In this week's Finshots Markets, we talk about Nykaa and the "masterstroke"

The Story

Last week, everybody was calling Falguni Nayar (the CEO of Nykaa) a genius. She was credited for coming up with an ingenious solution to stave off a sudden fall in Nykaa’s stock price — something new-age companies have had to struggle with of late.

And how did she do it you ask?

Well, by issuing bonus shares it seems.

But…it didn’t quite work out for Nykaa. The stock price has fallen by 10% this week. And now, everyone’s eating their words. And Nayar’s copping some blame.

If you’re confused and wondering what on earth is going on, let’s break it down for you.

See, most people have a brief 3-day window to buy shares when a company goes public (IPO). And if they’re lucky they actually get the shares they wanted. Then, they pray and hope that the shares list at a premium. And if they do, they can sell their shares at this higher price and pocket the difference.

But this isn’t the case for everyone. There’s another category of investors. They’re called pre-IPO investors.

They go through a slightly more elaborate process. Before an IPO rolls out to the general public, a company might reach out to private investors (say venture capitalists) to raise a bit of extra money. And these ‘pre-IPO’ investors, as they’re commonly known, get a discount on the price.

This makes sense. They take a bit of extra risk. And you compensate them with the discount. And if things do go wrong between now and the IPO, you have a bit of spare cash, and the pre-IPO investors have to deal with the fallout. That’s their life. But if the IPO does go according to plan and the shares list at a premium, they stand to make a lot of money.

But there is an issue here. If they decide to dump all the shares on the first day and quickly pocket their gains, it could crash the share price. It could create panic among people—mostly amongst retail folks who bought shares at the IPO price.

And the market regulator SEBI knows this. So it imposed certain rules and said, “Hey, you’ve got these shares at a discount. So we think it’s only fair that you wait for a year* after the IPO before you sell them. That’s the lock-in period for you.”

*The lock-in has been reduced to 6 months

So you can imagine what happens after a year…After patiently waiting for the lock-in period to expire, many of these pre-IPO investors quickly rush to offload their shares. And one year after the IPO, share prices could slump.

And this is exactly what has happened to a lot of new-age companies that hit the stock markets last year. The lock-in period ended. Investors rushed to dump their shares and the stock price tanked. Look at what happened to Zomato’s share price after the lock-in period ended — it fell by over 20%.

Now Nykaa has probably been watching all of this closely. And it’s safe to say that it didn’t want to see its share prices plummet like all the others. So it came up with an ingenious plan — issue bonus shares in the ratio of 5:1.

What’s that you ask?

Well, it means Nyka was offering every investor 5 shares for every share they held. For free!

But there is a catch.

If you had 1 share worth ₹1,200 earlier, you won’t have 6 shares worth ₹1,200 each now. Instead, the price drops proportionally. So you will have six shares worth ₹200. And  the total investment remains constant.

Alright. But why did everyone call this a masterstroke?

For starters, a lower share price is more attractive to retail investors. Optically, it’s more affordable. So maybe Nykaa believed that more folks would jump in to buy the shares. And you can see how the increased demand could help prop up the share price.

But that’s not the important bit. Nykaa issued bonus shares exactly before the one-year lock-in period ended. And here’s why they believed it would help — when a bonus share is issued, investors don’t get their hands on the ‘new’ shares immediately. Instead, the shares are credited after a while. However, the share price is adjusted almost immediately.

Now think about it — earlier, a pre-IPO investor who held 1 share could offload it and make ₹1,200. Now, they’d only get ₹200 if they sold that 1 share. They’d have to wait a few days before they’d get the other 5 shares.

So Nykaa wouldn’t see selling pressure on the day the lock-in period ended. The impact would be spread out over a few days. And maybe by then, retail investors would see the ‘low’ price and lap up the shares. The extra demand could propel the price upwards. But there’s one more thing about those 5 extra bonus shares.

Since they were given for free, the taxman assumes that the purchase price is set at zero. So when these shares are sold immediately at, let’s say, ₹200, the entire ₹200 is considered a profit. It’s a short-term profit that incurs a tax of 15%!!! Sure you could adjust the long-term capital gain loss you made on the original share you owned (purchased at ₹1,200 a year ago and sold at ₹200) against long term capital gains elsewhere. But there is a possibility you could walk away with a higher tax implication in some cases.

So some investors may just decide to hold their shares even in the face of a correction.

Now we can’t say with absolute certainty whether the strategy worked. Because the stock did fall by 10% eventually.

But it has raised a few eyebrows.

People aren’t entirely happy with the way Nykaa has gone about this.

Especially considering Nykaa’s P&L has been facing headwinds. The company’s quarterly net profit (July-September 2022) has halved to ₹9.9 crores when compared to last year. And shenanigans like these don’t help. It gives people the impression that the management is more interested in ‘optics’ as opposed to working on the company’s bottom line.

People are questioning if this is an indication of a corporate governance problem.

And no company likes to be called out on such matters.

So yeah, while Nykaa might have stemmed the sell-off in its share price a bit, it may have long-term implications for the company.

We’ll just have to wait and watch how investors treat Nykaa after this incident.

Until then…

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