Why the Reliance bonus goes against the grain

Normally, when a company issues bonus shares, it is a robust signal of optimism. The company is telling its investors: we think our earnings are growing fast enough to service the higher equity base.

However, the Ambanis have always been exceptions to the rule. From the time of Dhirubhai Ambani, they have never believed in gifting shares. This is why the flagship company, Reliance Industries, has always been stingy with bonuses, despite being immensely profitable most of the time.

In fact, the markets take a bonus issue from Reliance as a negative signal, as evidenced by the weak trend in Reliance shares even after the company announced its “Diwali gift”.
Do the markets know a thing or two about Reliance that we don’t?

One suspects that it does. And this is what it could be. As a business philosophy, the Ambanis believe in regularly raising capital. There is a constant search for new money, cheap capital. This was, in fact, Dhirubhai’s original business model — and it continues to this day with his sons. He believed that companies that want to grow must always have lots of cash, and this is why he constantly looked for ways to raise money whether he had a project to fund or not. The cash comes first, the project later.

Throughout the 1980s and 1990s, Reliance invented one reason or the other to raise cash, and not all of it went into projects. First came a series of non-convertible debentures (NCDs) that everyone in the markets knew would finally be converted into shares at huge premiums. When it seemed as if Reliance could not possibly need more cash, Dhirubhai created new companies (Reliance Petrochem, Reliance Polypropylene and Reliance Polyethylene — popularly called the ilu-pilu twins after a popular song on the 1990s). 

The idea was obviously to rake in the cash before merging them back into Reliance.
Dhirubhai’s success flows from the capital raising machine he created. As other commentators have noted before, Reliance is really two companies in one: a giant money churning machine, and a humdrum, vertically integrated oil-to-textiles business. The second is incidental to the Reliance success.

The formula could have worked in almost any other business had Dhirubhai cared to enter them. It’s just that he happened to start with textiles and began integrating backward into petrochemicals, petroleum and oil exploration when he spotted business opportunities. He would have been even more successful as a banker.

Coming back to the bonus question, Dhirubhai never believed in them since it meant giving away capital rather than raising it. To be sure, he did acquiesce in some bonus issues — most notably in 1997 — under shareholder pressure, but his heart wasn’t in it. His stock reply, when pressed for bonuses at annual general meetings, was that he believed in “mini bonuses” in the form of rights and other issues. He preferred to let shareholders invest in his companies rather than take the money away. He left shareholder rewards to the market.

His two sons have largely followed in his footsteps. This is one reason why Mukesh Ambani created another petroleum company to raise money when all along everyone knew that Reliance Petroleum would be merged back with Reliance at some point of time. His brother Anil Ambani, too, raised money in Reliance Power when he could have done the same through Reliance Energy (now Reliance Infra).

His Reliance Communications is offloading its towers into a new company, again to raise capital. Neither brother believes in bonuses, but Anil was forced to consider one in Reliance Power when the share price tanked soon after it was listed last year.

There is thus good reason to believe that brother Mukesh’s bonus issue last week in Reliance Industries is also a negative signal. To understand why, let’s see what a bonus really is. It is a mere redesignation of capital. Most companies hold shareholders’ funds in two parts — equity capital, which is entitled to dividends, and reserves, which are not. A bonus issue shifts capital from non-dividend earning ownership to dividend-earning, and usually leads to cash outflows. This does nothing for the company itself.

Bonuses are not even tax-efficient. A bonus share has zero purchase value, and hence if you sell them within a year, you have to pay short-term capital gains taxes at your marginal rate.

So why did Mukesh Ambani announce a bonus issue? There are many theories, and I don’t plan to examine them. But the signal is probably negative.