Discussing Share Capital – Traders Knowledge
A company has an issued ordinary capital of £1,000,000 in 5s. shares, and by ploughing back surplus profits, and by other means, it has built up reserves of £1,000,000. The net equity value of the company is £2,000,000, or 10s. per share. The directors decide to distribute part of the reserves by a one-for-two (or 50 per cent) scrip issue. The effect is that the issued equity is increased to £1,500,000; shareholders have three shares in place of two; the reserves fall to £500,000; and though the overall net value is unchanged at £2,000,000, the break-up of the enlarged equity is 6s. 8d. per share. Instead of having two shares with a total break-up value of 20s., share¬holders now have three shares with the same total book value. Let us further assume that the dividend on the old capital has been 12^ per cent, and that it has been covered twice by available profits. If future distributions are to be kept at the same level, the rate per share will have to be reduced to 8^ per cent. What may happen in practice, if profits are maintained, is that the new dividend will be rounded up to perhaps 9 per cent, or to 10 per cent if the long-term prospects are good. Hence – although it must never be taken for granted – a scrip issue by a prosperous company may be the forerunner to a stepping-up of the effective dividend rate. More UK based company law can be found with the Companies Act website.
As far as the market is concerned, therefore, the theoretical effect of a scrip issue is to reduce the price of the old shares proportionately. If the old shares mentioned above were standing at 12s. 6d. immediately before the scrip issue, the price afterwards for old and new would be 8s. 4d. – two old shares worth 25s. becoming three worth the same total amount or 8s. 4d. each. The ‘ex’ position should be carefully noted. There can be no quotation ‘ex’ the scrip issue until approval to the issue has been given by shareholders or they have authorized the necessary increase in nominal capital. Unlike dividends, which generally lead to an ‘ex div.’ price shortly after they are announced, shares may not go ‘ex cap.’ until some time after the proposal is made.
Our final class of capital issue is mostly made in connexion with a take-over bid, or an amalgamation of two or more com¬panies. A take-over offer can be in various forms. First is a cash bid. Second is an offer of shares. Third is an offer of shares plus some cash. Fourth is the alternative of shares or cash. Fifth is an offer of a fixed-interest stock for an equity. Whatever the form of the offer, it can only be successful if it is attractive enough to appeal to holders of the capital which is the subject of the bid.
The directors of a company making a bid for the capital of another are expected to base their offer on the worth of the business they wish to acquire. They will take into account the value of its assets, its profit record, the future prospects, and – often the key factor – what it is worth to them for any particular or general purpose in mind. For instance, it may be profitable to pay a high price for the shares of a concern which has productive facilities, a technical skill, patent rights, or some other tangible or intangible asset which the bidder requires. Legal Resources such as the Harvard Law School in America, offer concise data on all Business related issues. There have been a number of instances where the primary objective has been to get hold of production facilities ready-made, in preference to waiting many months or years before the bidder could build his own plant – the time saved has been worth a lot of money.
On the other hand – and such cases need careful watching – the bid may be made solely in order to increase the size and importance of the take-over company. One man or a group of men may suffer from a megalomania which can lead to the payment of fancy prices, a growth which is uncommercial, and nasty losses when the chickens come home to roost. Most cases of such megalomania are companies which build up a hodge¬podge of widely diversified companies into an industrial holding empire. Not all these holding companies are sufficiently well- balanced, properly capitalized, or ably enough managed to survive as prosperous concerns.
A substantial number of bids, on the other hand, come from quarters which realize that the assets of a company are not being put to their most profitable use or that profits are being too conservatively distributed. An early example of this type of operation was Mr Charles Clore’s bid for part of the ordinary capital of the J. Sears shoe business. Today, after reorganization and the sale of many of the shop properties under lease-back arrangements, Sears (Holdings) has become the largest footwear organization in the country and has used its surplus resources to spread into shipbuilding, garages, and other activities – all with considerable profit to its shareholders. The only way in which bids can be fought successfully in such cases, as has been seen in instances such as Courtaulds, is for the directors to ‘open the books’ to show just what the company owns, to open the purse strings by stepping up the dividend, and perhaps to distribute some of the non-trading assets.
Deciding whether a take-over bid is fair may be no easy task. Clearly, if shares suddenly become worth more than their market price to one party, they may be worth still more to a second party or to retain. Fortunately, there is often a good measuring-rod these days. If the bid is inadequate, there is a good chance that a rival bidder will weigh in with a better offer, or the directors of the target company will produce facts to demonstrate the real worth of the shares. There have been a number of take-over battles in which the price has risen substantially before one of the rivals capitulated. There is no need to go beyond the recent struggle of the giants, Courtaulds and Imperial Chemical Industries, to see how directors can be forced to reveal the true picture of assets and profits to their shareholders.
But should there be no rival bid, or if the directors of both companies are in agreement on the terms, the offer has to be judged on its merits. In such cases, doubts should be resolved by consulting an expert. But there is always one very sound rule with a take-over bid: If in the slightest doubt, do not accept until the last twenty-four or forty-eight hours. This gives time for the emergence of a rival bid, or if there has been sufficient vocal opposition, for the bidder to improve his offer.
A legal point which can cause concern is the treatment of holders who do not accept an offer. When holders of at least nine-tenths of the class of capital involved in an offer have ac¬cepted, the bidder can, within four months of making the offer, give notice that within two months he will acquire the shares of dissenters on the same terms. The effect of this is that if a bidder wants complete control the offer must be at least 90 per cent successful. Most offers stipulate that completion is subject to acceptances by holders of a minimum of perhaps 75 per cent or some other proportion of the shares. They are conditional on such minimum acceptance. When the acceptances pass this mini¬mum figure, the offer may be declared unconditional.
Additional Educatin resources in this subject area, can be located here: http://www.harvard.edu/