Mon, May 14, 2018 - Page 6 News List

EDITORIAL: Capital reduction is not all good

Hon Hai Precision Industry Co’s announcement on Friday last week that the company plans to reduce its paid-in capital by 20 percent and return NT$34.66 billion (US$1.16 billion) to its investors, or NT$2 per common share, has surprised many, as it would be the first time the world’s largest contract electronics manufacturer has carried out a capital reduction program since it started trading on the Taiwan Stock Exchange in June 1991.

The company said that the planned capital reduction is a separate consideration from its cash dividend — it is proposing to pay shareholders NT$2 per share this year — but part of the company’s efforts to reassess its profit-sharing program with shareholders.

In Taiwan, refunding cash through capital reduction is tax-free for shareholders, so it is both reasonable and beneficial. Overall, shareholders and investors might feel content with receiving NT$4 per share in cash this year from the company if the capital reduction and dividend payout proposals are given the go-ahead at the annual general meeting on June 22.

Prior to Hon Hai’s announcement, dozens of companies listed on the Taiwan Stock Exchange or the Taipei Exchange had presented plans to implement capital reduction this year, which they claim is a standard business practice and should not affect their operations, clients or employees. In theory, capital reduction means companies can optimize their capital structure with a better ratio of debt to cash reserves, as well as generate the most effective return on equity performance, thus improving their shareholder value.

For some companies that are performing poorly, capital reduction is a useful tool to recover part of their accumulated losses, while for other companies that have accumulated ballooning cash holdings — such as Hon Hai, which had net debt of NT$15.3 billion, but about NT$642.50 billion in cash at the end of last year — the reduction in capital is considered an effective way to increase their earnings per share and share price, as local investors are generally enthusiastic about companies that carry out such reductions.

Regardless of the motives behind capital reduction, most companies that carry out reduction programs seem to believe that they would be better off making their capital structure small and beautiful, rather than big and ugly. However, since there are other capital management initiatives that can also assist companies in streamlining their business processes to achieve greater improvements in capital structure and cash flow, one might ask whether the reduction means a muted outlook on future business performance when the rate of development in a prospective industry matures, or if the move has to do with changes in the nation’s economic structure.

Thus, the government should be wary of a succession of companies undertaking capital reduction programs, as the trend might indicate that businesses do not see the need to raise funds and expand their operations in the short term. The phenomenon might also indicate a future lack of investment opportunities or a deterioration of the investment environment in Taiwan. Either way, it has raised concerns about the weakened competitiveness of local industries and the slowdown in the nation’s economic growth from a long-term perspective.

Even more worrisome is that some capital reduction programs are used to allow businesses to withdraw their investment from Taiwan, as they need more capital for investment in markets elsewhere. On Saturday, Hon Hai confirmed that its Shenzhen-based subsidiary, Foxconn Industrial Internet Co, has received approval from China’s securities regulator to debut on the Shanghai Stock Exchange. Coupled with the fact that several other Taiwanese companies are looking to float shares of their subsidiaries in Shanghai or Hong Kong instead of Taiwan, the government should keep a wary eye on companies’ capital reduction practices.

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