For a well-established non-bank financial company, Mahindra & Mahindra Financial Services has done something unusual: it is offering existing shareholders a right issue priced at Rs 50 (face value of Rs 2 plus Rs 48 premium) at a steep discount to the market price (Rs 135 around mid-morning on 27 July). The issue opens tomorrow (28 July).
Some people will read this as promoter diffidence due to the company’s weak quarterly performance, but that would be a wrong reading. At a time when the sector is in trouble, companies need more capital and less debt. A rights or public issue is the right way to enhance capital to stabilise operations and prepare for any adverse turn in the economic scenario.
But there are several other reasons why rights issues at deep discounts make more sense even for strong companies.
One, a rights issue can be priced at any price, even at par, without doing any shareholder – whether promoter or minority shareholder – any injustice. Their shares remain the same.
Two, a low-priced rights issue leaves something on the table for even the smallest investor, since there is a wide gap between market and issue prices. This means subscribers can even borrow money from the bank to invest in a rights issue and then exit at a profit even after paying interest costs.
Three, a cheap rights issue can be a substitute for a bonus or stock split, since the capital gain resulting from it will be taxed at a lower rate than dividends. Short-term capital gains earned after paying securities transaction tax (STT) are taxed at 15 per cent and long-term gains at 10 per cent. Dividends are taxed at your tax bracket, which could be 30 per cent plus surcharge and cess. Low-priced rights can thus be a substitute for dividends when cash flows are a concern.
Four, low-priced rights issues can be a way of expanding liquidity in equity, especially for companies with very low floating stocks. High priced issues will narrow holdings to smaller groups and institutions.
Five, low-priced rights issues change the designation of capital in favour of the minority shareholder. If an issue is priced close to market price, the company gains in terms of cash and larger reserves. But both equity and reserves are shareholder capital. The former is directly owned by the shareholder, while the latter is indirectly owned, but essentially under the control of the promoter.
A larger equity base with a smaller reserve fund gives the shareholder a clearer picture on earnings per share compared to when most of the funds are designated as reserves. This way earnings per share are shown clearly to the shareholder, who does not have to use another metric – return on net worth – to calculate how well the company is faring.
For companies, in fact all companies which are not hugely cash surplus, this is the time to load up on equity – even if at a discount to market price.
PS: We should be surprised if the M&M Financial rights issue is not a runaway success.
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