Nykaa’s bonus issue | What does it mean for the company’s corporate governance record?

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Nykaa’s 5:1 bonus share issue has kicked up a debate about corporate governance at the online start-up.  Was the company’s management right to step in and protect the shares from volatility, or was the management wrong in denying shareholders a fair exit?

On November 10, when the lock-in period for investors ended, the company announced the bonus issue. Some saw this as a good move: increase the share’s liquidity to increase retail participation. Some even thought it was an ingenious way to prevent a fire-sale, like it had happened with Zomato. Zomato’s price had fallen by 14.3 percent when the lock-in period ended. It fell by another 11 percent over the next few days.

Also read: Lock-in period ends but no fire sale thanks to bonus-issue move by Falguni Nayar

When the one-year lock-in period ended for Nykaa, it freed up 67 percent of shares for sale. Even if some of this had hit the market, the share price would have corrected sharply. But after the bonus issue, only a sixth of the holding was immediately available for trading.

The remaining five shares need to be transferred to the investor’s account within 15 days of the announcement, so it protects the stock from immediate selling pressure.

Investor advisory firm IiAS had recommended voting in favour of the bonus issue. In their November 2 note to investors, the advisory had reasoned, “The bonus issue will lower the per share price, improve liquidity, and expand the retail shareholder base. The new equity shares will rank pari passu in all respects with the existing equity shares of the company.” Pari passu means on an equal footing.

The advisory’s COO, Hetal Dalal, added, “The timing of the bonus issue is perhaps a testament to the market savvy of NYKAA’s promoters.”

Nykaa’s MD and CEO Falguni Nayar was in investment banking for decades before starting out with Nykaa.

Voices against the issue

On the other side of the debate are those who see this as a “stupid” move on the management’s part from the long-term perspective, and as a “glaring letdown of fiduciary responsibility” on the part of the independent directors on Nykaa’s board.

According to InGovern’s founder and MD Shriram Subramanian, the bonus issue is anything but clever.

“Issuing bonus shares to reduce selling pressure was a stupid move. The market will remember this and it affects the way long-only institutional investors view a company,” he said.

“The bonus issue may have a short-term benefit but, if the company is going to be around for 10 or 15 years or longer, then this move only serves as (an adverse) signal for investors. Also, if an institutional investor was planning to sell after the lock-in period ended and the bonus share issue locks up the shareholding, it will only further alienate the institutional investor,” said Subramanian.

According to him, Nykaa should immediately credit the bonus shares into the shareholders' accounts to mitigate any negative sentiment created by the bonus issue. Some brokers believe that it will be made available sooner, even by November 14.

Also read: More than 140 companies issue bonus shares in 2022, highest since 2006

Shyam Sekhar, founder of SEBI-registered investment advisory firm ithought, tweeted about a section of the investors being short-changed because of the tax burden placed on them. “How on earth did a board think this bonus was good for its pre-IPO investors, IPO investors, and those who bought on listing? Who are the independent directors? What were they doing?,” he tweeted.

When Moneycontrol reached out to one of the independent directors on the board, he said that he couldn’t comment on the issue because he isn’t an executive director, and therefore, isn’t involved in the day-to-day running of the company. He added that none of the independent directors would be able to comment on the matter, and that the management would be in the best position to elaborate on it.

This is odd since the bonus issue directly affects minority shareholders, and independent directors are there to protect the minority shareholders’ interest.

Taxing change

So, what is the tax play?

It disincentivises investors who want to exit the stock by bringing their proceeds under a higher tax rate. Early investors were sitting on a neat pile of profits towards the end of the lock-in period, and they would have been taxed at the lower LTCG (long-term capital gains) tax rate of 10 percent.

But after the bonus issue, only the first share would be taxed under LTCG, the remaining five would be taxed under the higher short-term capital gains (STCG) tax rate of 15 percent.

Even among this set of investors, some will benefit more from the bonus issue than others.

For investors whose acquisition costs were much lower than the current ex-bonus share price — mostly friends and close relatives of the Nayar family — there will be considerable tax savings if they choose to sell only a small chunk. On the other hand, investors who have a higher acquisition cost — such as private equity (PE) investors — have to bear a larger tax burden if they choose to sell their bonus shares. Read here to understand the math behind it.

IiAS’ Dalal said that she isn’t the right person to comment on taxation or tax advantages, and suggested we reach out to an audit firm for clarification.

Some critics have commented that the management needn’t have stepped in to protect the share prices, since the market would have discovered its fair value over time. After all, Zomato’s share, which had plunged to a record low post the lock-in period, has since recovered by nearly 53 percent.