The Stock Exchange, in a guidance letter tonight, says it will reject listing of bonus issues of 200% or more, because they tie up too much of the float between the ex-date and distribution date. They propose stock splits as an alternative, but they omit the faster and better way to reduce board lot value, which HKEx itself used in 2008.

SEHK tackles bonus issues, misses the obvious
27 April 2016

The Stock Exchange of Hong Kong Ltd (SEHK), which has been running the statutory monopoly stock market in HK for nearly 30 years, has at last understood that when a company declares a bonus issue, then between the dates on which its shares begin trading "ex-entitlement" and when the bonus shares are actually issued, there is a reduction on the effective free float of the stock. For example, when you do a 9 for 1 bonus issue, then on the ex-date, the stock price should drop 90%, and if the free float was previously 25% of the company then it is reduced to 2.5%. A given dollar amount of buying or selling then has a magnified effect on the share price.

Tonight SEHK has published a guidance letter saying that it "may not grant listing approval for large-scale bonus issues" and "Generally, the Exchange is likely to raise concern...when a company proposes a bonus issue of 200 per cent. or more of its existing shares".

In other words, a bonus ratio of 2 new shares for each existing share, or higher, is likely to be rejected by SEHK. This is a step in the right direction, although it is clumsily worded. If you want a limit of 200%, then you say "not more than 200%". What they will now get is companies proposing bonus issues which are close to 200% but cause odd lots of shares to be allotted, such as 9 for 5 (180%), 19 for 10 (190%) or 39 for 20 (195%) and so on. A board lot of shares is the unit in which shares are traded on SEHK. Fractional board lots are harder to sell and attract a discount. Hopefully the Exchange will discourage the creation of odd lots of shares, leaving the only option as 1 for 1, because any other bonus issue would create an odd lot for someone.

Webb-site has a database of bonus issues over the last 30 years. There have been 70 which exceeded 2 for 1 (200%), and another 45 which were 2 for 1.

The guidance letter says nothing about providing proper reasons for the bonus issue, rather than the usual baloney about "providing a return to the shareholders" (it doesn't). Cutting a pizza into more slices doesn't give you a bigger Pizza, and creates crumbs which are wasted.

There is really no good reason for a bonus issue, and in many cases of H-share issuers, they are downright harmful beyond the transaction costs, because they also have a tax impact. The PRC, in its financial backwardness, regards any bonus shares whose par value is transferred from retained profits as a dividend and slaps a withholding tax on it. We called out another example recently: Dalian Port (PDA) Co Ltd (2880), which is proposing a 3 for 10 issue of so-called "Dividend Bonus Shares" which will likely hit many shareholders with a 10% withholding tax on the par value, increasing the effective tax on the parallel cash dividend from 10% to 50%.

The guidance letter points to the alternative of a stock split, which is not as disruptive, as trading in all shares in the clearing system continues seamlessly on the ex-date. So if issuers are concerned that their board lot has become to large in dollar terms to be accessible to smaller investors, then they can do that. However, that still involves the expense of a shareholder circular and meeting.

If your board lot is too heavy, cut it up

There is a third option, which SEHK missed in its Guidance Letter: simply reduce the lot size. If you do so by a factor of the original board lot, then nobody who has whole board lots will get odd lots. That doesn't need a circular or a meeting. You don't even need the archaic "parallel trading" system, which was supposed to have been abolished anyway in 2008 but was delayed indefinitely.

Hong Kong Exchanges and Clearing Ltd (HKEx, 0388), the listed parent of SEHK, did this itself on 5-Mar-2008, when it announced a cut in its board lot from 500 to 100 shares. Recommending that solution was one of the last acts of your editor as an HKEx INED before he quit. One announcement, no circular, no shareholder meeting, no fuss. HKEx's share price then was HK$141.0, so that cut the board lot from HK$70,500 to a sensible $14,100.

Note that a sensible board lot is determined by typical minimum brokerage charges. If a broker charges a minimum of say $50, then that amounts to a 0.5% commission on a $10,000 trade, so you don't really want to get a partially-filled order below that transaction size. SEHK has an outdated guideline of $2000 per board lot, with over 600 stocks below that level. A $50 minimum is then 2.5%. The guidance should be increased to $10,000. HKEx has a selfish reason not to do that - as we explained at the end of our article on 18-Apr-2016, HKEx makes money per board lot by charging "scrip fees" in the clearing system.

©, 2016

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