Understanding “Corporate Exercises” in businesses
As part of our investing journey in the stock market, we will frequently come across various corporate exercises that companies will undertake.
Some of the more common ones are:
- Dividends
- Bonus issue
- Stock split
- Private placement
- Rights issue
- Buybacks
In this post, I’d like to spend some time to discuss about each of these.
What are “Corporate Exercises”
Firstly, we need to understand what are corporate exercises.
These are not limited to listed companies. Essentially any businesses can undertake these exercises, be it a public listed or privately held company. As part of my day job, I have a role in advising privately held companies about different corporate exercises that they should undertake for various different reasons.
Corporate exercises, in essence, cover anything that affects the shareholders and/or the shares that they hold. These have no relevance to the day to day operations.
There are a lot of different reasons for a business to undertake corporate exercises, but one of the more common ones is to increase shareholder value. A properly planned corporate exercise can increase the value of the business significantly.
Dividends
The most common and widely known corporate exercise of all.
Dividends are the distribution of some of the companyโs profits to the companyโs shareholders. I have shared in my other post here about key things to look out for when we talk about dividends – dividend payout ratio, dividend yield, dates, etc.
It is regarded as a reward to shareholders and a consistent dividend track record will place the company in a very highly regarded pedestal for some investors. After all, it is a source of passive income for investors.
Impact on value of shares
The share price will fall by the same amount of the declared dividend. This is because the shareholders have cashed out that amount from the business and hence the “value” of the business will decrease by that amount. Remember this, RM1 cash in the business is equivalent to RM1 value of the business. “Cash is King”, as they said.
Bonus Issue
This is similar to dividends in the way that shareholders are getting “paid” for holding shares in the company. The difference is that instead of cash (from dividends), they are getting additional shares instead.
This is usually quoted as a ratio. That is… for every x number of shares you hold, you will be awarded additional x number of shares. Take a look at the extract of a recent bonus issue announcement by Public Bank Berhad.
Impact on value of shares
This is best shown via an extract of the same Public Bank Berhad’s bonus issue document.
As can be seen, the share price will be adjusted downwards so that the total value of the shares held will be the same after the additional shares have been issued out.
A key rationale quoted by a listed company to engage in a bonus issue is to reward shareholders. However, you may also realise that in a bonus issue, the “reward” is not very obvious.
More importantly, it increases liquidity of the shares by way of:
- Adjusting the share price to an affordable range for a wider investor base (e.g. PBB’s RM17 / share to RM3 / share is equivalent to RM1,700 / lot vs RM300 / lot)
- Increasing volume by way of more shares and, indirectly, more trading activity
How is this similar to dividends?
One may then ask, “How is bonus issue the same as dividends? In dividends, we get cash in our bank accounts.”
Recall that when it comes to dividends, you get cash in your bank account in return for a reduction of value in your shares (i.e. share price drops, but number of shares held remain the same).
For a bonus issue, the value of your shares remain the same (i.e. share price drops, but number of shares held increases).
Many investors opt to sell off the bonus shares, making it a pseudo-dividend, as the price per share is now lower. It creates an opportunity for investors to cash out a small portion of their shareholding.
However, if you have no need for the cash and the prospect of the business is good, this is better served to be kept untouched to be able to realise better value for you.
Remember, you are reducing your equity stake / shareholding % in the company if you sell the bonus shares – that means less upside and less dividends.
Hold on.. The benefit?
Yes, there is no direct benefit for you in a bonus issue other than potentially more dividends if they keep the dividend per share the same or higher in the future.
Indirectly:
- Lower share price (affordability),
- Increased volume (liqudity & volatility), and
- News of the corporate exercise (sentiments)
We hope that it will help in increasing the share value.
Stock Split
Stock split happens when a company divides its existing shares into multiple shares.
In a no par value regime – like Malaysia and Singapore – this functions exactly like a bonus issue.
The only difference lies with:
- The name (i.e. Bonus Issue vs Stock Split, whereby bonus issue sounds infinitely better)
- The ratio that is quoted (i.e. Bonus issue 1:1 is the same as a stock split of 2:1)
Impact on value of shares
Same as bonus issue above
Private Placement
Things gets a bit exciting when it comes to private placement. This means that the company is raising additional funds from investors privately rather than in the open market.
There are usually only 2 reasons private placements happen: Growth or Survival.
It is very important to take a look at the utilisation of proceeds when it comes to private placements.
Impact on value of shares
Private placements entail dilution of shareholding. This means that if you previously own 1% of the shares, it will become less than 1% by the end of the private placement.
Why? Because the company issues out new shares to the new investor(s) at a price that is at a discount of the listed price. So if you own 1,000 shares over a total shares of (100,000 + new shares), then you would be holding less % in the company.
Wait.. why? The price is usually at a discount of less than 10% of the listed price. The reason for this is because an investor will only invest in bulk at a private placement with a discount to the market price.
The effect is:
- Short term: Share value will drop due to the dilution – for the same value, there are more shares, so the share price will be adjusted downwards (but often times you will see the share price go up before the proposed private placement take place)
- Long term: Depends on the effectiveness of the use of funds – we hope it will appreciate a lot more
Here’s an interesting read in the Edge about private placements trend in Malaysia just last year.
Rights Issue
Where private placements are about raising funds from external investors (privately), rights issue is the act of raising funds from existing shareholders.
Each shareholder of the company will get the “right” to subscribe to additional shares in the company based on the amount of shares he / she holds. Such shareholder can choose to exercise the rights or not.
Similarly, it is important to take note of the reason for the rights issue.
Impact on value of shares
The direct impact that we will see is a drop in price due to the dilution effect. That means new shares have been issued so the price per share will decrease as a result to account for the same value shared by a larger number of shares.
However, a rights issue is not as straight forward as it is for a private placement. Often times, a rights issue will allow a shareholder to subscribe to shares that others have forfeited – excess shares. This could easily change the shareholding of the major shareholders.
Changing of shareholding can come with major changes to the company. It is not guaranteed to happen, but definitely a risk that is present. So it is best to do a thorough study on the proposed exercise if any of the companies in your portfolio has declared a rights issue.
Buybacks
The last part that I’d like to discuss is share buybacks. This is done when a company buys its shares from existing shareholders (usually in the open market). This effectively takes the shares out of the public market, thus reducing the amount of shares out in the open.
A few reasons that buybacks happen:
- The company regards its shares as undervalued – i.e. cheap
- There is additional cash in hand
- To make the financials look more attractive
- Consolidate ownership of the company
Impact on value of shares
This depends on the sentiment in the market.
When share buybacks happen, the earnings per share increases (earnings remain the same, but amount of shares reduced), amongst other financial ratios.
Another effect of share buybacks is the dividends to the remaining shareholders *may* increase if the company is paying out the same amount of dividend or higher… but to lesser shareholders.
Ultimately, share buyback sends all kinds of signals to the market and one has to study the company further to determine if the value of the shares is indeed undervalued or is it just another corporate hocus pocus.
There you have it. You have levelled up your knowledge on corporate exercises!
Till next time.
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