Recently, Aegis Logistics announced the issue of bonus shares to existing shareholders. It will issue two additional shares for every three existing shares. These so called bonus shares will be paid from reserves it has accumulated over a period of time. Before you read this post, I suggest you read my earlier post about what really is a Bonus Shares.

Aegis has accumulated a reserves of Rs 167 crore in last few years against equity capital of only Rs 18.77 crore. These reserves are nothing but accumulated profits. The company will issue additional 12.5 million shares and increase capitalization by additional Rs. 12.54 crore. The new capital base for Aegis is likely to be Rs 31.31 crore [18.77 + 12.54]. In this announcement, there is no indication or even a hint on why the company decided to issue bonus shares. It is up to financial media and investors to figure out.

I have mentioned on many occasions, when you practice buy-and-hold philosophy, you need to put these types of events under the lens. In reality, buy-and-hold means, one should continue to hold the shares as long as it meets your portfolio objectives. And also it continues to meet your expectations in future. Earlier I review a similar event driven situation of ABB buyout offer. Similarly, I should evaluate if it makes sense for me to continue holding shares of Aegis.

Benefits to Aegis and its Business

From the viewpoint of balance sheet (or financial statements), the issues of bonus shares does not affect the total capital structure of the company. In addition, it does not affect the valuation of the company. All the company did was capitalized a portion of shareholder equity which was represented by reserves. It took an XX amount from reserves, and transferred to capital equity. The end sum still remains the same. It was merely a book entry. So what does it do for the company?

• Conserves cash within the company: Issue of bonus shares does not involve outflow of cash. If it were to return cash to shareholders in the form of dividends, then cash would go out of the company. Plus, it saves dividend tax payable to the government.

• Increases capital base: Higher paid up capital base increases the credit standing among industrial lenders and financial institutions. This increases the borrowing capacity and credibility. Let us take an example. I own a house which is fully paid. I have 100% ownership. The paid up value is 100. Now, I want to buy another house. It is likely that I have higher probability to get lower interest rate, or lower down payment, or lower fees. I have an asset base to show my capability to repay or credibility that I will not run it to ground. Instead, if I have only 40% ownership. In this case, I do not have leverage to negotiate further loans to my benefit. The lender will have upper hand.

• Retention of management control: The bonus shares are issued in proportion to current holdings. Therefore, there is no dilution of the promoter holdings or majority shareholders.

• Other Intangibles: Perception driven issues. If Aegis keeps accumulating higher reserves, it puts pressure on management to share it with all three stake holders. Shareholders asking for more dividends, employees asking for higher pay packets, and customers asking for reduced rates. (a) Depending upon the cumulative number of bonus shares, in almost all scenarios, it is likely to increase total number of shares. This reduces EPS. (b) It most cases, it is likely to reduce per share dividends. It alleviates the concern of profiteering by promoter – just a perception, but far from reality. (c) Increase in total share counts also increases liquidity and reduces market share price. Image a company that has only Rs 19 crore paid up capital base, but market cap is Rs 800 crore! (d) lower capital base with the perception of high profitability increases potential competitors. Everybody wants to jump into such a business; and (e) Takeover or buyout risk.

Risk to Aegis and Management

• Issuing bonus shares increased the capital base of Aegis. It will now have to justify this by growing the business more. It will now have to increase its earnings. Otherwise, what’s the point of increasing capital base, if profits are not growing? It is also possible that EPS will likely get reduced.
• Increase number of share counts, makes it challenging to even maintain current level of dividends. In all likelihood, the dividends will get reduced. For an existing shareholder it does not make a difference. For new investors, this creates a mental block.
• Only paid up capital base is entitled to the receive dividends. Surplus and reserves, even though part of total value, is not entitled to receive dividends. So management is taking risk of increase dividend cash outflow.

Benefits to Existing Shareholders

Since bonus shares are issued in proportional to the existing shares, there is no change in percentage ownership by individual shareholders.

• Dividend growth: It is likely that per share dividends will get reduced. However, historically, it has been observed that this reduction is not proportional to increase in share counts. Meaning, overall, existing shareholders will continue to see the growth in dividends.

• Quality of Management: Aegis management could easily use this reserves and surplus to fund its growth (and not give bonus shares). It can say, “managed growth capital from internal sources”. Nobody can find any fault with this! Right?. But what if squanders money? Different ways could be (a) higher employee bonus or options in the name of attracting talent, (b) reducing rates for customers in the name of growth by scale of economies, (c) investing is business that are not its core strength (d) increased one time dividends which benefits promoters more than minority shareholders, and (e) others. In these scenarios, the existing shareholder does not get anything. In case of Aegis, I view issuing bonus shares as management’s willingness to share its bounty with shareholders. It has taken a prudent step by give some portion in the form of equity. By doing this, it is giving a message that long term shareholders will likely get more returns in future. Increase dividends, increase share capital appreciation, increased value of business.

• Short term market price volatility: In short term, it is highly likely that price volatility will keep the price higher (relative to what a proportional change in value should be). The perception that it is good, bumps up short term market price. Current shareholder who are looking for exits can profit from this event. So in reality, company did give back returns to its shareholders. Long term it is likely to return back to lower levels.

Putting all of the above in context for Aegis, it sits very well with my objectives of (1) share holder returns in present and positioning for potentially higher returns in future; and (2) effective use of capital for future growth.

Summary is….

When I first bought shares of Aegis Logistics, I did not expect that capital appreciation will happen so fast. Being a small cap with low capital base, I did not anticipate that its market price will increase at such a pace. In my view, the current market price is too high to sustain for long time. The current market price demonstrates the euphoria of bonus shares and has already priced the future growth. This future growth still does not exist. In this context, I decided to withdraw some capital. Why sell only few and why not sell all?

I still believe Aegis is good company and well positioned for future growth. But then one question that I always keep asking, is there an opportunity for me to maximize my returns? Had Aegis shares remained sub 350, I would have done nothing. I would have continued to hold. At that point, it would probably not make sense to withdraw capital. It would have reduced future potential returns (dividends + capital appreciation). There is always a cross over point (I don’t know where). And I would certainly think that at 450+ that crossover has been reached for Aegis. I ended up selling enough number shares to get back my original capital plus 16% growth.

Capital allocation for maximizing returns is something that is not learnt easily. It is very difficult to understand because it is built on future expectations. We all know how true are future expectations in such models! Was partial selling a right thing to do? Will this maximize my returns? I don’t know, but it does increase the likelihood.