One bonus to save two IPOs

19 February 2008

The proposal to issue bonus shares is a tacit admission by Reliance Power that its IPO was overpriced. But, the real reason behind the move may be to save the proposed IPO by the group's Reliance Infratel. By Vivek Sharma

A couple of months back, a small property developer in a southern metro ran a full page advertisement for a new apartment complex he had just launched. 'Buy a 3 bedroom apartment, get a Maruti SX4 absolutely free!!'

The property was priced at Rs3,500 a square feet, or Rs49 lakh for each 1,400-square feet apartment. Comparable apartments from other builders in the same area were being offered at Rs3,000 per square feet or a total cost of Rs42 lakh. The difference of Rs7 lakh is slightly more than the ex-showroom price of the SX4 base version, which is what the builder was offering. The road tax, insurance and other costs were the buyer's problem.

There was nothing 'free' in the offer; the builder inflated the price to include the cost of the car. One would have expected potential buyers to see through this 'fantastic offer', but that was not the case. The builder sold more than three-fourths of the property in two days flat

We all love free stuff. We get excited when something is free, even when we know that it is not 'really free' and we are actually paying at least a part of the cost. We all know that there are 'no free lunches', but we all suspend reason and opt to get excited whenever we see a 'free offer'.

In the consumer's perception, a free offer makes the deal much cheaper. Investors generally do not think like consumers and get excited when assets are actually getting costlier - when share prices and property prices go through the roof. Investors will be scared to buy when there is a fire sale, when assets sell at a deep discount to their inherent values. There are investors, like Warren Buffet, who do not behave like this. They make a lot of money and become enviable legends.

Investors behave like consumers only when they are offered something 'free' - like bonus shares. The term 'bonus shares' itself is pretty exciting and reinforces the impression that they are free. That is why they bid up stock prices whenever a company announces its intention to issue bonus shares.