There has been an increase in the cases of boards of directors of companies listed in the Saudi market seeking approval to reduce the capital of their companies, often at rates ranging between 20 and 90 per cent of the capital. What are the reasons for this?
In the recent period, until about a year and a half ago, there were requests to reduce capital for many companies, for example the Tourism Projects Company, Al Hokair Group, Chemanol, Al Nabeeb, Petro Rabigh, Fitaihi Group, and Al Hokair Group. Naseej International, Shaker Company, Al Madina Cement, Al Jouf Cement, Maadeniya, Anaam International, Al Kabelat, Amiantit, and a number of insurance companies.
The Saudi Cable Company submitted a request this week to reduce the capital from 262 million riyal to 67 million riyal. About three months before that, the company reduced its capital from 360 million riyal to 262 million riyal and at that stage tried to obtain the approval of shareholders to raise the capital in the amount of 400 million riyal was not approved. Now, after the capital has been reduced to 67 million riyals, the company is trying to increase it by 400 million riyals, hoping that the shareholders will agree to it this time.
And do not forget the case of Zain Saudi Arabia in recent years, where it started with a capital of 14 billion riyal at the time of listing in the financial market, then reduced it to 4.8 billion riyal, then increased had up to 10.8 billion riyals, and then reduced it again to 5.8 billion riyals, and after a few years it decreased to 4.5 billion riyals and immediately increased it to 8.99 billion riyals!
Of course, these acrobatic movements made by companies have causes, but they provoke the resentment of investors and raise many questions about the economic viability of these operations, how long they will last and when the company will have to stop operations to make losses. amortize and bring in more money.
Companies reduce their capital either by buying a portion of their shares directly from the owners and paying the value of the purchased shares in cash to the owners. However, these types of capital reduction actions are rare and the reasons for them differ from the causes of general and regular capital reductions, being the reason that the company does not need its capital at its current size. This type of capital reduction has taken place over the past two years at the Selek Company and Fitaihi Group as well as the City Cement Company, and when this happens, the number of the company’s shares in the market decreases, the share price rises and the capital increases. down, and the market value of the company decreases, and the reason for the decrease in the market value of the company This is due to the fact that it took cash from its assets to buy shareholders’ shares, and its value would decrease.
As for the general method, this is done by canceling a portion of the shares. In this case, the number of shares in the market decreases, the price of one share increases, and the company’s capital decreases, but the market value remains unchanged. . The reason why the market value does not change is because this process of capital reduction takes place without affecting the company’s assets.
Reduction of capital by canceling a quantity of shares issued due to the company’s need to extinguish its accumulated losses in order to meet the requirements of the financial market. The company earns the yellow color if its losses range from 20 to 35 percent of the capital. and the orange color for the loss category is between 35 and 50 percent. The red color is for those whose losses exceed 50 percent of the capital. But there is another reason for this process, which is more important, which explains the large number of capital reduction operations, and this is due to the company’s need for money through the process of raising capital. This is a bit strange: if the company has to raise its capital, then why is it reducing it? The reason, as we have mentioned, is that the company that reduces its capital, by canceling a number of its shares, is in fact without money. statement of financial position. But this process of capital reduction is necessary if the company wants to obtain funds from investors while its share price in the market is close to the nominal value of the share, i.e. ten rial. Why?
The reason for the need to reduce the capital before it is raised is that the share price in the market will decrease in proportion to the amount of capital raised, and therefore it is possible for the share price to fall below ten riyal and then the capital raised process will not succeed because the shareholder will not pay ten rial per share to raise the capital while the share price in the market is less than ten rial. Thus, one of the main reasons for the need to reduce the capital before the capital raising process is due to this part, that is: the fear that the share price will fall below the nominal value.
Do companies really benefit from capital reductions and capital increases? That is, improve the performance of companies that reduce and then raise capital?
There is a study conducted by the Capital Markets Authority on companies’ data for a period of 15 years from 2005 to 2019 in which 307 financial restructuring operations were carried out for companies, including capital reduction operations through 39 operations, capital acquisition operations through bonus shares, with 217 operations A process for raising capital through a rights issue. As a result of the legislation related to dealing with the losses of listed companies, the capital reductions increased from 3 percent of the total restructuring operations before 2016 to 35 percent after 2016. That is, most of the capital reductions are to legislate rather as commercial reasons.
It appears that there is no direct link between the company’s capital and its operating financial results, as capital is an accounting item that can be changed in various ways, while operating results are a commercial matter that is subject to various factors such as supply, demand, marketing. and acceptance of the company’s products and services, and so on. This observation is clear and correct if the capital reduction only cancels shares for the purpose of effecting a formal amortization of the loss, but what about the reduction of the capital by the company buying its shares from shareholders has an impact on the company’s operational results?
The study found there is a significant improvement in the profit margin index, which rose from 10 to 16 percent before the capital reduction to 40 percent after the reduction, compared to the company’s results in the two years that the capital reduction process in the two preceded. years after surgery. This improvement in financial results is more pronounced in the companies that have made reductions and are not companies in need, as the change in the profit margin was from 18 percent before the reduction to 50 percent after the reduction.
The effect of capital reduction on net income was also studied, and again the question was about the impact of capital reduction operations on the company’s operating results, and this time net income was taken as a measure of the company’s performance financial results. Here, too, the results of the research showed a significant positive change in the company’s performance after the capital reduction process, and again, the results were more positive for the companies that made the reductions, which are not companies that fail.
Quoted from Al-Eqtisadiah