On a Wing and a Pledge: The falling rupee and volatile stock markets have added to India Inc’s woes.

The debt problems in Europe and the global downturn are taking a heavy toll on industry.  Fund raising has not only become difficult, but more expensive too. For many promoters, the only way to raise more money has been to pledge their shares. This can prove to be a double-edged sword if the share prices fall further and trigger margin calls, points out the ET Intelligence Group

Tough times call for tough measures. Since January 2011 stock markets across the globe have been reeling under pressure as a result of fiscal and debt concerns in the US as well as the Euro zone. Markets have become very volatile, inflation pressures have risen and more recently, India has also had to deal with a sharp fall in the rupee. Raising funds from the capital markets in such an environment has become increasingly difficult. Costs for borrowing from banks and other financial institutions have also risen. This could be one of the reasons that the number of pledged shares by promoters to raise funds have risen to such a great extent over the past few months. 
Promoters may pledge shares for numerous reasons ranging from personal needs to business expansion and acquisitions. However, there are risks involved. As per Sebi regulations, it is mandatory for a company to disclose the number of shares pledged, but it is not mandatory to disclose the price, the reason for which the shares have been pledged or at what price a margin call will be triggered. 
In volatile market conditions such as those prevailing now, a sharp drop in the share price increases the likelihood of a margin call getting triggered. This means that the promoter either has to make a payment or pledge more shares. If the promoter doesn't have the ability to do either, the bank or financial institution has the right to sell the pledged shares. 
The case of GTL is one such recent example. In July 2011, the company informed the exchanges that ICICI Bank had acquired a 29.3% stake in the company after taking over the pledged shares from its promoter. 
Amid a sharp rise in the number of media reports on promoters of listed companies pledging their shares, we at ETIG decided to take a closer look. From a universe of all the companies listed on the Bombay Stock Exchange and the National Stock Exchange, we examined the change in the number of pledged shares during the July to September 2011 period. We found that the total number of shares pledged by promoters has risen 12%, reinforcing the fact that promoters are facing problems in raising funds. 
After narrowing down our sample by excluding all companies with a market capitalisation of less than 1,000 crore, we have featured 10 companies where the promoters have pledged over 70% of their holdings. The companies have been listed in descending order of percentage of promoter holdings pledged. Apart from the companies discussed below promoters of companies like Suzlon Energy, DB Realty, NIIT Technologies, Strides Arcolab, TV18 Broadcast, Omaxe, Era Infra Engineering, Plethico Pharma, Parsvnath Developers, Indiabulls Power, India Cements, Jaiprakash Power Ventures, Videocon Industries, Alok Industries, Religare Enterprises, Apollo Hospitals Enterprise, Lanco Infratech, Fortis Healthcare and Adani Power have all pledged over 50% of their holdings. 

• TATA COFFEE 
The entire 57% promoter holding in Tata Coffee is pledged. The company which is in the coffee and tea plantation business has a high working capital requirement. Its net working capital to sales ratio for FY11 was 0.5. Also, the debt to equity ratio as on September 30, 2011, was 1.7 which has decreased from 2.0 last year. 
Tea and coffee prices are volatile, and this means that its net profit margin is volatile too. For the September quarter, the net profit margin was 4% against 6% last year. Given the cyclical nature of the business, considering growth in net sales would be more appropriate. And net sales have been growing consistently. 
Considering this and the strong financial standing of its parent — the Tata group, investors can overlook the high percentage of shares pledged. 

• GUJARAT PIPAVAV PORT 
Gujarat Pipavav Port, promoted by APM Terminals, had pledged its entire stake as collateral for loans taken in 2009. As of June 2011, the company has a comfortable debt-to-equity ratio of 0.5:1, and debt of 765.4 crore. In December 2010 quarter, the company made a turnaround by reporting profits for the first time since going public. Since then, the company has shown a steady growth in profits. 
As the major ports in Mumbai and Gujarat are operating at near 100% capacity, any incremental growth in volumes is likely to move towards private ports like Mundra and Pipavav. Also, coal-fired power plants with a capacity of over 3,000 MW are expected to be commissioned near Pipavav in the coming years. The coal for these plants would be handled by Pipavav Port. With this expected growth, the company will be able to meet its debt obligations in future. 

• PIPAVAV DEFENCE & OFFSHORE 
The company had pledged its shares for long-term debt to build a ship-repair unit. The company presently has an order book of 7,000 crore which gives revenue visibility for the next two years. The company recently formed a joint venture with Mazagaon Dock to build warships for the Indian Navy. As on date, Mazagaon Dock has an order book of nearly 1 lakh crore and Pipavav expects some of these orders to flow to the JV. It plans to build its second dry dock, which will require capital expenditure of around 3,000 crore over the next three years. The recent announcement regarding preferential allotment to an overseas investor provides breather to the company which is in dire need of cash. 

• KINGFISHER AIRLINES 
Losses for the debt-laden led airline, which is led by Vijay Mallya, doubled in the July-September 2011 quarter sending smoke signals out to investors. The company cited high fuel costs and increased operating expenses as a cause for the same. 
Its debt has risen 1.2 times in the past two years and operating cash flows have been negative. The company also had plans to launch a GDR issue, but this had to be shelved on account of hostile market conditions. 
Its promoters pledged 90% of their shares in July 2011. At the time, the company had a market capitalisation of about 1,969 crore. Its share price has fallen 36% since then. The promoter holds a 59% stake in the company. It has already pledged almost this entire stake. With no rescue plans in the offing so far, if the share price of Kingfisher Airlines falls further there is a strong chance of a margin call being triggered. 

• UNITED SPIRITS 
Unlike its cash-strapped cousin from the airline industry, United Spirits had not faced as many hardships… until recently. Profits have grown at 25% CAGR over the past three years. Until March 2011, operating cash flows were up 44%. The company has accumulated huge debt due to the numerous acquisitions it has made over the years. On September 30, 2011, its debt stood at 4169.7 crore. 
United Breweries (Holdings) pledged its shares in United Spirits in two tranches on June 28 and July 13, respectively. At that time the stock was trading at around 955. It now trades at 740, a decline of 22%. The promoter group holds 28% in the company, which is not high. It has already pledged 89.64% of this stake which doesn't leave the promoters with much to spare in case of a margin call. 

• JSL STAINLESS 
The Ratan Jindal-controlled company had borrowed heavily over the years in order to finance its expansion plans. As the expansion did not yield the expected results due to harsh market conditions, the company opted to restructure its debt with the CDR (corporate debt restructuring) cell. As part of the scheme, the promoters had to pledge their shares with the lenders. Currently, 87.7% of their shares are pledged. 
As of September 2011, the company's debt stood at 9,569.4 crore. It has a low interest coverage ratio of 1.93 times which makes it look difficult for the company to pay back its debt even though the management stated recently that it plans to exit its corporate debt restructuring plan ahead of schedule. At the time the shares were pledged, they were quoting at about 104. But even though the shares have fallen 33% since then, the likelihood of a margin call is relatively less since the company is undergoing debt restructuring. 

• WOCKHARDT 
Due to wrong bets on currency derivatives, Wockhardt posted losses for three consecutive years from FY08 to FY10. This led to a sharp correction in the company stock price. Also, the debt on the company's books — raised to make acquisitions in the past — is very high at around 3,800 crore, The promoters hold a 74% stake in the company. But equity dilution at the current low valuation is not a lucrative option. The promoter group has pledged shares as a security against the loan taken for short-term working capital as well as long-term debt. 
The company has turned profitable from the last three quarters and is seeing strong operating cash flow and most of its existing debt has been restructured. With 1,300 crore plus that it will receive from the Danone deal and 1,200 crore operating cash flow in the current fiscal, the company will be in a position to clear its debt which is mainly payable after FY13 as per the restructuring. 

• STERLING BIOTECH 
Sterling Biotech is a highly over-leveraged company. It has a debt 3,750 crore. The interest paid by it for the September quarter was 82% of earnings before interest and tax. As a result of this high interest outgo, the company's net profit margin has declined from 11.7% to 2.4% in the last six months. Its profit after tax was only 11 crore, down by 67% quarter-on-quarter and interest paid was 72 crore. 
The biotech company has spent a huge amount on research and development which is capitalised till now and not recognised as expense. The big worry is that the promoter share holding in the company is only 33%. Out of this 85% is pledged, reducing the option of further fund raising by pledging shares or offering more shares as collateral in case the share price corrects. 

• ORCHID CHEMICALS AND PHARMACEUTICALS 
K Raghvendra Rao, R Vijayalakshmi, R Divya and R Sowmya hold 29.8% in Orchid Chemicals. In July 2011, they pledged 77% of their holdings in the Chennai-based drug manufacturing company. The price and reasons for the same have not been disclosed. 
Since the announcement, shares of Orchid Chemicals have fallen almost 50%. Given that the promoters have already pledged 77% of their shares, there's little they can do in case the share price falls further. They even run the risk of losing control over their company. 
While the company has achieved a major turnaround in operations and has promising growth prospects, its balance sheet still needs to improve. As on September 2011, the company's debt stood at 2,076.2 crore, which includes FCCBs of 530 crore due in February 2012. 

• UNITECH 
Unitech's earnings have gradually declined over the last three years from 1,625 crore in FY08 to 567.7 crore in FY11. Due to this, funding and debt repayment have impacted execution over the last few quarters. The promoter has pledged 72% of his stake in order to raise funds to complete the current projects. 
The company is currently facing a crash crunch and it is very critical for the company to finish its projects at the earliest in order to improve its cash flows. Revenue recognition is likely to increase only when some of its FY10 projects are completed and this looks unlikely before the end of the current fiscal. 
Though operationally the company is not doing so well, the risk of pledged shares being sold is less as in the real estate business, many a time shares are offered as collateral along with real estate assets thus reducing the risk of bank or financier dumping the shares in the open market.