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:
- Bonus issues cost money - the company need to produce an announcement, produce and print a circular, hold a general meeting to approve them, and then send out share certificates to registered shareholders.
- Bonus shares do not create any value for shareholders - they just divide the same pie into more slices. In fact, because of the cost of making the issue, the company and investors are slightly worse off.
- Unless the issue ratio is N new shares for each existing share (where N is a whole number), bonus issues create "odd lots" of shares - that is, some holders will end up with a number of shares which is not a whole multiple of one "board lot" - the minimum transaction size on the stock exchange. Odd lots are usually only saleable at a discount to the market price, so that's another loss, particularly for smaller shareholders who may only hold 1 board lot or a few.
- When the existing shares begin trading "ex" the entitlement to the bonus issue, a portion of the company becomes untradeable until the new shares are issued, thereby reducing the liquidity and locking up people's investments. For example, in a 1 for 1 bonus issue, half of the value of your holdings becomes frozen during the ex-entitlement period, until the new shares are received.
- Often, the adjustment to the stock price caused by the bonus issue results in a larger minimum bid-offer percentage spread. For example, a stock priced at HK$4 which does a 1 for 1 bonus issue will have a $2 share price, and the $0.01 tick will not change, so the percentage gap doubles from 0.25% to 0.50%. Wider spreads reduce liquidity.
- The adjustment to the stock price makes it harder to compare dividends and stock prices from year to year, because the history has to be adjusted for a fair comparison.
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 There is also a complicated and outdated system of "parallel trading" for the old and new certificates, which should have been abolished on 3-Nov-2008 but was deferred and has has since vanished into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:
- The limiting factor for many investors is the minimum commission (in dollars) charged by their broker. Whatever the percentage commission, there is usually a minimum, such as HK$100. With a commission rate of say 0.25%, that translates to a deal size of HK$40,000 (about US$5141). Any deal smaller than that involves a higher effective commission rate. Most board lots are worth a lot less than that, so they are not the limiting factor. See this page for a list sorted by board lot value.
- Despite the fact that most of the public float is immobilized in the central clearing system, CCASS (operated by HKSCC, which is owned by HKEx) and therefore settlements are paperless, investors still get charged "scrip fees" by HKEx, usually via their bank, broker or custodian, when the first dividend or other distribution is made after their purchase. This is an amount per board lot, which is $1.50 for CCASS participants, but often marked up by intermediaries to as much as $5, and sometimes they don't wait until a dividend date to charge you. So smaller board lots increase transaction costs - a $5 fee on a $2,000 lot is 0.25%.
- Despite this, the Stock Exchange normally allows a stock split without a board lot change as long as the resulting board lot is worth at least HK$2,000, and at the time of writing there are 411 stocks (out of 1413) with board lots worth less than $2,000.
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:
- You don't need a circular or shareholders' meeting to do it - a simple announcement will do.
- Shares in the clearing system will remain saleable throughout - none of the value gets frozen while you wait for bonus shares to be issued.
- You don't even need the archaic "parallel trading" arrangement. When HKEx cut its own board lot in 2008, it simply announced the change and carried on with the same stock code.
- No odd lots are created, as long as the old lot is divisible by the the new lot.
- There is no change in the share price or increase in the percentage bid-offer spread.
- No adjustments are needed when comparing current prices and dividends with historic ones.
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:
|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.
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
Organisations in this story
- ASIA COMMERCIAL HOLDINGS LIMITED
- CASH FINANCIAL SERVICES GROUP LIMITED
- Chigo Holding Limited
- Heng Xin China Holdings Limited
- HONG KONG EXCHANGES AND CLEARING LIMITED
- Lonking Holdings Limited
- SA SA INTERNATIONAL HOLDINGS LIMITED
- TRULY INTERNATIONAL HOLDINGS LIMITED
- WEICHAI POWER CO., LTD.