Investment Advisory Service

Saturday, 18 February 2012

Hotel Leela checks into CDR !

Tucked away in the hundreds of announcements made everyday on the National Stock Exchange was this small announcement made on February 10, 2012.

One of the super brands in the Indian hospitality industry with premium luxury properties has fallen onto bad times and has sought the help of bankers to get out of this mess. What caused this mess in the first place ? The ingredients of this recipe remain the same as always : overoptimistic promoters, audacious and ruthless expansion fuelled by EXCESSIVE LEVERAGE.

As of September 2011, Leela had 4,295 crs of debt on the balance sheet. The quarterly interest cost has soared to 111 crs which translates into an annual interest outgo of around 444 crs. This excludes any interest that the company might be capitalising on the properties under construction. How does the interest outgo compare with the earnings of the company ? In FY11, the company earned total revenues of 525 crs and operating earnings (EBITDA) of 154 crs. Thus, the interest outgo itself is 3 times the annual operating earnings of the company and just a shade higher than the total revenues. Fair point that some of the properties will start contributing now and the earnings will increase but still the overall picture is pretty ugly.

To tide over the crisis, the company has plans to sell some commercial properties and vacant land in Chennai and elsewhere. Recently the company sold the property at Kovalam ( The Leela, Kovalam) for 500 crs. Still,  a lot more needs to be done to repair the balance sheet.

To the already precipitous situation of the company, add the information that ITC Limited is sitting pretty with 13.39% position in Hotel Leelaventures and has hoards of cash to swoop in more shares from the market if needed. The recent take over code comes in handy to raise the stake up to 26% without making an open offer.

The promoters of Leela know that the situation is precarious and with lower stock price , the job of the predatory activist investor becomes easier. Keeping this in mind, they have been buying from the open market and have increased their stake from 54.6% in Dec 2011 to 56.57% in Dec 2012.

The CDR process might be a double edged sword for Leela. Though on one hand, it will provide relief on the interest payment and moratorium on the repayment of debt but on the other hand, conversion of bank debt into equity (standard clause in a CDR process)  might humongously increase the number of shares outstanding. The debt is huge and even if a slice of debt is converted to equity, it will lead to a huge dilution and subsequently the dominant shareholding of the promoters would be compromised.

Let's check that with an illustration. Right now, the company has 38.78 cr shares outstanding and the promoters own roughly 22 cr shares (56.5%).  Assuming that only 1000 crs of debt (out of 4,295 crs)  is converted into equity at the current price of Rs 38. This will lead to an issuance of additional 26.3 cr shares. Thus the total number of shares would become 65.03 crs while the promoters will continue to hold only 22 cr shares which would be only 33% of the outstanding equity. This lower holding might make the promoters vulnerable and put the company in play.

Overall a very interesting combination of a marquee company in a debt trap, premium properties with high liquidation values and  a predator lurking in the shadows.

Leela will need a whole lot of kind and generous bankers to check out of this mess ! Amen.