An introduction to bonus debentures

Fundamental Analysis
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There’s a very innovative corporate action that Britannia underwent last month, wherein they issued bonus debentures to all their existing shareholders. Personally, I’d never heard of bonus debentures before and found the concept pretty interesting. Sharing here for the larger community’s benefit

What are bonus debentures?

We all know the concept of bonus shares, where companies convert a part of their free reserves into additional shares. Similarly in the case of bonus debenture issues, the same free reserves are converted into debt instruments (NCDs) that are issued to existing shareholders. The total number and value of outstanding shares of the company remains the same.

The basic idea then is that companies create fresh debt securities out their free reserves, and issue them to their shareholders (thus effectively borrowing from their shareholders). This is a cheap way to raise capital for companies at affordable rates.

What’s the difference ?

Unlike bonus issues where there is no wealth creation, in case of bonus debentures every existing shareholder of the company is credited additional NCDs into their demat accounts. This is in addition to the existing shares, whose value continues to be the same. As a result, there is wealth creation in case of bonus debenture issues.

These additional NCDs issued are tradable on the exchange, and shareholders can sell them and lock in their profit. So for instance in Britannia’s case, the company issued to each of its shareholders an NCD of face value Rs 29, carrying 8% interest for a maturity period of 3 years. This came at no cost to shareholders.

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Explained in another way, the company creates a bond for shareholders from its equity reserves, pays 8% interest on them for 3 years, and after 3 years redeems the bond and gives the principal back to the shareholders. All this, at no extra charge to shareholders.

What are the advantages of doing this?

This is a cheap way to access capital for the company, wherein it has borrowed from its own shareholders instead of raising external debt. The company has also saved on the administrative costs associated with raising external loans.

This is also quite tax efficient. In case the company had paid out a similar amount to shareholders as dividends, those payouts would have been taxed both at the company level and at the shareholder level, resulting in 40+ % tax.

From a shareholder’s perspective, 8% interest is better than what they’d get with FDs and other debt instruments. Of course, they can sell the NCDs anytime they want, since the instruments are listed on the exchange and have decent liquidity.

Win-win for all.

Why doesn’t everyone do this?

A few reasons. The biggest reason is that the Companies Act does not easily allow this. Specific approval is required from the National Companies Law Tribunal (NCLT) to do this, which is a tedious process which might take a few months.

For most companies, they may be borrowing because they don’t have cash on their balance sheet to fund their operations. So a mechanism like this does not really work for them.

My guess is this is typically only possible for companies like Britannia that generate a large amount of cash in their business and don’t have ways to effectively reinvest that cash in the business (FMCG companies or tobacco companies, for instance).

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Thank you. Well written and an indepth paper on Bonus Debentures. Hope we get to read more of these new concepts in this forum.

One point which I need clarification is - when you say, this is a cheap way to access capital - is this money not already with the company - also for a company of Britannia stature, dont they get cheaper funds than 8%. I thought most of the leading Corporates in India, the lending rates are linked to market rates such as MIBOR or any such benchmark rate.

When I read the original article on this, I thought the Company was giving this bonus debentures with an Interest rate of 8% as the overall package will be equal to the amount they had originally proposed to give to shareholders.

Not clear on this point as well
“For most companies, they may be borrowing because they don’t have cash on their balance sheet to fund their operations. So a mechanism like this does not really work for them.”

Appreciate if you could explain, time permitting.

With regard to tax efficiency - Yes, this is a novel concept. I wish SBI Nifty 50 ETF instead of declaring dividends by cash, which become taxable in the hands of the holders, could come out with something similar. (unlike MFs where growth and dividends are segregated, in ETF we do not have this option)
@viraj_joshi14

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This understanding is correct. The NCDs carry a coupon rate of 5.5% per year (paid annually), and the face value of Rs. 29 per NCD will be paid out by the Company at the end of 3 years.

The way I understand this is that it allows the Company to recycle its existing cash.
Instead of paying out an equivalent dividend of Rs 29 this year to its shareholders, the Company can pay out that Rs 29 at the end of 3 years, thus effectively borrowing from its shareholders for 3 years at 5.5% per year. In this case, Shareholders have no reason to be upset either (which they would if no dividends were paid and the cash was simply retained with the company). Since the NCDs will be listed, shareholders can sell the NCDs and realise the money immediately.

So this arrangement is typically only possible for companies that-

  1. Have a lot of cash on their balance sheets and not many opportunities to invest them in the business;
  2. Wish to/ have a history of payouts to their shareholders

Think of who the largest shareholders in any company usually are (Hint: the promoters). This is a way for the promoters to get 5.5% return on capital which they may not really need immediately. 5.5% is super high by the standards of the prevalent low interest regime.

Hope I’ve answered all your questions :slight_smile:

Edit: The coupon rate/ interest in this NCD issue is 5.5%. Corrected now.

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Hi,
Britannia CMP is 4967 and Britannia-N3 debenture is trading at 29 (as of 10/02/2024). The coupon rate/interest rate is 5.5%. Please consider my queries

  1. On which amount I will get the interest ie 4967 or 29
  2. What if I but few additional Britannia-N3 debentures?
  3. What will happen upon maturity/expiry of debentures?
    Thanks
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  1. The bonus debentures were issued at a face value of Rs 29, and the 5.5% per annum interest is based on this amount of Rs 29. The interest payable has nothing to do with the share price of Britannia itself.

  2. You can buy more units if it makes economic sense. Please note that the debebtures will mature in June 2024, so you may calculate the payoff accordingly.

  3. Upon maturity, the debenture units will be debited from your demat account, and a sum of Rs 29 (face value) + the accrued interest of 5.5% of Rs 29 per debenture will be paid out to your bank account. Please note that there will be a TDS implication of 10% as well, post the tax changes introduced in Budget 2023.

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Just read this thread, not sure how I missed the original post.
Good information.

Yes, this is not widely used corporate action.
I heard of it first in 2015 when NTPC issued bonus debentures :slight_smile:
I sold off NTPC shares some time back, but this post reminded me that I am still holding those debentures of minuscule value.

Not really true. When NTPC did this way back, they already had debt on their books and they were using this to raise additional debt.
For cash rich companies, doing this does not make sense at all as they are taking on debt on their books, which they do not need it. For them doing buyback makes more sense.

from NTPC’s example what i understood was that this was done so govt can get some cash (NCD could be sold off) without diluting it’s holding or reducing companies balance sheet.

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Yep, agree. Bonus debentures help the promoters get a nice payout without affecting the company’s balance sheet. Promoter= GoI in NTPC’s case :slight_smile:

Had mentioned this in my earlier response:

“Think of who the largest shareholders in any company usually are (Hint: the promoters). This is a way for the promoters to get 5.5% return on capital which they may not really need immediately. 5.5% is super high by the standards of the prevalent low interest regime.”