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.

Tata Capital NCDs - Update

A few days back, I blogged about Tata Capital NCDs here.

The NCD-Option III closed today at Rs 1110 thus substantiating the belief that markets are efficient though sometimes with a time lag.

And time lag can vary from a few days to a few years.

R Systems- Update 1

As per the recent amendments in the Takeover Code, a committee of independent directors need to give their recommendations to the shareholders on the open offer. Complying with that, R Systems has constituted a committee. It will be interesting to see what recommendations they come out with !

Here is the BSE announcement :

R Systems International Ltd has informed BSE that pursuant to the provisions of (Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 the Board of Directors of R Systems International Limited (the Company) has constituted, by passing necessary resolutions through circulation, a Committee of Independent Directors, namely Mr. Raj Kumar Gogia, Mr. Suresh Paruthi and Mr. Gurbax Singh Bhasin to give reasoned recommendations on the Open Offer given by Mr. Bhavook Tripathi for acquiring 26% shares of the Company in terms of Public Announcement dated December 15, 2011 and Detailed Public Statement dated December 22, 2011.

Meanwhile the promoters have been continuously buying shares from the open market.

Tata Capital NCDs- Why this inefficiency ?

On January 7, 2012 Tata Capital Limited NCD - Option 3 (Non Convertible Debenture) traded at an average price of Rs 1134 on the BSE. This debenture was issued in March 2009, had a face value of Rs 1000 and carried an annual coupon of 12%. At a price of 1134, the IRR for this debenture worked out to be 10.2%

Tata Capital Limited had come out with this NCD issue in February 2009.  The debentures were offering a coupon between 11-12% p.a depending on the payment option chosen by the investors. The original issue size was Rs 500 cr with an option to retain an oversubscription up to Rs 1000 crs. With equity markets in bad shape and a nice yield of 12% , this bond to be issued by the house of Tatas created a buzz in the market and the issue was oversubscribed and received Rs 2300 crs.

One important clause of the debentures which a lot of investors miss to read and the financial advisers fail to stress is the availability of the put and the call option. Under this option, after some scheduled time period as mentioned in the document, the issuer has the right to call the debentures and the investor has the right to sell (put) his debentures and take his money back. And both these situations would ideally happen in a case where the market interest rates fluctuated either in the interest of the issuer or in the interest of the debenture holder.

In Tata Capital NCD, the document stated that the put / call option could be exercised after a period of 3 years (in one series it was 3.5 years) from the date of the issue. This announcement made by the company on Saturday mentions that the company has decided to exercise the call option and the directors of the company have approved of the variation in the terms of the NCD. The coupon rate has been reduced across different series. For Option III discussed in the opening paragraph, the coupon has been reduced from 12% per annum to 10.50 % for the rest of the maturity period which is 2 years and 2 months from now.That is a sharp reduction and I concluded that market participants will factor this new development . I quickly calculated that for the IRR to remain at 10.2%, the price of the debenture should come down to Rs 1108 which is 26 bucks lower than the Saturday's closing price of 1134.

To my surprise, this announcement had no bearing today on the price of the Tata Capital NCD and the Option III NCD is still trading at Rs 1134. At this price, the IRR with the reduced coupon rate is 8.81% which is lower than the bank deposit rate for an FD of the same maturity. (Axis Bank is offering 9.3% interest for an FD with a maturity term of 2 years and 2 months). Any rational investor should ideally withdraw his money from this NCD and put it in a bank fixed deposit.

I always thought that bond market participants are more nimble compared to the participants in the equity markets.

What explains this inefficiency? The announcement is out there on the exchanges and there is no information asymmetry. The debenture size of 1500 crs is large and unlikely to escape the attention. Taxation can't explain the inefficiency. These debentures are taxable at the same rate as bank FDs.

Is there anything I am missing here ?

UTV Software Communications- Move to go private

There is a lot of action happening in the Indian entertainment space ranging from higher DTH penetration, movie production, the entertainment distribution business, realty shows, radio and not to forget the hugely successful  IPL (at least for BCCI and the viewers). With an eye on roughly 240 cr eyeballs in India, the increasing disposable incomes and increasing share of entertainment of the consumer's wallet, Walt Disney Company acquired close to 50% stake in UTV Software Communications in 2008 at around Rs 860 per share

In July of 2011, the company followed up with a delisting offer to acquire the stake held by the public shareholders. There are 4.07 cr shares outstanding and Walt Disney owns 50% of it. Ronnie Screwvala and affiliates own another 20% stake and they are classified as Indian promoters. As per the delisting guidelines, the process to be followed is a reverse book building process where the public shareholders are allowed to tender their shares at a price of their choice above a minimum "floor price".

The first milestone in the delisting exercise was the postal ballot process. The delisting guidelines state that in the postal ballot , the number of share-votes casted by the public shareholders in favour of the delisting should be at least twice the number of share-votes casted by the public shareholders against the delisting process. Note that for the postal ballot to be successful, the promoter votes are counted separately and the public shareholder votes are counted separately. That's a fair clause to prevent the public shareholders from getting bulldozed by the votes of the promoters if both were clubbed together. The postal ballot was passed successfully in this case and the first milestone was reached.

Further milestones were the regulatory approvals required from the BSE, NSE, Foreign Investment Promotion Board, Cabinet Committee on Economic Affairs and the RBI. With some delay, all the approvals have come through. Getting the regulatory approvals is an important milestone as the uncertainty surrounding the deal gets cleared and also the time period of the deal gets fixed. There should not be any further delays from here.

As per the public announcement , the reverse book building will start on Jan 16th 2011 and will end on January 20th, 2011. The shareholders can tender their shares at any price higher than or equal to the floor price of 835. The acquirer "Walt Disney" has provided an indicative price of Rs 1000 per share that it would be willing to shell out. This price is only an indicative price and neither does it prohibit the public shareholders to tender their shares at a price higher than Rs 1000 nor does it prohibit Walt Disney to accept the discovered price in the reverse book building if it is more than Rs 1000 per share.

What is required for this delisting to be successful ?

1. Quantitatively, the acquirer should be able to reach 90% post the reverse book building. If the number of the shares do not hit that mark, the delisting exercise would fail irrespective of the price discovered. Since acquirers already have 70% stake, they require another 20% to reach the mark of 90%. That means out of 1.22 cr shares with the public, at least 81.3 lakh shares need to be tendered in the book building which is 2 out of every 3 shares with the public. Looking at the shareholding pattern of Dec 22 (available in the public announcement), around 91 lakh shares are held by FIIs and Corporate Bodies and the rest 31 lakh shares are held by individuals. This is an important number to focus as the FIIs and Corporate Bodies are investors who  are aware and understand the dynamics of delisting and can be expected to exercise their votes. If most of them exercise in favour of delisting, the required  numbers can come through. Secondly, the shareholding of FIIs and Corporate Bodies is concentrated and not diffused as in the case of individual shareholders. I would give a 90% chance that the required number of shares would come in the delisting. 
2. Secondly, the acquirer should accept the discovered price. With an indicative price of Rs 1000, there is already an anchor. Usually it has been observed in the past delistings, that the shareholders want "a little more" than the indicative price and the acquirer also keeps some headroom between the actual price that he really wants to pay and the indicative price. Also, with FIIs and other corporate bodies, it is likely that they will not tender their shares at absurd prices which will drive Walt Disney away. A 10% premium can be expected over and above the indicative price.                                                      

What are the risks to this transaction ? The greatest or gravest risk I would say is the downside risk to the stock price in case the delisting fails for either of the reasons described above. The fundamentals of UTV don't support the price of Rs 1000 and if the delisting fails (10% chance), the stock can easily nosedive to Rs 700 before one can exit.

 

Also, the employees of UTV have been continuously selling stock in the market. But that might have to do with taxation issues and derisking of their portfolios as a large part of their networth might be in the UTV stock.

 

 

There is a :

 

90% chance of book getting built and exit price being 1100 and ;

10% of chance of book not getting built and exit price being 700;

making the weighted average price being 1060;

while the current price is 990;

providing an expected absolute return of close to 7% in a span of 15 days.

I have invested money in this situation with a clear understanding of not participating in the book building. Tendering the shares in the delisting would be akin to "burning the bridge" while it makes sense to "preserve optionality" in this case. For a better understanding, read Prof. Sanjay Bakshi's posts: Link 1 and Link 2 .

These special situations are not very juicy but are very stimulating to work on. They help to keep abreast with the latest regulations and also help to forcefully keep a slice of portfolio in such cash equivalents which can be very useful in case of a severe market decline.

Hiranandani Battle

Mint reports about the ongoing family dispute in the high profile Mumbai based real estate developer : Hiranandani Group. With the group patriarch and his son on one side and the daughter on the other; gone are the days when the family disputes used to be domain of only the males of the business families.

link

What's happening at R Systems ?

One, Mr Bhavook Tripathi (BT) has made an open offer to the public shareholders of R Systems International Limited. The open offer is interesting as it appears to be a hostile bid. Mr Tripathi has been buying the shares of the company from the open market since July- August 2010 and it took him almost 16-17 months to acquire a 22% stake in this company. Under the recently amended take over code, the open offer has to be made if the shareholding of the acquirer crosses 25% and the open offer has to be for 26% of the the fully diluted equity capital.

Is the company vulnerable to a hostile take over ? From the prima facie look of the shareholding pattern, this doesn't appear to be the case. As per the Sep'2011 shareholding pattern of the company, there are 1.23 crs shares outstanding and the promoters own 47% of the company. Doesn't look like that the promoters could be thrown out unless one of the promoter groups is trying to perform a coup with the help of Mr Tripathi. At most, Mr Tripathi can call a meeting of the shareholders and get on to the board and be a constant PITA (pain in the ass) for the promoters.

Incidentally, BT has an interesting precedent to prove his prowess. He and some other persons acting in concert forced Abbott US to pay up a higher open offer price post to the acquisition of Solvay Pharma. In Sep 2009, Abbott Labs US decided to buy world wide operations of Solvay Pharma wherein the Indian operations of Solvay also got acquired indirectly by Abbott. The price of Solvay India was around Rs 900 per share then. As per the Takeover code in India, in indirect acquisitions the acquirer can make a public announcement for an open offer to acquire 20% of the total outstanding shares from the public shareholders within 3 months of the consummation of the deal. Consummation is important because it means when the global deal has got all the regulatory approvals and anti trust approvals or whatever the case may be from all the countries where the operations of the target company are situated. That is a time consuming task by all standards and that provided a perfect hunting ground for Mr Tripathi. He kept on buying shares of Solvay Pharma from the market every day at higher prices. 

The public announcement for the open offer came on Feb 17, 2010 which was a good 5 months after the acquisition. By that time, Mr Tripathi and PACs had acquired more than 7% of Solvay and they had taken the price up to Rs 3000. As per the takeover code, the open offer has to be priced at an average price of 26 week or 2 week period (higher of the 2 prices) prior to the public announcement of the open offer. The open offer was thus priced at Rs 3054.

The 7% stake held by BT and PACs amounted to 107 crs. Even if the average price for Mr Tripathi was half of the offer price, he stood to make a neat 50 crs in this deal. So he is not new to the intricacies of the take over code. Even in R Systems, he might have a well planned exit.

Coming back to R Systems, the promoters own 47% and Bhavook owns 31% (he bought more after making the offer). Remaining public float is 22%. The open offer is for 26% of the shares. Essentially, all the shares should get accepted in the offer. The open offer price is 122 and the current market price of R Systems is 131. Looks like a very attractive place to park cash. On the downside , one may have a maximum loss of  9 bucks and on the upside the appreciation could be good given that one will be riding the coat tails of Mr Tripathi. 

I haven't done a detailed analysis of the intrinsic value of R Systems but the company is debt free and has 75 crs of cash in the books as of June 2011. The market cap of the company at the price of 131 is 160 crs.

Since the announcement of the offer, the promoters have also joined the fray and they are also buying shares from the open market. The company has announced plans to divest some non core assets etc.

What might be the risks associated with this deal ? One risk could be the time delay. The battle continues to go on between the promoters and BT and nothing comes out of it for a good long time. Second risk which my colleague Arpit pointed out was that the promoter(s) reach an agreement with BT and sell their own shares to a third party which further tenders into the open offer. That will reduce the acceptance ratio for the minority shareholders and hence there might be losses more than Rs 9 per share. Fair point but we agree that that might be a low probability event. Third risk could be that promoters transfer the cash and other attractive assets of the company by way of a loan or some other agreement thus reducing the value of R Systems. But that might be difficult as BT owns 31% of the company and he can block any special resolutions. Any thoughts what other risks might be there in this transaction ?

I haven't put my money into this and am still sitting on the sidelines. It will be interesting to watch the outcome of this. Whether this deal goes on to cement BT's reputation of a clever strategist or he faces the fate of Mahabharata's Abhimanyu in the chakravyuh :  easier to get in, difficult to get out.