An easy way of spreading cheer among shareholders is through a stock split. Shareholders end up holding more shares, while the equity capital is unchanged. Unlike a bonus, a stock split does not increase in a company’s dividend liability, assuming it keeps the dividend ratio constant.
Sun Pharmaceutical Industries Ltd is splitting its Rs 5 face value shares into Rs 1 face value shares, which means a shareholder owning 100 shares now will own 500 shares. Though the company has not stated any reason for the stock split, it comes close on the heels of Sun’s successful resolution of the long pending acquisition of Taro Pharmaceutical Industries Ltd.
While the stock split could be to share the company’s victory with its shareholders, there could be other reasons as well. Liquidity improves as there are more shares in circulation. Sun’s share price has also reached the Rs 1,900 level and a split will lead to a lower share price, which does have a psychological effect. Also, Sun had given a sales guidance of growth of 18-20% during fiscal 2011. Despite very good results in the first quarter, the company has not revised this guidance. Thus, its performance in the remaining three quarters may not be as good. It had stopped selling two key generic drugs in the US market, which will affect its performance. A stock split also gives it some cushion to weather any uncertainty in its performance.
Graphic: Yogesh Kumar/Mint
Sun’s biggest win in fiscal 2011 so far has been its resolution of the Taro dispute. After winning the court case, it exercised its option to acquire the promoters’ stake in Taro and also converted warrants. As a result, Sun now owns 53% of Taro’s equity and 69% of its voting rights. Sun and Taro’s promoters have settled their outstanding disputes and Sun has appointed its directors to the board of Taro.
What now remains to be seen is how Sun intends to integrate Taro’s operations and whether Taro’s financials are worse than the proforma numbers. The company’s last audited results were till 2007. If an audit results in its performance coming in below the proforma numbers, it could affect the company’s valuation as well.
Sun’s share price rose by only 1.7% on 24 September, when the stock split was announced. The muted market reaction may be partly due to its share price already having risen by 10% since the court verdict on Taro. Its share now trades at around 26 times its estimated fiscal 2011 earnings per share. Apart from the stock split, the factors driving its valuation in the near to medium term will be its ability to resolve its US subsidiary’s pending issues with the US Food and Drug Administration and a better-than-expected performance in the remaining three quarters of this fiscal.