Bonus Debenture - An Indian Experience


By

Dr. Meda Srinivasa Rao
Professor
Mrs. E.Mamatha
Asst.Professor
Sree Vidyanikethan Institute of Management
Tirupati-517102, Andhra Pradesh
 


Introduction:

India has undergone a paradigm shift owing to its competitive stand in the world. As per "Economic Survey 2014-2015" GDP growth slowed down to decade's low of 4.5% in 2012-13. It picked up marginally to 4.7% in 20123-14 and it is likely to grow in the range of 5.4 to 5.9 per cent in 2014-15. The new government creates a proactive environment by initiating faster clearance, reforms on land acquisition, allow to FDI in insurance and defence, hassle free tax environment, boasts of a stable annual growth rate, rising foreign exchange reserves and booming capital markets among others are looking for a very optimistic future to India. As rightly mentioned Jayanth Sinha, Minister of State for Finance said that , "Indian economy has potential to become a USD 4-5 trillion economy in the next 10-12 years for awaking foreign Investors. As per (NCAER) National Council of Applied Economic Research, India has the second fastest growing services sector with its CAGR (Compound Annual Growth Rate) at 9.00% just below china 10.9%.

Financial services are fundamental to economic growth and development. Banking, savings and investment, insurance, and debt and equity financing help private citizens save money, guard against uncertainty, and build credit, while enabling businesses to start up, expand, increase efficiency, and compete in local and international markets. As stated by Alfred Rappaport, the ultimate objective of any business organization is to maximize share holders value. To achieve the desired objective firm's need to maximize their long term profits which means increase Revenue and decrease cost. To achieve the basic objective of minimization of cost, one of the important element is decrease financial charges. To decrease the cost of capital organizations selected different sources of capital; These may be Traditional and modern in nature. Modern financial instruments like STRIPS, TIPS, ZERO COUPOUN BONDS, and FCCB and others.  The corporate India initiates to avail new avenues to extract opportunity through a new financial instrument namely the Bonus Debenture, It has been emerged in 2001 by FMCG giant HLL and laid a foundation to this innovative financial instrument, followed by some companies in Indian capital market.

With this backdrop, the present study concentrates with the following objectives:

* To understand brief history of Bonus Debentures in India.
* To know the different companies who issue Bonus Debentures and their brief background.
* To highlight impact of issue of Bonus Debentures on financials of select companies.
* To draw suitable inferences and conclusions.

Conceptual Clarification about Bonus Debentures:

Every company wants to please the investors. One of the ways to make them happy is to distribute deemed dividends in the form innovative financial instruments like bonus debentures.

"Bonus Debenture is a written instrument acknowledging a debt under the common seal of the company given to equity share holders of the company for free of cost, having Interest rate, maturity period, and redeemed after the maturity period and the Interest payable to the equity share holders in the form of "Deemed Dividends" , tax deductable in the perspective of Share holders and Issuing Company".

* Cash rich companies who issue debentures to the shareholders by capitalising the reserves and thus do not charge anything from the shareholders. These debentures are free of cost.

* The companies capitalise the reserves to issue debentures that are redeemed after a specified period. Interest on these debentures is paid during this period notes issued by corporate out of their general cash reserves to their shareholders for free.

* Bonus debenture has a face value, an interest rate and maturity period. Company redeems bonus debenture when the maturity period becomes due.

* The reserves that the company distributes belong to the shareholders. Company could have done it in the form of cash dividend instead of issuing bonus debentures.

* A very lucrative proposition for the shareholders is that, the shareholders get interest in all the years till the debentures are mature.

* Company also benefits by getting the advantage of tax as the interest on debenture is tax deductible. Bonus debentures do not dilute the share value like bonus shares and the company can take the advantage of leverage.

* Company defers cash outflow till the time it pays interest or redeems the debentures. For tax purposes, the allotment of bonus debentures would be treated as dividend.

Review of Literature:

According to, CA. Puja Aggarwal and Dr. Barnali Chaklader, in their article titled "The Bonus debentures an innovative financial Instrument" explained about Bonus Debentures, Deemed Dividends payments and tax structure of some selected companies. Similar Authors was written a case study on issue of Bonus Debentures in Britannia Industries Limited and its impact on share prices.

The Hindu Business line published an article on Bonus Debentures written by Mr.V.Nalinikanth, explained detailed background and the reasons for preferring Bonus Debentures by selected companies.

Circumstances favour to issue of Bonus Debentures:

1. Cash rich Companies occasionally issue Bonus Debentures to satisfy their equity share holders.

2. The companies want to avoid cash outflow

3. The companies want to Re- Invest their profits in the form of Retained Earnings will issue Bonus Debentures.

4. Companies want to get tax advantage from the dividends paid to equity share holders.

Benefits to issuing company:

* The issue of these debentures allows the company to keep its cash with itself until its time for redemption. The cash can be ploughed back into the business or used for a potential acquisition, Expansion and Restructuring

* This exercise will help the company improve its return on equity and economic value added.

* As there is no immediate cash outflow, It would still be able to utilize its excess cash over the next 2-3 years.

* This could also help the company get exemption on tax on interest payable on the debentures.

* This may also be one way of offering "bonus'' without increasing the equity capital.

* The scheme will also enhance the efficiency of the balance sheet in the context of excess cash carried for several years

* In effect, instead of giving vague signals that the company may pay some special dividend in future years, Interest rate, by issuing bonus debentures.

* The biggest advantage of the proposal is that it achieves two objectives in one stroke. Not only is the company able to enhance shareholder value, but is also able to retain the funds to meet any interim investment needs.

Benefits to the Investors community:

* For the investors, the present move by the company will definitely send a strong signal about future benefits they are going to derive in terms of tax-free receipt of redemption amounts and also the yearly interest on debentures. Since the debentures would be considered deemed dividend, the investment cost of the debentures in the hands of the shareholders would be its face value.

* Like bonus shares, these debentures are issued for free. Similar to other debentures, the bonus debentures carry a face value and companies pay an interest rate to its holders at fixed intervals and they are redeemed after a fixed period.

* Due to its design, a bonus debenture ensures repayment of surplus cash to shareholders over the 3-5 year period. Due to the annual interest component, shareholders also get an assured fixed income every year irrespective of the behaviour of the stock market, which is a positive move if markets suddenly were to turn limp.

* When the debentures are either sold or redeemed, the sale price or the redemption amount received by the debenture holder will not be taxable to the extent of the capital value of the debentures already taxed as dividend in the year of the issue of the bonus debentures. Only the additional appreciation will be taxed as capital gains.

Why it is not so popular in India:

As we have seen above that since 2001, only some companies have issued bonus debentures. In spite of the fact that bonus debentures have a number of advantages, it is still not a widely used financial instrument by the companies. There are strong reasons why bonus debenture is not a popular financial instrument amongst companies.

The bonus debenture issue is subject to approval by the board of directors, the proposal will also have to be approved by the shareholders, High Court and the Reserve Bank of India.

Unlike a bonus issue, there is no increase in the company's equity capital. The analyst, however, added that a bonus debenture would impact the company's future earnings since it had to pay interest on them

Bonus debentures vs. other financial instruments

By issuing bonus shares, the equity of the company does not get altered, but when the bonus debentures are issued, it results in decrease in equity and a corresponding increase in debt. This results in high leverage and thus increases the risk perception of the company. No company would like to witness these kinds of changes in the balance sheet structure. Secondly, bonus shares do not involve cash outlay in any form. But bonus debentures involve three major cash outflows,that are, Dividend distribution tax, cash outflow in terms of interest and outflows at the time of redemption of bonus debentures.

Dividend involves immediate cash receipt for the shareholders but bonus debentures does not involve immediate cash receipt for the shareholders because a part of it is given as interest and a part of it is given at the time of redemption.

Period of the study: From 2001 to 2014

Companies issue Bonus debentures a Glance:

1. Hindustan Unilever Ltd, 2. AstraZeneca Pharma India Ltd  3. Britannia Industries ltd, 4.Dr.Reddy Labs,
5. Coromandel international

A study of Bonus Debentures and its impact on financials of selected companies

The study concentrates on selected companies, who issues Bonus Debentures in India, It also emphasis on Bonus Debentures and its impact on financials of selected companies. To measure the impact on financials of selected ratios are considered in the study. The study highlights selected ratios and it states Pre-issue of Bonus debentures and Post- issue of Bonus debentures. The study also concentrates on draw suitable inferences based on selected ratios of pre and post issue of Bonus Debentures of sample companies.

The table 1 to table 7 explains about impact of different companies' financials pre and Post issue of debentures and table 7 explains about comparative financials of respective companies

Hindustan Unilever Ltd:

The Dividend per share due to bonus debenture has significantly affected, this clearly demonstrated in table 1. Pre issue of bonus debenture Dividend per Share (DPS) was limited to Rs 5, the same in post issue increases to 5.5. Investors who prefer to invest with an expectation of higher regular dividend per share would likely some positive impact of their expectation.Impact on free reserves per share and net profit margin were an impressive upward move, this may due to high profitability and cash reserves. This may be a positive signal to existing share holders, even issue of bonus debenture the trend is on upward move.Return on capital employed and return on networth both were demonstrated that pre issue of bonus debenture is an impressive ratio than post issue period, this may caused to additional investment through plough back profits may not impressive.Debt equity ratio was an diminishing mood when compared to pre issued bonus debenture period, this indicates additional debt through bonus debenture or negligible impact on financial leverage of the firm. It implies that retirement of debt capital more than value of Bonus debenture injected in the firm.Interest coverage ratio facilitates to understand how best the firm full fill the debt burden, here it indicates no negative signal due to bonus debenture on interest coverage ratio, it implies that whatever additional commitment towards interest through bonus debenture not impact on interest coverage ration of the firm.Earnings Per Share, book value indicates that the impressive upward move may not turned back by bonus debenture issued.There are wide fluctuations in P/E ratio, this may caused due to investor's perception about the outcome of issuing Debentures.

2. Astra Zeneca Pharma India Ltd:Dividend per share significantly impact on post issue of bonus debenture, This clearly demonstrated that portion of Earnings dividend towards meeting interest obligation may resulted to decrease dividend per share.Free reserves per share data shows  that pre issue excesses cash reserves , indicates that pre issue and during the issue an impressive figure than post issue, it demonstrated that some negative impact on profitability.Return on Capital Employed and Return on Networth figures indicates that post issue of Bonus debentures are in adverse effect on rate of return, this may due to rate of return received through additional investment may not equal or it may be less than pre issue return on investment.P/E ratio indicates that the investors faith on the firm about potentiality of future prospects, it reveals in the data, in the post issue of bonus debentures investors are not very encouraging to purchase the stock lead to price fluctuations.

3. Britannia Industries ltd

The data clearly demonstrated the impact on issue of bonus debentures of the companies financials especially dividend per share, free reserves per share, net profit margin, return on capital employed indicates that there was a pessimistic mood on the values, which explain how negatively influenced on financials of the firms. The reasons are many but one of the reasons may be bonus debentures.Return on net worth was another direction it explains that proportion of change in networth is less than proportion of change in net profit after the tax. This clearly stated that return on additional investment through issue of debentures are grater than additional commitment by bonus debentures, it was a good sign for potentiality of additional investment.Debt equity ratio indicates that additional financial leverage as a result of bonus debentures; it implies that additional commitments in terms of interest burden, it enhances credit risk of the firm.PE ratio indicates the stability of confidence levels of investment community towards the form.

4. Dr. Reddy Laboratories Ltd:

Dividend per share, free reserves per share data clearly explains, how cash rich of the firm: even the firm issue bonus debentures that may not any impact on dividend per share and free reserves per share.Net profit margin indicates the volatility of profit margins, this may caused by several other factors other than bonus debentures.Return on capital employed and earnings per share were in positive mood when compared pre issue figures it revels the potentiality of new investments, It was also demonstrated through PE ratio, how opmistic the investment community about issue of debentures.

5. Coromandal International Ltd:

Figures of dividend per share, free reserves per share revels the cash richness of the firm.Net profit margin is likely decreases when compared to pre issued period. Return on capital employed, return on networth, interest coverage ratio or in downward move, the debt equity ratio is in upward move, earnings per share was little shrinking when compared to per issue of bonus debentures. There is no significant impact on PE ratio.

Comparative study of different companies and their financials due to issue of Bonus debentures:

Conclusion:

Impact on issue of Bonus Debentures in Indian Incorporation is not similar in all cases. Companies which issue these securities are financially very strong and they are very much investor centric companies. So many cases the outcomes of issue of Bonus debentures are positive in India.There is a very need of further research and the topic by including opportunity cost of loss of dividends by Investor community and the reward of receiving as a interest and Principal amount of Bonus debenture by including time value money, then we can able to justify a further of this topic.There is common observation about Dividend per share pre and post issue of debentures in the study. Britannia's DPS was abnormally changed after issue of Bonus Debentures. AstraZeneca's DPS was affected negatively by nearly 33% after issue of Bonus Debentures. There was a slight change in HUL's DPS; hence there are no similarities of changes in dividend per share due to issue of bonus debentures.Free reserves per share also not show any specific trend between the selected companies due to issue of bonus debentures. Net profit margin changes due to issue of bonus debentures are in positive move due to issue of debentures in the case of HUL and Coromandel International, where as other three companies net profit margin is in negative direction. Hence there is no specific outcome from this study about net profit margin and it changes due to bonus debentures.Return on capital employed of HUL and Britannia was negatively effected, Dr.Reddy Labs and Coramandel Internationals ROCE where positively effected this may be caused by potential return on additional investment of respective company by employing funds through of bonus debentures. Return on networth of all selected companies are not influenced in similar fashion, it implies that there is no commonalities on to change in return on networth. Debt equity ratio in normal case after bonus debentures must be in upward move  here the study indicate mixed trend, this implies that some selected companies redeemed their borrowed funds during this period. Interest coverage ratio of selected companies in this study could not present any specific trend. Earnings per share of HUL, AstraZeneca and Britannia was in negative move due to issue of bonus debentures, whereas, Dr.Reddy Labs and Corramandal International is in positive direction. Except Dr.Reddy Labs all other companies' book value move in positive direction due to issue of bonus debentures. Price earnings ratio indicates investor's confidence on respective company in a specific period. It is moving upward means the recent developments in the company creates further confidence on investment community, hence their prefer to pay high price to invest in the respective stock. The study reveals that Britannia and Reddy Labs move on issue of debenture support to increase confidence levels of investor community, where as other two companies HUL and AstraZeneca action may negatively affected investors confidence. In the case of Coramandel International investors response is negligible.

References:

1. "Bonus Debenture as an Innovative Financial Instrument" in Chartered Accountants Journal written by CA. Puja Aggarwal and Dr. Barnali Chaklader.

2. "De claration of Bonus Debenture: A Case of Britannia Industries Limited" in vol II Jounal of case     Research, written by CA. Puja Aggarwal and Dr. Barnali Chaklader.

3. "The Role of financial services sector in expanding Economic opportunity" by Christopher N.Sulthan and Beth Jenkins.

4. "The role of Financial services in Economic Development: A study in Developing Countries", in Excel International Journal of Multi disciplinary Management Studies,  Vol II by Dr. Suresh Vadde.

5. WWW.Indian Business line.nic.in / Economy

6. WWW.Excellup.com

7. www.Moneycontrol.com

8. www. india infoline.com

9. www.Bse.com

10. WWW.Nse.com

11. WWW.Britannia.co.in

12. WWW.Hul.co.in

13. WWW.Reddy labs.co.in

14. WWW.Coramendal Internationl.co.in

15. WWW.Astrazeneca.co.in

16. www.karvy.com/articles/hll13102001.htm

17. "Understanding Bonus Debentures" by V.Nalini kanth in The Hindu Business Line.

18. "Economic survey 2011-2012" conducted by PMEAC.

Annexures

Table 1: Summary of details of Bonus debentures in India

S.no

Name of the company

Date of Allotment

Maturity period

Redemptio n date

Amount issued (Crores)

Face value each
(Rs)

Ratio to equity

Interest rate
(%)

Share prices on  DOA

10days averages of share prices

Financials used for the study

Before

after

1

HLL

16th Oct,2001

18 months

16th Oct,2004

220

6

1:1

9

174.85

169.98

167.885

2000-2001

2

ASTRAZEN ECA

12th Jan,2008

1 year

11th Jan 2009

625

25

1:1

8

23.36

23.35

21.58

2007-2008

3

BRITTANN IA

22nd mar,2010

3years

22nd Mar,2013

407

170

1:10

8.25

16.34

16.50

16.44

2009-2010

4

REDDY LABS

24th Mar,2011

3years

24th Mar,2014

520

5

6:1

9.25

1,542.10

1552.89

1614.99

2010-2011

5.

CORAMAN DAL INTERNAT IONAL

23rd,July, 2012

4years

23rd July,2014

495

15

1:1

9

242.25

257.315

222.415

2011-12


Table 2. Hindustan unilever Limited

S.no

Ratios

pre- issue of bonus debentures(2000)

Bonus debentures issue during the year (2001)

Post- issue of bonus debentures(2002)

1

Dividend per share

5.00

3.50

   5.50

2

Free reserves per share

10.21

12.72

15.52

3

Net profit margin(%)

11.96

14.01

17.13

4

ROCE(%)

66.70

61.50

58.05

5

Return on Net worth(%)

52.67

50.64

48.38

6

Debt Equity Ratio(%)

0.04

0.03

0.02

7

Interest coverage Ratio(%)

131.87

248.31

234.94

8

Earnings per share

5.95

7.00

8.04

9

Book value

11.30

13.82

16.62

10

PE Ratio

4.43

6.64

1.91


Table 3. ASTRA ZENECA PHARMACEUTICALS LTD

S.no

Ratios

Pre- issue of bonus debentures(2007)

Bonus debentures issue During the year (2008)

Post- issue of bonus debentures(2009)

1

Dividend per share

15.00

15.00

10.00

2

Free reserves per share

61.72

31.96

55.81

3

Net profit margin(%)

19.68

20.11

14.30

4

ROCE(%)

Not Available

65.98

62.02

5

Return on Networth(%)

Not Available

63.56

39.86

6

Debt Equity Ratio(%)

Not Available

0.54

Not Available

7

Interest coverage Ratio(%)

Not Available

24.24

654.33

8

Earnings per share

24.58

29.53

23.05

9

Book value

63.72

46.46

57.81

10

PE Ratio

2.18

1.28

1.53


Table 4. BRITTANNIA INDUSTRIES LTD

S.no

Ratios

Pre- issue of bonus debentures(2009)

Bonus debentures issue during the year (2010)

Post- issue of bonus debentures(2011)

1

Dividend per share

40.00

25.00

6.50

2

Free reserves per share

322.15

154.03

35.41

3

Net profit margin(%)

5.75

3.38

3.42

4

ROCE(%)

25.29

24.67

24.06

5

Return on Net worth(%)

22.60

29.40

32.19

6

Debt Equity Ratio(%)

0.03

1.08

0.96

7

Interest coverage Ratio(%)

18.38

48.28

5.63

8

Earnings per share

75.51

48.77

12.16

9

Book value

345.14

165.86

37.78

10

PE Ratio

18.52

32.80

30.60


Table 5. Dr. REDDY LABORATORIES LTD

S.no

Ratios

Pre- issue of bonus debentures (2010)

Bonus debentures issue during the year (2011)

Post- issue of bonus debentures (2012)

1

Dividend per share

11.25

11.25

13.75

2

Free reserves per share

304.97

341.13

380.00

3

Net profit margin(%)

18.48

16.84

13.51

4

ROCE(%)

15.87

14.20

19.22

5

Return on Net worth(%)

14.30

14.84

13.58

6

Debt Equity Ratio(%)

1.10

0.24

0.23

7

Interest coverage Ratio(%)

250.76

220.90

25.22

8

Earnings per share

50.11

52.78

53.81

9

Book value

350.30

355.69

396.19

10

PE Ratio

25.56

31.22

32.74


Table 6. CORAMANDEL INTERNATIONAL LTD

S.no

Ratios

Bonus debentures issue year (2012)

Pre- issue of bonus debentures(2011)

1

Dividend per share

7.00

7.00

2

Free reserves per share

77.94

61.57

3

Net profit margin(%)

7.03

9.01

4

ROCE(%)

26.37

32.06

5

Return on Net worth(%)

29.23

36.47

6

Debt Equity Ratio(%)

1.02

0.72

7

Interest coverage Ratio(%)

10.84

12.47

8

Earnings per share

24.53

24.64

9

Book value

83.92

67.56

10

PE Ratio

11.62

11.60


Table 7.Comparitative analysis of financials of selected companies

Ratios

HUL

AstraZeneca

Britannia

Dr. Reddy

Coramandel

Pre

Post

Pre

Post

Pre

Post

Pre

Post

Present 2011

Post

DPS

5.00

5.50

15

10

40

6.50

11.25

13.75

7

7

FRPS

10.21

15.52

61.72

55.81

322.15

35.41

304.97

380

77.94

61.57

NPM

11.96

17.13

19.68

14.30

5.75

3.42

18.48

13.51

7.03

9.01

ROCE

66.70

58.05

NA

62.02

25.29

24.06

15.87

19.22

26.37

32.06

RONW

52.67

48.38

NA

39.86

22.60

32.19

14.30

13.58

29.23

36.47

D/E

0.04

0.02

NA

NA

0.03

0.96

0.10

0.023

1.02

0.72

ICR

131.87

234.94

NA

654.33

18.38

5.63

250.76

25.22

10.84

12.47

EPS

24.58

23.05

24.58

23.05

75.51

12.16

50.11

53.81

24.53

24.64

BV

63.72

57.81

63.72

57.81

345.14

37.78

350.30

396.19

83.92

67.56

PE

2.18

1.53

2.18

1.53

18.52

30.60

25.56

32.74

11.62

11.60


 


Dr. Meda Srinivasa Rao
Professor
Mrs. E.Mamatha
Asst.Professor
Sree Vidyanikethan Institute of Management
Tirupati-517102, Andhra Pradesh
 

Source: E-mail March 24, 2015

          

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