NTPC Limited has informed the Exchange that the Board of Directors of the Company, in its meeting held on December 23, 2014, has approved a Scheme of Arrangement for the issuance of secured, non-cumulative, non-convertible, redeemable, taxable, fully paid-up bonus debentures of face value Rs. 12.50 against each equity shares of Rs. 10.00 (face value) by utilizing its free reserves pursuant to provisions of section 391 to 394 of the Companies Act, 1956 and other applicable provisions of the Companies Act, 2013, subject to requisite approvals under applicable laws.

If we unfold the pages of history of Corporate World, we would find that Companies have been declaring several kinds of corporate action, since beginning, with the objective of returning profits to the share holders. Over the years of operation, most well managed and growing companies build significant accumulated profits and reserves, which is either employed as working capital or capacity expansion; or it could be utilized to some extent to reward the share holders mostly in four ways – Bonus Shares, Special Dividend, Buy Back and Bonus Debentures. First three corporate actions are popular but the concept of Bonus Debentures in our country has not gained much popularity till date, although this is one corporate action which is beneficial to the company as well. Earlier, only few companies have opted for this route to reward share holders by utilizing accumulated profits, the pioneer one was Dr Reddys (2010), Coromandel International (2011) and Blue Dart (2013) – only 7 companies so far have declared the issue of Bonus Debenture. NTPC is the 8^th and the latest addition in this list. The principal reason for not gaining popularity is that Bonus Debentures is not dealt by any specific section of the Companies Act and it is issued by way of Scheme of Arrangement which requires the approval of respective High Courts, besides Share holders and other appropriate authorities. Consequently, the whole process is little lengthy and cumbersome.

Structure of Bonus Debentures

Now let us look at the structure of this innovative Corporate Action. Bonus Debentures are Debentures issued by the Company free of cost to the shareholders, capitalizing the amount of Free Reserves, in proportion to their share holding. Debentures carry interest for a certain period of time and thereafter are redeemed. Further, the Debentures generally get listed and may be sold before maturity. So, Bonus Debentures carry face value, interest and redemption option along with listing benefits. If we consider few of the past cases, Hindustan Lever issued one bonus debenture of Rs. 6 for every equity share of Re 1. Britannia issued one bonus debenture of Rs. 170 for every equity share of Rs. 10/-. Dr. Reddys issued 6 bonus debentures of Rs. 5/- for every equity share of Rs. 5/- each. So, in terms of return to shareholders, it is really lucrative.

Benefits for the Investors in case of Bonus Debenture

• If you are Bonus Debenture Holder by virtue of holding equity shares, you will get interest on debentures, dividend if any on the equity shares, redemption amount after the maturity period and you can sell it on the Exchange.
• Further, in case of Bonus Debentures, the number of shares remains same and hence the price of the shares does not get diluted.
• Bonus debenture is treated as Deemed Dividend under Income Tax Act and the issuer company pays Dividend Distribution Tax. Since Dividend is tax free in the hands of share holder, hence redemption or sale proceed of the bonus debenture is also tax free for the debenture holders. However, if it is sold in the market at higher rate than its face value, then the difference amount shall be taxable.

Benefits for the Company in case of Bonus Debenture

• Issue of Bonus Debentures is beneficial to the company as well. Annual interest payments are adjusted against company’s profits and hence the company enjoys tax benefits, unlike bonus shares.
• An issue of Bonus Debentures does not dilute the equity capital and, therefore, does not result in substantial reduction of EPS, which happens in case of bonus shares.
• Issue of Bonus Debentures does not result in immediate cash outflow from the company and company can retain cash till the maturity of debentures. It also enhances the strength of Balance Sheet since it carries excess cash balance.
• Since the payment of principal amount is charged to the company’s reserves, the Return on Equity (RoE) gets improved, which could attract significant re-rating of the company.

NTPC Case

PSU Power Major NTPC has approved issue of Bonus Debentures to shareholders in order to utilize the free reserves of the company and reward the shareholders. As on March 2014, NTPC is sitting on a whopping cash balance of Rs. 72,000 crores.

Existing share holders of the company will get bonus debenture on 1:1 basis having face value of Rs. 12.5 amounting to Rs. 10,000 crores. According to the company, the issue of bonus debentures will help the company improve its RoE by Rs. 10,000 crores by shaving it off from the reserves and converting it to debt.

The Bonus Debentures shall be redeemed in three installments – Rs. 2.50 per debenture at the end of 8^th year, Rs. 5 at the end of 9^th year and Rs. 5 at the end of 10^th year.

The major twist in this issue lies at the coupon rate i.e., interest rate. NTPC has declared the interest rate which is market linked, 50 Bps over and above 10 Year G-Sec Yield.

Note: The above article should not be treated as any buy advice for any particular stock.