Simply Put: Share capital reduction

Two colleagues discuss the recent news on share capital reduction and what it means to shareholders.

Chintan: The share capital reduction announcement by Reliance has left me wondering about the array of corporate actions that can be announced by companies. One hears new strategies every day.

Sneha: Well, share capital reduction is not new but flies under the radar compared to share buybacks which are executed in listed space. Reliance Retail Ltd, which is an unlisted firm, will be extinguishing non-promoter held shares for a consideration of ₹1,362 per share. The twitterverse vented their ire that the shares were trading at ₹2,500-₹3,500 per share prior, implying a huge loss. But the company can do so as per Companies Act (Section 66) with majority shareholder approval (75 per cent).

• Also Read: Reliance Retail to reduce equity capital held by non-promoters

Chintan: Briefly, what does the Act specify?

Sneha: The company board must approve of it, which is done as on July 4 followed by shareholder approval. Next the company will file an application with NCLT, which will assess the process, creditor status and pending dues if any. But not valuations. And pfft, the shares are extinguished.

Reliance employed independent evaluators to arrive at the considered price and they valued the company at close to half of Reliance Industries’ value and on top of that gave a 40-50 per cent premium. Despite all this, if unlisted trading happened at significantly higher valuations, this corporate action carried out a reality check.

Chintan: That might hurt investors whoever they are.

Sneha: Employees with stock options, speculators who bought it from employees for value unlocking or impending arbitrage opportunity…could be anyone. But taxation will be another blow on top of this.

Chintan: There is more to this saga?

Sneha: The entire proceeds will be taxed as dividends (and not capital gains) in the hands of erstwhile shareholders and dividend income will be taxed as other income for taxpayers. The ability to offset acquisition cost and pay capital gains is also not available now.

Chintan: Why doesn’t the company consider a buyback?

• Also Read: Hindenburg report impact. Adani group’s ability to raise capital could be reduced: Moody’s

Sneha: Well, buyback also extinguishes shares but for listed companies. But essentially, buyback presents the optionality to tender your shares or voluntarily participate in an open offer. This would not ensure complete tendering (which is the aim) and also, price discovery will be in minority shareholder’s court.

Chintan: This episode makes it amply clear that listed shares provide many guard rails to protect minority shareholders against being rammed by the majority. And to buy unlisted shares, the (lack of) governance risk should drive prices lower more than any speculative arbitrage opportunity.