This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at firstname.lastname@example.org
On Thursday, NTPC announced March 23rd as the record date for its debenture issue. NTPC will be issuing these debentures to all its shareholders in the ratio of 1:1, which means a shareholder will get one debenture of face value Rs. 12.50 for every one equity share of Rs. 10 each held in the company on the record date. The share price of the company was up 6% in Thursday’s trading session before finally getting closed 3.87% higher at Rs. 159.70.
The company announced its plans to issue such debentures last year on December 23rd. After the shareholders’ approval to issue these bonus debentures, the ministry of corporate affairs (MCA) on Wednesday approved NTPC’s plan to reward its shareholders by issuing these bonus debentures.
Features of NTPC’s Debentures
Coupon Rate – Though its coupon rate has not been disclosed as yet, it will be 50 basis points or 0.50% higher than the average 10-year government security (G-Sec) rate. e.g. If the average G-Sec rate is 7.7%, the debenture holder will get 8.2% interest each year for the next 10 years.
Maturity Period – The debentures will be issued for a duration of 10 years, but will be redeemed at the end of 8th, 9th and 10th year in the ratio of 20% (or Rs. 2.50 per debenture), 40% (or Rs. 5 per debenture) and 40% (or Rs. 5 per debenture) respectively.
Nature of Debentures – These debentures will be secured, non-cumulative, non-convertible, redeemable and taxable as per the tax slab of the investor.
Listing – The debentures will be listed on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) to provide flexibility to its investors to monetize their holding at any point of time during its duration of 10 years.
Benefits of Issuing Bonus Debentures to Shareholders
Why NTPC is issuing these debentures and not paying dividend or issuing bonus shares instead? I think there are multiple reasons for that. Here are some of those reasons:
To Avoid Dividend Distribution Tax – Paying dividend attracts paying dividend distribution tax (DDT) to the government, whereas issuing debentures does not attract any such tax to the issuer. So, I think in order to avoid paying DDT, NTPC is issuing these debentures. I wonder why all listed companies don’t issue such debentures to avoid DDT.
Update: The company will be required to pay the dividend distribution tax (DDT) as the issuance of debentures will constitute “deemed dividend” as defined in section 2(22)(b) of the Income Tax Act.
No Immediate Cash Outflow – NTPC will be issuing these debentures out of its free cash reserves. But, it does not result in an immediate cash outflow for the company. This issuance will reduce NTPC’s cash reserves and an equivalent amount of liability will get created on the liability side of its balance sheet without affecting its cash balance on the assets side.
Cheaper Mode of Loan – NTPC will be issuing these debentures at an approximate rate of 8.2%, which is still below the average rate at which the company borrows money from the capital markets. As the 10-year G-Sec itself is yielding 7.72%, I think 8.2% is still quite cheaper for NTPC.
Interest Amount as an Expense – NTPC will be paying annual interest on these debentures, which the company will show as an expense in its income statements. This way the company will show a lower profit and thereby its tax outgo will also reduce.
Investor Loyalty – An investor, who gets such add-on securities issued by a company without any additional investment, would hold on to its shares for a longer tenure in the hope of more such issuances. So, this way NTPC will be able to attract more equity investors.
Investor Benefit – Such debentures are good for the shareholders as it is very difficult for them to have a direct exposure to such high grade papers from corporate like NTPC. Last year, NTPC issued tax-free bonds at 8.93% rate of interest. The issue received a bumper response as it got oversubscribed on the first day itself.
Should You Buy NTPC’s Shares Now?
So, should you, as an investor, buy shares of NTPC in the hopes of getting these debentures and try to make a quick profit? The answer is Yes, as well as No.
Yes, for those investors who want to hold on to the shares of NTPC for at least one year, this issuance of debentures is of great value. Without spending a single rupee, the investor will be getting these debentures and also the interest income every year.
No, for those investors who want to make a super quick profit thinking that the equity market is inefficient and there is a scope of arbitrage here. The stock has already run up by Rs. 10-15 in the anticipation of this issuance of debentures and I think it should fall by at least Rs. 10 in a day or two before its Record Date of March 23.
Moreover, as the company will be required to pay dividend distribution tax (DDT) on the total amount it will be using from its free cash reserves for issuing these debentures, it seems that there is no real benefit for the investors. In fact, this way the company is getting used by the government to fund its fiscal deficit gap.
So, only if you believe that NTPC is a good company fundamentally, there is a value in its share price and also want to hold on to its shares for more than one year, then you should buy its shares to get these debentures allotted. Otherwise, avoid buying it now.