Running with the pack

SMARTSHARE

On January 25, 2005, Tata-house retailer Trent announced that "in order to part finance expansion plans, the board has approved the issue of partly convertible debentures (PCDs) with warrants, aggregating to Rs 118.1 crore, (excluding the value of warrants) on 'rights' basis".

The PCDs are a three part instrument with a face value of Rs 900. Part will be converted into an equity share at a price of Rs 400 on allotment.

Part will be a non-convertible debenture (NCD) of Rs 500 with a coupon rate of 2 per cent per annum and a redemption premium paid on maturity so as to give a yield to maturity (YTM) of 5.5 per cent per annum over five years.

Part will entitle the holder to acquire against cash payment, one share of Trent in the third, fourth or fifth year, at a price between Rs 650-750 per share (to be fixed at time of issue). The PCDs will be issued to shareholders in the ratio of 1:10 and there is no preferential allotment.

Translation: Anybody who owns 10 shares of Trent can pay Rs 900 to end up owning 11 shares, plus a zero-premium option to buy another share later for a price between Rs 650-750 per share. The holder will also possess a Rs 500 debt investment designed to pay 5.5 per cent over five years.

It's an interesting exercise to examine this hybrid instrument. The share is currently trading at Rs 566. Let's assume that is the prevailing price at issue. After 10 per cent dilution, the price should drop to about Rs 510 post-issue. So there's an instant capital gain of Rs 110 on Part A.

The debt in Part B is back-loaded. The annual payoff of 2 per cent is low and the YTM over five years is lower than a bank FD, which would work out to around 6.25-6.5 per cent YTM currently.

Part C is a free shot at capital gains. If the strike-price is less than the prevailing price during the three-year timeframe when the option can be exercised, there will be a gain on C. Otherwise not.

Another way to look at this. Assume a sell off of the equity share. The holder keeps the warrant and a debt investment (face-value Rs 500) for a cost of Rs 390. The YTM for the PCD jumps to 10.87 per cent with further gains possible on the option/warrant. The terms are generous. This is why there is no preferential allotment "" the promoters are happy enough to run with the pack.

How can one lose? Only if the expansion plans go bust and the share price collapses. This looks unlikely. Trent intends to set up a 100 hypermarket grocery chain in North and West India and it's ramping up the Westside success story as well.

Trent has seen 40 per cent YoY revenue growth over the last two fiscals and 70 per cent growth in bottomline (excluding prior period adjustments and extraordinary items "" it has complicated financials).

In the first three quarters of 2004-05, income at Rs 171 crore exceeded the full year 2003-04 income of Rs 155 crore. Operating and net margins have dropped quite a bit.

At a 2003-04 PE of 43, the stock's pricey. The valuation reflects expectation of high growth. The PCD subscriber will lose if those hopes are belied.