Nykaa: Business & Bonus Share Strategy
Brilliant or Terrible?
Nykaa is an Indian e-commerce company, founded by Falguni Nayar in 2012. It sells beauty, wellness and fashion products across websites, mobile apps and has 100+ offline stores. It became the first indian unicorn startup headed by a woman.
Background of Nykaa’s Business
When Nykaa entered the industry, there were mainly three retail distribution channels for beauty products: organized, unorganized, and online. Nykaa’s goal was to sell original products, improve transparency, and educate customers about the types of products and how to use them. They even created a platform (or Nykaa Network) for people to discuss their queries, which helped the buyers engage with the users of their desired product & build trust before buying. Since make-up is a personal thing for women, they started opening physical stores for people to visit and improve the customer experience.
The cherry on top was Nykaa’s inventory model.
The latest FDI rules in India (back then) stated that e-commerce companies with foreign funding can only operate on a marketplace model, not on an inventory model, which worked in favor of Nykaa as they could now buy in bulk (negotiate discounts) & sell at a high price in the retail market.
Inventory Model - An inventory model is a business model where marketplaces store their products in bulk in their warehouses and ship them to the customers once the orders are confirmed.
Marketplace Model - The marketplace model refers to the business model where e-commerce marketplaces provide a centralized platform to multiple sellers where they can sell their products while connecting with potential customers.
Nykaa had the first-mover advantage as only 8% of total beauty products were sold online back then, and 92% market was still untapped. The market was far from saturation back then, but the current structure is very dynamic due to the entry of players like, Purplle, Shoppers Stop, AJIO, Sugar Cosmetics, etc.
Why did Nykaa use the bonus share strategy?
After Nykaa went public, the lock-in period for some investors was about to end & this is when Nykaa’s bonus share strategy came into the picture. It was a move to prevent investors from selling their stake in the company.
Lock-in Period - When investors buy shares in an IPO, they are lock-in for a period set by the underwriter. It is usually between 6 and 12 months but can be longer. If the investor sells their shares before the expiry of the period, they may have to pay the penalty.
Bonus share strategy - Bonus shares, in essence, increase the number of outstanding shares and reduces the share price but do not change the overall value of the investor’s holdings.
Let’s take an example:
If you have one share of Rs. 3000 and the bonus share split is 5:1. Then Rs. 3000 will be split into six parts (Shares) of Rs. 500 each. It doesn’t change the value of your investment. According to the government of India, the value of one share dropped from Rs. 3000 to Rs. 500, which means that you incurred a loss of Rs. 2500 on that one share, but you have gotten five free shares worth Rs. 500 each.
But what would Nykaa achieve by doing this?
The short-term capital gains tax is 15%, and the long-term capital gains tax is 10% in India. So, if a person sells the 5 “free” shares, he incurs a 15% short-term capital gains tax, discouraging them to sell their holdings. The genius part was that Nykaa knew that Long term capital losses can not be set off against short-term capital gains. They presumed that this strategy would make investors hold their investments.
But… The investors sold their holdings, realizing the losses & putting the reputation of the founders at stake.
Considering the outcome, Was the strategy even good?
Now, there are arguments on both sides about whether or not this is a prudent move by the management.
The argument in favor would be that if there is no hurdle for investors to exit, then there would be a crash sale that would dent prices miserably. That damages investor sentiment and creates a perception of poor stock performance.
But…
While the move intends to soften the blow on the stock price performance, it puts an unnecessary and unaccounted-for burden on a swath of shareholders.
More importantly, it also goes against the principle of equity; when it comes to how the tax benefits stack up for the various category of investors. The tax incentives are aligned in favor of promoters and early shareholders and against other existing shareholders who have been there since listing and some pre-IPO shareholders.
Not only is the whole attempt to manage prices futile, but there is also no way for management to win. The only way, therefore, is to focus on the core business and ensure that value gets recognized in the market.
