Nykaa’s move to time the record date for bonus shares with the release of lock-in shares comes across as part of a two-pronged strategy to deter a fire sale that would lead to a big drawdown in the stock price.
While the move has indeed achieved the objective of avoiding a fire sale on the day of the release of lock-in shares, whether it will completely avert a fall triggered by lock-in share sales going ahead is still in question.
The move seems brilliant and an ingenious way to arrest a stock price fall, but it comes at a significant cost to existing shareholders of Nykaa and a certain section of pre-IPO shareholders.
While the promoters and early shareholders will now be able to exit the stock partially with a minimal capital gains tax, the management has created a hurdle in the form of a short-term capital gains tax for other shareholders who may like to exit.
Short-term capital gains tax is levied at a flat rate of 15 percent as opposed to the long-term capital gains tax rate, which is only 10 percent.
Nykaa’s bonus issue has stabilised the stock price that fell 8 percent on November 9, and nearly 20 percent in the past one month. The stock opened at Rs 171 ex-bonus, and the day on a high at Rs 185, gaining more than 5 percent in an otherwise lackluster market.
Evidently, Nykaa’s move seems to have been orchestrated after the disastrous fall in the stock price of Zomato following a similar event that sent shock waves across the markets in July this year. Zomato fell 30 percent in two days, creating a pandemonium in the markets.
While the bonus issue has arrested the fall on November 10, that does not rule out selling when the bonus shares actually hit demat accounts and the lock-in shares will be available for sale down the line.
Play on tax implications
There is no clarity on when the bonus shares are likely to hit the investors’ accounts. Brokers are expecting them to be credited in about two weeks; it could also come through by November 14, some sources said. But it is not just a question of availability.
The bigger play is on the tax implications
It’s about aligning tax incentives in a way that disincentivises investors and deters them from selling stock while offering others an incentive if they choose to partially exit the stock.
How does this work? Normally, a bonus does not increase or decrease the value of your shares. If you hold one share which you acquired for Rs 100, whose current market price is also say, Rs 100, and you get a 5: 1 bonus, you end up with six shares with the price of roughly Rs 17 (Rs 16.66X6=100).
Now under income tax rules, the cost of acquisition of your one share will still be taken as your original cost, which is Rs 100, but now the value of that share is one-sixth, so your books will show a capital gains loss of Rs 83. For all the additional bonus shares issues, the cost of acquisition becomes zero as they are counted as free shares.
Now, if your acquisition cost was, let us say, Rs 10 instead of Rs 100, and the same bonus issue came through when the prevailing market price was Rs 100, you will now have to pay a capital gains tax on Rs 7 (Rs 17 ex-bonus price minus the cost of acquisition of Rs 10) instead of Rs 90 (prevailing price of Rs 100 minus cost of acquisition of Rs 10) for the first share.
Note, this is only for the original or first share you hold. If you decide to sell all the shares, including the bonus shares, there will be no difference in tax liability because on the free bonus shares, cost of acquisition is counted as zero. You will pay a higher tax as they will be counted entirely as capital gains.
Gains for pre-IPO investors
In the case of Nykaa, most pre-IPO investors are sitting on pretty gains on the original investment. Private equity investors are sitting on anywhere between 5x to 100x their investment.
This means for some investors, whose average costs are very low compared to the prevailing ex-bonus price, there will be considerable tax savings this year if they choose to sell only a small chunk.
On the rest of the holdings, if they sell, they end up paying a short-term capital gains tax, a nasty surprise. But considering the profile of early investors, who are largely friends and close associates of the Nayar family, this is a sweet deal if they would like to take out some money by selling partially and staying invested with the rest of the stake for the long haul.
Bonus stripping
For others, especially private equity investors, whose acquisition prices are higher than the ex-bonus price, there may be some benefit in the form of bonus stripping, wherein the ex-bonus share price hovering at levels lower than the cost of acquisition will help one book a capital loss and offset it against a capital gain elsewhere.
But overall, these private equity investors as well as all other shareholders will now have to incur an additional short-term capital gains tax as the cost of acquisition for the bonus shares will be counted as zero. Earlier, these investors would have paid long-term capital gains tax of 10 percent if they were to sell their entire holding. Short-term capital gains tax is levied at 15 percent.
Banga, Sekhsaria and Munjal
Currently, Caravel Group founder Harindarpal Singh Banga, who has a 6.4 percent stake in the company, holds shares at an average cost of Rs 7. Similarly, high networth individual (HNI) Narotam Sekhsaria, founder of Ambuja Cement, has an acquisition price of Rs 9.9.
Sunil Kant Munjal, one of the founder-promoters of Hero Group, holds a 3 percent stake with shares acquired at Rs 56.5 apiece. These investors may choose to sell to the extent there is a tax advantage and hold the rest of the stake for the longer term.
In the case of private equity investors Steadview Capital and Fidelity Securities, with current shareholding at 3.5 percent and 1.3 percent, who acquired shares at Rs 202 apiece, the funds may sell one-sixth of their holding and get the capital loss benefit, as the current price is lower than their acquisition price. But the bonus holdings will attract a short-term capital gains tax rate of 15 percent.
The other two private equity investors won’t have the same benefit of capital loss because Lighthouse India Fund’s cost of acquisition stands at Rs 76.7 and TPG Growth had acquired shares at Rs 117. So these will end up bearing the brunt of short-term capital gains tax entirely.
A prudent move or not
Now, there are arguments on both sides in terms of whether or not this is a prudent move by the management.
The argument in favour would be that if there is no hurdle for investors to exit, then there would be a crash sale that would dent prices miserably as in the case of Zomato. That damages investor sentiment and creates a perception of poor stock performance. The moves smoothen the volatility, if anything.
The argument against is this. While the move is intended to soften the blow in terms of stock price performance, it puts an unnecessary and unaccounted-for burden on a vast swath of shareholders.
More importantly, it also goes against the principle of equity when it comes to how the tax benefits stack up for the various category of investors. The tax incentives are aligned in favour of promoters and early shareholders, and against other existing shareholders who have been there since listing and some pre-IPO shareholders.
And then of course, there is the question of whether management should care about share price at all. The moment they start to go down the path of looking at stock prices and calibrating moves, it is a slippery slope.
Not only is the whole attempt to manage prices futile, there is no way for managements to win either. The only way therefore is to focus on the core business and ensure that value gets recognised in the market.
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