Tight market conditions are pushing Indian companies to tap their shareholder base to fund expansions and acquisitions.
The credit crisis which erupted in January 2008 and the subsequent crash in equities have made it difficult for Indian promoters to raise funds. High cost of debt and lower stock valuations are forcing Indian companies to increasingly turn towards their own shareholders to tide over their capital requirements.
Till September this calendar year, Indian companies had raised a record Rs 28,000 crore by way of rights issues, which is about three-and-a-half times more than what they raised in 2007. In fact, just two ongoing rights issues, Tata Motors and Hindalco, are expected to garner roughly a $1 billion each (total of over Rs 9,000 crore). So, why the surge in opting for this instrument and what are its implications?
Corporate view
Companies have traditionally opted for rights issues to meet funding needs, ‘reward’ shareholders and, at the same time, avoid dilution in stake. Investment bankers and analysts believe that rights issues make significant sense in a tight market to raise money without losing control and is more apt as compared to follow-on offers, qualified institutional placement or private equity.
Adds Prithvi Haldea, managing director, Prime Database, a firm that analyses primary market data, “Companies don’t have much of a choice as the market is not in good shape.” Raising money at high interest rates also does not seem to be a viable option in an environment where economic growth is decelerating.
While some companies are delaying their projects, others such as Hindalco, Tata Motors and Suzlon have debt repayment deadlines to meet or acquisitions to complete and cannot delay the raising of resources any longer. While these companies have a valid case, does it help to subscribe to the issues?
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Long-term play
Companies typically offer the rights issue at a discount to the market price to entice shareholders to subscribe to the offer. And, in stable market conditions, the discounts holds true for a considerable period. But, in the short term, it is difficult to make a case for rights issue, especially during volatile times as things could turn unfavourable.
For instance, two companies, Indian Hotels and Oudh Sugar have seen their shares trade below the issue price six months and one month after the closure of their respective rights issues. This could be due to a combination of depressed market conditions and weak industry outlook.
Says S P Tulsian, an investment consultant, “Subscribing to rights issues for an investor with a short-term horizon does not make sense. Subscribe if you have long term view, so that investments by the company can yield higher earnings over a period of time.”
| A MIXED BAG | |||||||||
| Rs crore Companies | Financial performance | PE (x) | |||||||
| Net sales | CAGR*(%) | OP | CAGR*(%) | Net profit | CAGR*(%) | FY08 | FY09E | FY10E | |
| Hindalco Industries | 59,794 | 82.0 | 7,270 | 39.2 | 2,343 | 23.3 | 6.4 | 5.6 | 5.1 |
| Gujarat NRE Coke | 887 | NA | |||||||
NA
NA
In the current context, while the rights issue offer price of Tata Motors and Hindalco were at a significant discount to the share price at the time of announcement, depressed market conditions and adjustments (due to equity dilution) to the price has made these discounts meaningless. “Ideally,” says Haldea, “there should be a 10 per cent discount to the market price for a retail investor to subscribe at the time of closure.”
Analysts say that during tough market conditions, it is the institutions and promoters who benefit the most from the issues as they get a large chunk of these shares at one go at sub-market prices. They also add that unsubscribed retail portions due to market price falling below issue price and differential voting rights (DVRs) allow managements to maintain or improve their shareholding as well as raise money.
New instruments
The Tata Motors rights issue is perhaps the first one which will have a DVR portion. Prior to this, Pantaloon Retail had issued DVRs to its shareholders in July as part of a 1:10 bonus issue. While DVRs have been issued by companies such as Warren Buffet’s Berkshire Hathaway and Google, it is a new concept in India. While a regular ordinary share gives you a right to vote as well as a claim on dividend, you need 10 DVR shares (in case of Tata Motors as well as Pantaloon) to get voting rights equal to one ordinary share.
The lower voting rights are compensated by offering investors a 5 per cent higher dividend over and above the regular dividend. Says Kishore Biyani, managing director, Pantaloon Retail, “You create another instrument which has less voting rights, where one is able to raise funds without losing too much control.
This is a popular trend but the way it picks up will depend on promoters and their perception. If investors are comfortable with less ownership but at higher regular returns, then why not adopt it?”
Whatever the instrument, retail investors must look at the prospects the business offers before taking the investment call. Here is a list of major issues which are in the market or will hit the market over the next few months, analysis of key business issues confronting the promoters and whether you should subscribe to them or not.
Tata Motors
The dip in equity prices had forced Tata Motors to whittle down its initial plans to raise Rs 7,200 crore and instead stick to a smaller offering of Rs 4,200 crore. Tata Motors needs to repay the $3 billion (Rs 13,500 crore) loan it took to fund the acquisition of Jaguar Land Rover (JLR).
While Tata Sons and group companies which have a 33.39 per cent stake in Tata Motors are expected to pick up their quota of shares, analysts say that LIC and New India Assurance (hold 16 per cent) are also expected to pick up the ‘A’ ordinary due to the discount to market price and extra dividend sweetener.
As the price of the ordinary share is lower than the current price, expect it to be undersubscribed (See table Details of rights issues). This may help the Tata group to pick up the unsubscribed portions. On the business side, Tata Motors has two issues that need careful handling.
The first is to find an alternative site for the Nano project and start production on a fast track basis. The second is the challenge of running Jaguar Land Rover (JLR) which includes investments on the research activities for meeting the lower emission regulations and the prospect of a pension shortfall (review is due in April 2009).
While for the month of June 2008 (when Tata took control of JLR), JLR has made a net profit of $58 million on an EBIT of $63 million, to sustain a profitable operation and at the same time make R&D investments on new products and technologies will be a tough ask given the slowdown in global markets.
At home, the sluggish business environment is not helping matters. Sales volumes of its vehicles in the first six months from April to September 2008 have grown just 1 per cent to 2.65 lakh units, to a large extent helped by its fast selling light commercial vehicles (grew at 17.4 per cent y-o-y).
The long term business case for the stock (acquisition of a profitable JLR at fire-sale price and prospective sales boost from Nano in FY10) is quite strong and the valuation on a fully diluted and conservative basis with a P/E multiple of 8 for FY10 is hardly demanding.
However, given that the current market price is below the offer price, it would make sense to buy on dips than to subscribe to the offer. And, if you are looking for better dividend income and willing to take the risk pertaining to the acceptability of this instrument by the market, the DVR offer looks decent.
Ramco Systems
Ramco Systems (Ramco) is a developer of ERP (enterprise resource planning) applications, which enables seamless integration of business processes across various functions in an organisation and across geographies.
After years of consistent R&D and investments, Ramco was the first to launch internet-enabled software-as-a-service ERP in India, in February this year. Termed as OnDemand ERP, it enables clients to subscribe for a software module on a monthly fee. “It takes care of all IT infrastructure, maintenance and support needs and over a period of 3-5 years, would prove to be 50 per cent more cost effective than the traditional ERPs (read: SAP and Oracle),” says Chetan Pathak, vice president, enterprise solutions, India, Ramco Systems.
With the intention of aggressively marketing OnDemand ERP and reduction in borrowings (by Rs 75 crore) Ramco plans to raise Rs 195.82 crore through the rights offer including warrants.
Earlier in July, Ramco had announced that three rights share (Rs 75 each) would be allotted for two equity shares held. The revision in the issue terms has narrowed the gap between the rights offer and current market price to just Re 1 thus, making the offer pricing unattractive.
For many years now, the company has been incurring losses and infusing funds by way of preferential and rights issues (Rs 336 crore so far), even as it relentlessly invested money in developing ERP products and services, which a handful of players around the globe can boast off. And, while the company is ready with its unique offering in form of OnDemand ERP and the untapped market of SMEs is huge, analysts feel that Ramco’s future rests on how well this product is marketed.
The company is confident of breaking even this year (Q1FY09 consolidated operating loss stood at just Rs 74 lakh) on the back of good traction in its OnDemand ERP service; with about 150 clients and more than 2,000 users, each charged Rs 7,500 per month (annualised revenues of Rs 18 crore).
With this base likely to rise to around 5,000 users by end-FY09 and double to 10,000 in next fiscal, expect a sizeable jump in revenues going forward. And, with most of the expenses already incurred, the profitability should hopefully improve. While the company's growth story is about to take off, like other issues, Ramco’s issue leaves little on the table in the near-term. Long term investors with a high risk appetite could look at buying on dips.
Gujarat NRE
Gujarat NRE Coke has been a major beneficiary of the growing demand for coke (from steel industry) and rising global coke and coking coal prices. The company is the third one to announce a DVR issue, except that the shares on offer will have higher voting rights (one share is equivalent to voting rights of 100 shares). The company plans to raise Rs 100 crore by allotting such shares at a price of Rs 1,000 each, a huge premium over the current price of Rs 65.
The proceeds will be used for expanding the coke capacity of its Andhra Pradesh plant by 1.25 million tonne per annum (mtpa); from 1 mpta to 1.25 mtpa by December 2008 and further, to 2.25 mtpa by December 2010. Meanwhile, benefits will also accrue on account of higher integration.
The company owns coking coal reserves of 550 million tonne in Australia through its subsidiaries, which are equivalent to 30-40 years of its present requirement. The company sources about 50 per cent of its coking coal requirement from these mines, which will gradually increase to 100 per cent as production at these mines goes up to 0.90 mtpa by FY09 and 5 mtpa by FY13.
Thus, by FY14, the company will use about 45 per cent of the produce for captive consumption and sell the balance in open market resulting into higher revenues. This access to captive mines is expected to lead to a savings of $50 per tonne of coking coal.
| DETAILS OF RIGHTS ISSUES | ||||||
| Tata Motors | Hindalco Industries | Gujarat NRE Coke | Ramco Systems | Dish TV | ||
| Opens/Closes | Sept 29 to Oct 20, 08 | Oct 1 to Oct 10, 08 | Pending approval | Dec 08 $ | Nov-Dec 08 $ | |
| Instrument | Ordinary | ‘A’ ordinary shares * | Equity | Equity | Equity & Warrants^ | Equity |
| Ratio | 1:06 | 1:06 | 3:07 | 1 : 450 | 1 : 1 & 1 : 2 | 1.21 : 1 |
| Issue price (Rs) | 340 | 305 | 96 | 1,000 | 85 | 22 # |
| Discount to CMP (%) | 2.74 | 10.29 | 2.04 | 1654.4 (premium) | 1.2 | 15.38 |
| Issue size (Rs cr) | 2,185 | 1,960 | 5,047.70 | 100-120 | 130.55 & 65.27 | 1,140 |
| Dilution | 16.70% | 16.70% | 43% | 0.25% | 150% | 121% |
| Purpose of offer | To repay part of $3 billion bridge loan taken to fund the $2.3 billion JLR acquisition in March 2008 | Fund the bridge loan | Fund expansion | Repay debt, R&D and marketing expenses of its new product 'On Demand ERP' | Marketing and customer acquisition cost (subsidies on set-top box) | |
| * One vote for 10 shares, 5% extra dividend $ Tentative ^Warrant conversion in 18 mths # 50% on application, balance later | ||||||
Overall, higher global coke prices and expansion of capacities augur well. But, while stock valuations are attractive, the DVR offer is expensive for retail investors to participate. Explaining the reason for the choice of this instrument, a fund manager says, “This is merely to increase their (promoters’) voting rights (current stake at 40.7 per cent) in the company and we do not think any of the retail investors will participate in this. Anyway, this is good for the retail investors as money is coming without signification equity dilution and thus improving the book value per share.”
It will however, be interesting to see how institutional investors respond, given that they cumulatively hold a slightly higher stake (41.17 per cent as on June 2008) as compared to the promoters. Should they choose to stay away, and assuming that promoters subscribe to the entire issue, it will help the latter to increase its voting rights to about 51.5 per cent even as the equity capital goes up by just 0.25 per cent.
Hindalco
Hindalco Industries, which last year raised $3 billion in debt to acquire Canada-based Novelis Inc, has now come out with a right issue of over Rs 5,000 crore to repay the bridge loan. The remaining $2 billion will be financed through internal accruals and fresh debt of $1 billion (at higher rates).
The company currently pays interest at the rate of 4.8 per cent per annum, which is about 30-80 basis points over the Libor (annual interest outflow of $144 million). However, even as it is raising fresh loans of $1 billion (at interest rate of 6.8 per cent), it will help save $76 million or Rs 342 crore annually due to the decline in debt levels, which in turn, will take care of the expected 43 per cent dilution in equity due to the rights issue.
Lower debt, analysts believe, will also help the company further leverage its balance sheet for future expansions (capacity to rise by 50 per cent in next 2-3 years) estimated to cost Rs 19,800 crore.
On the flip side, falling global aluminium prices (down 29 per cent in last five months) and expected slowdown in consumption are concerns. Hindalco, which generates about 37 per cent of its sales and 83 per cent of EBIT (earnings before interest and tax) from the aluminium business, will feel the heat. Even in FY08, the aluminium business reported a decline of 17 per cent in EBIT, due to a 11 per cent fall in realisations.
Its copper business, accounting for 63 per cent of revenue, has been growing but, given that it enjoys low margins (EBIT margins of 4.2 per cent as compared to 33.9 per cent in aluminium business) its contribution to the bottom line is small.
Analysts are also concerned about the performance of Hindalco’s subsidiary, Novelis. The company has exposure to the US and European markets, and hence, the slowdown in these markets could prove to be growth deterrent.
The other concern stems from the high fixed-priced contracts that Novelis has with its customers. Novelis though is bringing down its exposure to such contracts; their share has declined from 18 per cent of revenue in FY07 to about 10 per cent in FY08. Besides, Novelis is also working towards reduction in operating and other expenses.
The results are partly seen in Q1FY09 numbers, wherein the company reported a net profit of $25 million compared to a loss of $142 million in Q1FY08.
Overall, given the subdued business environment, and the offer price of Rs 96 per share, the issue is less attractive for investors.
Suzlon Energy
Post the announcement of the Rs 1,800 crore rights offer on September 25, Suzlon Energy’s stock has fallen 15.71 per cent while Sensex fell by just 4.4 per cent. The company plans to raise these funds to fund the acquisition of Martifer's stake of 22.48 per cent in Germany-based REpower Systems (a 66 per cent subsidiary of Suzlon) for Euro 270 million.
The agreement is expected to be concluded by December 15, 2008, which will result in Suzlon's holding in REpower going up to 90 per cent. While the details of the issue are awaited, based on the size of the offer and assuming that it is priced at current levels (Rs 147) the dilution in equity is likely to be 7.9 per cent.
But, a higher holding in Repower should lessen the effect of dilution as the increase in holding by 24 per cent will allow Suzlon to account for a higher share of profits (of REpower), going forward. REpower made a net profit of Euro 21.12 million (Rs 137 crore based on euro-rupee rate of 64.9) in CY07.
Assuming a 20 per cent profit growth in CY08, the effective impact on earnings will be 5.2 per cent. Moreover, REpower could be leveraged in many ways; widening product portfolio and enhancing presence in growing markets like Europe and China. Additionally, Suzlon will have complete access to REpower’s superior technology besides allowing faster integration with the latter. Also, as REpower is expanding its capacities from 1,250 mw to 1,700 mw by December 2008, expect higher volumes.
Back home, Suzlon’s capacities will rise from 2,700 mw to 5,700 mw by March 2009. Besides, backward integration measures through the acquisition of gear box manufacturer, Hansen Transmissions (71.3 per cent stake), will help Suzlon in providing secured and timely supply of key components required to manufacture wind turbine generator.
Hansen is also increasing its capacities significantly from 3,600 mw to 14,600 mw, which will be used by Suzlon and for sales to third parties. Meanwhile, Suzlon’s order book of 3,039.5 mw or Rs 16,491 crore (1.2 times its FY08 revenue) provides good revenue visibility.
Overall, as the industry is growing and the company increasing capacities across the value chain, Suzlon stands to gain. While the prospects look good, the key factor to watch for is the terms of the offer, mainly pricing.
Dish TV
Direct-to-home (DTH) service provider, Dish TV India has rounded off its best ever quarter in terms of subscriber volume with gross addition of 5.3 lakh subscribers in Q2 FY09 versus 4 lakh in Q1 FY09. With this, the company's subscriber base has increased to 39.4 lakh, its market share being 57 per cent. However, the traction in the numbers has come at a price; Dish TV has been subsidising the set-top boxes that customers buy (it has lowered its entry point to Rs 1,990 as against Tata Sky's Rs 2,990).
Due to this, its average customer acquisition cost has gone up from Rs 1,800 in FY08 to Rs 2,500 (currently) and the management has indicated that it could go up to Rs 2,800 in FY09. Dish TV has scaled up its capital expenditure budget to Rs 1,600 crore to sustain its aggressive consumer acquisition strategy.
The company is raising Rs 1,140 crore by way of rights issue, which should also strengthen its weak balance sheet (debt of Rs 508 crore and accumulated losses of Rs 652.3 crore as on March 31, 2008).
Competition could further heat up as new entrants in the form of Sun TV, Reliance, Bharti Airtel and Videocon will use MPEG-4 streaming technology, unlike Dish TV and Tata Sky, which use MPEG-2 technology. MPEG-4 has superior picture quality and is backward compatible with MPEG-2, but same is not true the other way round.
And, while MPEG-4 set-top boxes are estimated to be 50 per cent more expensive than those using MPEG-2 formats, the new entrants have deep-pockets to sustain losses for a long period. Also, Reliance and Bharti have a wide reach, which they can leverage. These factors may thus weigh on the valuation of companies in this business including Dish TV (its share price has fallen 75 per cent in 2008 to Rs 26).
Analysts estimate about 50-60 per cent CAGR in overall DTH subscriber base to 18 million through FY10E. Dish TV made a loss of Rs 413.2 crore in FY08 (as against Tata Sky's reported loss of Rs 865 crore) and is expected to breakeven by FY12. Dish TV's near-term financial performance will not reflect the value being created owing to the long gestation period of the business.
With competitive intensity increasing, Dish TV remains suitable for investors with a high risk appetite, who are prepared to stay on for the long haul.