What is the right size?

Friday, 15 October 2010 01:50 -     - {{hitsCtrl.values.hits}}

By Lasintha Ferdinando

The order of the day at the Colombo bourse has been share splits and rights issue frenzy to capitalise on the excess liquidity in the market place and for companies to reposition their finances. It is a good time to take a relook at what the right size of a share value is.

There was no guidance or ruling on share splits in the SEC of Sri Lanka Act No. 36 of 1987 as amended by Act No. 26 of 1991 and Act No. 18 of 2003. In reality there are no additional funds raised by the company and it may be that the SEC is neutral where share splits are concerned. Hence, let us have a simplified understanding of why companies go for share splits:

1 To broad base the share holding

2 Increased liquidity and affordability

3 Majority shareholders could mitigate the risk of another major shareholder acquiring higher percentage shares

4 Decrease the price volatility

5 Decrease the response speed to market information

6 More of sentiments driven investor participation

7 Due to increased demand (affordability factor) value of share holding goes up.

8 Psychological comfort of owning higher number of shares

9 Companies’ portrait that they are well poised to take future challenges.

Whilst the above factors favour all investors alike, there is a great danger in splitting shares to such low levels. For example, suppose a major shareholder wants to cross the mandatory offer threshold and own the whole company, they will declare a higher number of share splits and dilute the share holding further.

The greater demand and supply created by this will sustain the price stability for the short to medium term. If the share price is not moved dramatically over the last one year due to highly competitive nature, the major shareholder who has a vested interest in the split could increase the share holding to cross the mandatory offer and offer the highest last traded price within the stipulated period.

This price offered is not necessarily being the fair value of the stock in question. The next step that will be taken is to de-list the company, so that the majority shareholder who acquired the company can have the full control at the expense of rest of the shareholders.

Hence, are the agents of the company performing their rightful duties? It is worthy to carry out a research into identifying the right size of the stock based on the companies’ mode of operandi?

From a marketing point of view a lower price could be perceived to be of cheap quality. Will a stock also be perceived in the same manner and the company image? It is evident that most of the blue chip companies are maintaining a healthy price level in the market place, except for those who have split the share to an unprecedented number.

In the name of fairness, details of this company/ies will not be shared. However, the characteristics of going for a share split and the danger mentioned above is all written around this/those particular share/s.

Another danger comes just after a share split, which declares a rights issue. Of course it is a good opportunity for the company to raise finance and even if the issue is not fully subscribed, the majority shareholders will ever so willing grab what is not filled. This means the majority shareholders acquire a higher percentage of shares at a discounted price.

As a primary responsibility of maintaining systemic risk of the stock market, it is high time that SEC make ground rules/directive in this regard of getting the right value of a share. And also companies should be mindful of the public perception of the cheap shares and getting their value right before a split.

(Lasintha Ferdinando holds a Masters from UOC, Associate Member of Institute of Bankers and passed finalist CIMA, UK. He counts over 20 years experience in the financial and banking sector.)