Financing Corporate Actions

Abhijeet Chandra

April 2015

U

Shares Debt

Shark

Bank

Internal

Funds

Risk averse

Fixed charges

Bounded rational

Risk lover

Understand business model

High return seeker

Secured Debt

Instrument

Unsecured Debt

Instrument

Shares and share-

based instruments

$

Bonds Debentures

Coupon

Maturity

Interest

Convertib

ility

Equity

Shares

Preference

Shares

Returns

?????

Returns

???

Risk Risk!!!

Interest charges

Limited funding

Short-to-medium term

Other commitments

Limited funds

Short-term

Funding through Financial Markets

Financial intermediation Channelize savings Market efficiency Information production

Securitization Reduces liquidity Cost effective Deceptive (!!)

Financial innovation Risk management Allocation of funds

Equity/Ordinary Shares

Personal investment of owner(s) in business

Limited liability

Risk capital: No commitment of repayment if business fails.

No fixed returns: Residual claims on income/assets

Right to dividend only if declared

Right to control the business: Voting rights

Pre-emptive rights

Dilution of financial interest if additional shares issues

Preference Shares

Preferential treatment while distributing dividends

Convertibility:

Convertible preference shares

Non-convertible preference shares

Redemption:

Redeemable preference shares

Irredeemable preference shares

Right to arrears in dividends:

Cumulative preference shares

Non-cumulative preference shares

Equity Financing

a) Ordinary shares b) Convertible Cumulative Preference Shares c) Authorized, Issues, Subscribed, and Fully Paid Shares d) Forfeited Shares Source: Tata Motors Annual Report 2012-13 (p.128)

Going Public: IPOs

Why Do Firms Go Public?

Pluss Easy to raise large amount of capital

For capital-intensive projects, M&A deals, etc.

Improved corporate image Corporate governance

Better access to future financing

Listing on stock exchanges

Minus's: Dilution of ownership, control, privacy

Pressure of short-term performance

Accountability to shareholders

Global IPO Trend

IPO Process

Eligibility norms Paid up capital > Rs 10 Cr.; MCap: > Rs. 25 Cr. 3-yr track record

Filing of offer document Offer document (letter of offer in case of Right Issue) and RHP Submitted to ROCs, SEBI and Exchange

IPO offer Price band Denomination Book building

Underwriting Allotment

See: http://www.nse-india.com/corporates/content/capital_market.htm for more detailed listing guidelines

and http://www.sebi.gov.in/sebiweb/home/list/3/15/10/0/Draft-Offer-Documents-filed-with-SEBI for recent RHPs

Bonus Issues

Additional shares given to the shareholders without any additional cost, based upon the number of shares that a shareholder owns.

These are company's accumulated earnings which are not given out in the form of dividends, but are converted into free shares. For example, if Investor A holds 200 shares of a company and a company

declares 4:1 bonus, that is for every one share, he gets 4 shares for free. That is total 800 shares for free and his total holding will increase to 1000 shares.

Encourages retail participation and increases their equity base.

When price per share of a company is high, it becomes difficult for new investors to buy shares of that particular company.

Increase in the number of shares reduces the price per share. But the overall capital remains the same even if bonus shares are declared.

Right Issues

Offered to the existing shareholder through Letter of Offer

An offer of specified securities by a listed issuer to the shareholders of the issuer as on the record date fixed for the said purpose (ICDR Regulations) Issue price: pre-determined in consultation with the Exchange.

Subscription period: Right issue shall be open for15-30 days.

3 day and 50 day monitoring report to be filed with ROCs and Stock Exchange

Ref.: http://www.sebi.gov.in/sebiweb/home/list/3/16/13/0/Draft-Letters-of-Offer-filed-with-SEBI.

Debentures and Bonds

Debt securities: Long-term creditors Usually secured by specific fixed assets

IOU: No ownership interest in the company Priority claim

Fixed maturity period The length of time for redemption

Coupon rate: fixed return

9.8% LIC Housing Finance Ltd. Bond Face value: Rs. 100

Coupon: 9.8%

Maturity: 31 Dec. 2014

Current Yield and YTM

Current yield: The annual return on the amount paid for a bond, regardless of its maturity. If you buy a bond at par, the current yield equals its stated interest rate. Thus, the

current yield on a par-value bond paying 6% is 6%.

However, if the market price of the bond is more or less than par, the current yield will be different. For example, if you buy a Rs. 1,000 bond with a 6% stated interest rate at Rs. 900,

your current yield would be 6.67% (Rs. 1,000 x .06/Rs.900).

Yield to maturity: The total return you will receive if you hold a bond until maturity. It also enables you to compare bonds with different maturities and coupons.

YTM includes all your interest plus any capital gain you will realize (if you purchase the bond below par) or minus any capital loss you will suffer (if you purchase the bond above par).

Bonds vs. Debentures: Subtle Differences

Security:

Bonds more secure than debentures. As a debenture holder, you provide unsecured loan to the company.

It carries a higher rate of interest as the company does not give any collateral to you for your money.

For this reason bond holders receive a lower rate of interest but are more secure.

Priority claims:

If there is any bankruptcy, bondholders are paid first and the liability towards debenture holders is less.

Periodical payments:

Debenture holders compulsorily get periodical interest on their money and upon completion of the term they get their principal amount back.

No compulsory periodical payments for bond holders. Rather, they get principal plus interest accrued upon the completion of the term.

In a nutshell

Bonds are more secure than debentures, but the rate of interest is lower.

Debentures are unsecured loans but carries a higher rate of interest.

In bankruptcy, bondholders are paid first, but liability towards debenture holders is less.

Debenture holders get periodical interest.

Bond holders receive accrued payment upon completion of the term.

Bonds are more secure as they are mostly issued by government firms.

Debt or Equity?

Debt:

Tax advantages

Easier availability

Low cost

Equity:

High risk capital

Changed perception of shareholders

Not so easy to raise

Sources of Financing for Corporates: 2001-11

Govt. and Corporate Bonds as % of GDP (March 2013)

Trades in Corporate Bonds

0

500

1000

1500

2000

2500

3000

3500

4000

4500

Traded Value (Rs. Crore)

Traded Value (Rs. Crore)

Trades in RDM

0

50

100

150

200

250

300

350

2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15

Traded Value (Rs Lakh)

Traded Value (Rs Lakh)

Trades in WDM

0.00

2,00,000.00

4,00,000.00

6,00,000.00

8,00,000.00

10,00,000.00

12,00,000.00

14,00,000.00

Net Traded Values Rs Cr

Net Traded Values Rs Cr