Truth of Reliance Power issuing Bonus Shares: Heal-up process

Anil Dhirubhai Ambani group controlled and recently floated Reliance Power company is now willing to offer Bonus share to the shareholders as a part of image building process. The bonus shares will be given only to the investors and shareholders other than the promoters. Hence, each shareholder will get an additional share for each share of Reliance Power that he is holding. If someone has 15 shares, then his shares will double to 30.

But what’s the catch?
As explained in this article,Issuing Bonus shares does not really add any value to the company. That’s a fact. Because, just by increasing the number of shares, the company does not creat any value or any new business.

Typically, what happens is as follows. If say I run a company which has a total of 100 shares and the price of each share is 2000 Rs. Now If I decide to go for a bonus share in the ratio of 1:1, then each shareholder will get another additional share. Hence, the total no. of shares will become 200. However, the Markets are efficient, so the price of the share will automatically adjust to half, i.e. it will come down to Rs. 1000 only.

In simple ways, initially, before the bonus issue, the total value of the company was 100 shares * 2000 Rs = 200,000 Rs. So just by giving a bonus share, the company has NOT created any value. Therefore, after the bonus issue, the market price will come down, so that the total value of the company will remain the same.

After the bonus issue, the no. of shares will be 200, so for the Market capitalization of the company to remain the same at 200,000, the share price will come down to 1000 Rs. No value is created. However, since the price has come down to 1000 Rs. level, there is some liquidity in the market. Now more people can purchase the share as the price has come to a bit lower level, hence there is liquidity induced. Generally, this is taken as a positive sign by the market, hence the price of shares usually increases.

How is Reliance Power Bonus Shares Issue different?
The Reliance Power Bonus issue is different because it is not applicable to the promoters. Therefore, the additional shares will be given only to other shareholders. The proposal will result in a dilution of the promoter group's shareholding (89.9 per cent at present) in R-Power.

So for an example, if the promoters hold 90% of the shares, then only 10% are there with other share holders. Therefore, if Reliance Power has a total of 100 shares, then 90 belong to promoters, rest 10 belong to other shareholders. These 10 shares will be doubled –taking the total no. of share to 110. Hence, the price will adjust accordingly.

For example, if Reliance Power is trading at 350, then the value of the company with 100 shares is 35,000. After bonus share issue, the total no. of shares have become 110. Therefore the share price will go to 35,000/110 = 318.18

Now, the 10% shareholders will benefit because they will have 2 shares at the price of 350, hence the effective cost will be 175 per share. And after the bonus share issue, the market price of each of the share is 318.18, therefore, the 10% stock holders will gain.

Who will loose? It’s the promoters that will absorb this loss – who hold the 90% shares.

In Conclusion:
It’s a good move by the promoters of Reliance Power Share to offer a Bonus share issue.

Related: Reliance Power Bonus Shares Allotment Date

The retail investors can gain, but only if the stock does not show more volatility. Please not that the numbers shown above are only for demonstration purpose. The actual value will be different depending upon what was the closing price during the record date and ex-date for the bonus issue.

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