Why do boards propose bonus issues and stock splits? We look at the drawbacks and the false and misleading reasons often advanced for such actions. If liquidity is really a concern, then a reduction in board lot size is the simplest and best way to go. Splits and bonuses are more a sign of desperation than of a sophisticated, value-focused board.

Truly pointless bonus issues and splits
27 December 2010

Bonus issues involve the issue of new shares to existing shareholders without payment, in proportion to the number of existing shares held. They are utterly pointless exercises, but somehow, every year, a dozen or more companies come up with false and misleading reasons to do them. Here are the drawbacks:

Most of the problems listed above also relate to stock splits - where existing shares are split into a number of new shares. On top of that, the par value of the share changes, so that usually involves the production of a new colour of share certificates, to distinguish them from the old ones. There is also a complicated and outdated system of "parallel trading" for the old and new certificates, which should have been abolished on 3-Nov-2008 but was deferred and has has since vanished into a regulatory black hole.

Against these drawbacks, the only credible benefit of a bonus issue or stock split is that, if the size of a board lot is not reduced, then the dilution reduces the value of one board lot. For example, a 2,000-share lot at $8 is worth $8,000, and after a 1 for 1 bonus issue, that becomes 2 lots, each worth $4,000. Theoretically, that makes the stock more accessible to smaller investors, but there are practical reasons why it usually doesn't. These are:

Board lot reduction

If a high board lot value is really inhibiting liquidity in your company's stock, then it is easier and better to just reduce the number of shares in a board lot. This has the following benefits:

Laughable reasons

With a completely straight face, sometimes directors give false and misleading reasons for a bonus issue or stock split. These are usually along the lines of claiming that they are "rewarding" shareholders or "returning" something to them, when it is mathematically false that they are doing so. Sometimes they speak of "strengthening the capital base" when they are not raising a single dollar of equity capital. Sometimes they even dress up the bonus issue as a "dividend" when it does not involve any return of capital or income whatsoever. Here are a few recent examples:

Announced Name Code Action Reasons
9-Dec-2010 Chigo Holding Ltd 0449 9 for 1 bonus issue "As a gesture of gratitude to the Shareholders for their loyalty to and support of the Company"
1-Dec-2010 Cash Financial Services Group Ltd 0510 5 for 1 split, board lot increase from 2,000 to 6,000 shares "The Board believes that the Share Subdivision will decrease the trading spread as well as the volatility of the trading price" (false: at announcement date, the price was $3.00 with a $0.01 tick, so a 5:1 split cuts that to $0.60 with a $0.01 tick, increasing the minimum spread from 0.33% to 1.67%).
18-Nov-2010 Sa Sa International Holdings Ltd 0178 1 for 1 bonus issue "In recognition of the continual support of the Shareholders, the Board decides to propose the Bonus Issue."
27-Oct-2010 Asia Commercial Holdings Ltd 0104 5 for 1 split, board lot increase from 1000 to 5000 "The Directors are of the view that the increase in number of the shares...will improve the liquidity in the trading" (false: the value of a board lot remains unchanged, since the lot size increases by the same factor as the stock split)
27-Sep-2010 Heng Xin China Holdings Ltd 8046 1 for 30 bonus issue "The Directors believe that a dividend in the form of the Bonus Issue is a reward to the continuing support of the Shareholders"
26-Aug-2010 Lonking Holdings Ltd 3339 1 for 1 bonus issue "The Board believes that the Bonus Issue is a return to the continual support of the Shareholders."
23-Aug-2010 Weichai Power Co., Ltd. 2338 10 for 10 bonus issue (yes, 1 for 1 would be simpler, but this is China) "The Board believes that the proposed Bonus Shares Issue will allow the Shareholders to participate in the growth of the Company" (false: that is what shareholders were doing already. The Bonus issue does not change anyone's share of the business).

What some boards may really be thinking is that some investors are dumb enough to regard a low nominal share price as a signal of value, regardless of how many shares are outstanding. This is naive when you consider that blue chips trade in the tens of dollars and are still popular with the most ignorant of retail investors. Even if a few punters really do think that a 90 cent stock is more likely to double than a $9 stock, they are greatly outnumbered, at least in asset terms, by larger and more sophisticated investors who see these gimmicks as a sign of desperation and poor judgment by corporate boards.

Truly confusing

One company recently caught our eye for proposing a bonus issue and a stock split at the same time: LCD-maker Truly International Holdings Ltd (Truly, 0732) is proposing a 1 for 10 bonus issue and a 5 for 1 stock split. They could have had the same effect with a 9 for 2 bonus issue - every 2 shares would become 11 shares. Truly confusing and Truly pointless. Indeed, even the company had to stop and think about how on Earth the timetable would work - then they came up with one which goes ex-bonus on 13-Jan-2011 (4 days before the meeting to approve it) and ex-split on 20-Jan, with certificates for the bonus shares being dispatched on 28-Jan.

The board lot remains at 2,000 shares. Unless you own an even number of board lots, you will end up with an odd lot, so about half of shareholders will get an odd lot. Based on the Christmas Eve price of $12.68, the adjusted price will be about $2.305. The minimum spread at that level is $0.01, or 0.43%, compared with the current spread of $0.02, which is only 0.16%.

We did try to engage Truly on this issue by writing to them on 1-Dec-2010, inviting the Directors to withdraw their proposals and adjust the board lot size instead if they wanted to, with the "bonus" that they would avoid appearing in this article. If they really wanted to slash the board lot value (currently $25,360), they could have just reduced the lot size from 2000 shares to 400 shares instead.

The reason given for the bonus issue was the usual load of rubbish: "As a gesture to thank the the Shareholders for their loyalty to and support of the Company, the Board has decided to propose the Bonus Issue...The Directors believe that the Bonus Issue will also increase the Company's capital base....". They should consider this article our gesture in return, and of course, no capital is being raised.

It's a shame - Truly is one of the few companies that actually produces some form of quarterly results on a voluntary basis, and they get our praise for that, but we can all do without gimmicks like splits and bonuses.

Shareholders accept cash, not confetti

So to all those boards out there who are thinking about screwing around with their share prices in 2011 with splits and bonus issues, save us the trouble, and save us the cost and inconvenience. If you want to "reward" your shareholders, then run a good business, maximise shareholder value, and return all your surplus capital to shareholders. It's theirs anyway. Sending them confetti is no substitute.

© Webb-site.com, 2010

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