Corporate Actions Simplified

A corporate action is an event which a publicly traded company has initiated which will impact shareholders. These corporate actions usually have a strong effect on the stock price and give investors a clearer view into the company’s financial position. Due to the possible effect on the company’s share price, it is important for investors to be familiar with different corporate actions.

A company may enter into a corporate action for a variety of reasons such as to increase profitability through a corporate restructure. These corporate actions may be in a form of spinoffs, mergers and acquisition. The company also may initiate a corporate action to influence the liquidity of the stock. A stock may be seen as a poor performer or too expensive if the share price is too high. Companies undergo corporate actions such as stock splits, reverse stocks split and buybacks to adjust the stock prices. And thirdly, companies may also want to return profits to shareholders and do so by using corporate actions such as dividends or bonus shares.

Types of Corporate Actions:

i) Mandatory Corporate Actions

Stock Split: Stock Splits can come in many ratios but the most common is a 2 for 1 stock split. These corporate actions occur when the board of directors decide to increase the amount of shares outstanding.  A company may decide to dilute the share price by issuing more outstanding shares. If a company had 50 million shares outstanding prior to the split, the corporate action will increase the amount of shares outstanding to 100 million shares. The stock price will halve in this 2 for 1 split so the value of the position for the shareholder is unchanged. The company’s market cap is also unaffected. It is a strategy used by company to make the stock more affordable to investors if they feel the current market price is too high. Stock splits are seen favourably by investors as it indicates that the company is growing and growth is set to continue.

Reverse Split: This corporate action event is facilitated when companies want to inflate their price. They may choose to do this as they believe their share price is too low or they are avoiding being delisted. The stock price of listed companies must stay above a certain level or they are delisted. In a 1 for 2 reverse stock split, 100 million shares outstanding at $1 become 50 million shares outstanding at $2. The value of the shareholding remains unchanged.

Spinoff: This occurs when a subsidiary company separates from the parent and issues new shares to create a brand new corporate entity. The board of directors may undertake a spin off when they feel the two companies are heading in different directions as they have formed different objectives. When a spinoff occurs the stock price of the parent entity should decrease by the price of the new entity. For example, if a parent company was trading $15, and spins off a subsidiary company for $5 per share, the stock price of the parent company should adjust close to $10.

Mergers: This is an event when companies merge together to create a more productive unit through synergies. When a merger has taken place both companies’ shares are given up and new company’s shares are issued instead.

Acquisition: An acquisition is when a larger company acquires the smaller one by buying the majority stake in shares.

The smaller company dissolves and the acquirer company has full control of the target company.

Bonus Issue: When a company has outperformed, they may decide to pay their shareholders an additional dividend in the form of stock or in the form of an option.

ii) Voluntary Corporate Actions:

Rights Issues: Companies may want to raise money to expand on their business through conducting a rights issue. In this event, existing shareholders are offered to buy the stock at a discounted rate. As this is not a mandatory corporate action, shareholders have a choice to either take up the extra shares or not. However if a shareholder does not take up the rights issue they run the risk of their shareholding being diluted as extra shares have been issued to existing shareholders. There are two ways a company can offer a rights issue, a renounceable entitlement and non-renounceable. A renounceable entitlement offer means shareholders can sell their entitlement onto the market. A non-renounceable offer means the shareholders cannot sell their entitlements on market so if they do not take up the rights issue, it just lapses.

Buy Backs: This is a corporate action where shareholders have the opportunity to sell their shares back to the company for the Buy Back price. The company may choose to undertake buy backs to reduce the outstanding shares in the market or to reduce the ownership of shareholders in the company. Buy backs can also improve a company’s earnings per shares (EPS). The EPS is an important ratio investors use to measure the company’s profitability. As the formula for earnings per share is net income/outstanding shares, if companies reduce the outstanding shares i.e. the denominator, then it would increase the value of the EPS.

Tender Offer: This is a public takeover bid. A prospective acquire may contact all the stockholders of the target corporation and offer to buy the stock from these shareholders as a price higher than the current trading price. The acquirer may only offer the premium price on the condition that a certain percentage of shareholders agree.

Lauren Hua is a private client adviser at Fairmont Equities.

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