Premature dilution at Jaiprakash fails to click

Premature dilution at Jaiprakash fails to click

Normally, when a subsidiary company gets merged into the parent firm, the latter’s holding in the subsidiary gets extinguished in the merger process. But Jaiprakash Associates has decided to issue itself new shares of its own company in lieu of its holding in its subsidiary firms. When a company holds its own shares, they are referred to as treasury stock.

Holding treasury stock is not a new concept, but this is one of the rare cases where a parent firm’s holding in subsidiaries hasn’t been extinguished, but has been converted into treasury stock. Such shares get created normally when a subsidiary/associate company that is being merged holds shares in the parent company.

This happened, for instance, in the merger of ICICI into ICICI Bank Ltd. The treasury stock thus created was offloaded to outside investors at a later stage and helped the company raise funds. Jaiprakash’s intent also seems to be the same. Analysts expect that the company will sell these shares to outside investors at some point and raise cash.

After the merger process, the company’s equity will get diluted by 18.4%. The issue of shares to outside investors, if it happens, will be at a later stage. The company could have well chosen to issue fresh shares as and when it found outside investors. The dilution in its equity could then have been postponed. Not that the current dilution alters the economic benefits of current shareholders. Because the beneficiaries of the treasury shares are the company’s shareholders, their economic interest doesn’t get diluted in any way. But the premature expansion in the company’s equity base sends the message that at some point in the future, an actual dilution in economic interest will also happen (that is when the treasury shares are offloaded in the market).

So, why is the company so keen to create treasury shares, especially when it had the option of issuing fresh shares after finding outside investors? One reason could be that a fresh issue through say a preferential allotment has to adhere to certain guidelines such as a lock-in period for investors and pricing restrictions. All this won’t apply when treasury stock is offloaded, pointed out a chartered accountant.

Whatever the reason, the markets are evidently unhappy about the imminent dilution in the company’s equity.

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