomfortably high-priced, may split them in order to reduce the entry barrier.

ITC has done both — a single ITC share of 1993 is the equivalent of 31 shares now. Infosys and Wipro have notched up even higher “division ratios” of 128 times and 360 times. But those split-bonus combos occurred over long stretches of time. It’s a new trend to do this with quite the same haste as Unitech and DLF. Given the magical returns, it’s likely to catch on.

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