The Ugly Indian

TN Ninan of the Business Standard has written a very crisp and thought provoking column concerning the case of Male Airport and similar contracts which were entered in the past and had Governments, Indian or foreign, as one of the parties to the contract. 

These contracts seem to put the Governments in positions where by if the revenue projections of a particular project are not met (which is almost always the case), the successive compensations by the Governments follow the case of mating rabbits and the payments end up getting spiralled in a Fibonacci sequence.

What choices do the Governments have apart from either scrapping the contracts altogether or to renegotiate them ?

The issue closely resonates with concerns raised by Neeraj Marathe in his blog about Noida Toll Bridge.

J B Chemicals- Corporate Disclosures

Aaron Levenstein said “ Statistics are like a bikini. What they reveal is interesting, but what they conceal is vital.”

Reading the following announcement provides an uncanny familiarity to the above quote.

Scripcode : 506943    Company : JB Chemicals		View All
Updates 15:19 With reference to the earlier announcement dated May 24, 2011 informing the Exchange about the Company’s sale of Russia-CIS OTC business undertaking to Cilag GmbH International, Switzerland, (‘Cilag'), a subsidiary of Johnson & Johnson, and announcement dated July 14, 2011 informing the exchange about the closure of the said transaction and the receipt part from the consideration, the balance being kept in the agreed Escrow Account, JB Chemicals & Pharmaceuticals Ltd has now informed BSE that the company and its subsidiaries have received claims by the Johnson & Johnson group entities which corresponds to the amount held in the Escrow account. The Company and its board of directors consider this action untenable, do not accept the claims and are seeking appropriate legal advice in relation to the same. The Company shall spare no efforts to protect the interest of all its stakeholders.

Please check the announcement here as well.

In the JB Chemicals- Johnson & Johnson deal, the release of the money kept in the escrow account has been challenged by the buyer; Johnson & Johnson. That’s informative but the announcement is silent on the amount of money kept in the escrow account. And how much claim has the company received from Johnson and Johnson ? Silence again. The announcement is plain English language and has no element of God’s language “Mathematics” in it which is what the shareholders would be very interested in. That leads me to a slightly modified quote of Levenstein that what the announcement has revealed is interesting but what it had concealed is vital.

JB Chemicals had sold its Russian OTC business to a subsidiary of Johnson and Johnson in July 2011. The total sale consideration was 738 crs plus $35 mil to be paid for the inventory and receivables of the said division. Despite being an important part of the transaction, the amount kept in the escrow account was never voluntarily revealed in the public domain and it was only on checking with the company that a figure of 175 crs was mentioned as being kept in the escrow account.

It is very important for the companies to leave opacity behind and lay bare the facts as transparently as possible; obviously without jeopardising the business interests. The lesson for the investors is to be very cautious of the money kept in the escrow account. In the recent times, many a deals like Gwalior Chemicals (now Gee Cee Ventures) had money in the escrow account which never reached the treasury and pockets of the shareholders.

Contrast the above announcement of JB Chemicals with that of announcements made by Ashiana Housing Limited here and here.

On both the occasions, negative developments surfaced with respect to the business of the company. Not only did the company promptly informed the stock exchanges, it also informed the shareholders about the monetary impact and the total amount invested in the projects impacted by the negative developments. That speaks highly about the quality of the corporate disclosures.

To be fair to the promoters of JB Chemicals, let me state that there is no act of dishonesty which I came across in my research on the company. There has been no incident of corporate misgovernance either. But it is imperative that the companies raise the bar of corporate disclosures a bit higher with every passing day. Shareholders would highly appreciate the effort without keeping any part of their love in the escrow account.

Imran and Vijay

Have a look at the above gold auction cum invitation notice posted in the Business Standard today by ICICI Bank. One Mohd Imran of Najibabad (Uttar Pradesh) had pledged gold ornaments and availed a loan against it. Failing to repay the loan, the bank has taken the step of auctioning the collateral. Nothing wrong on part of the bank. But look at the triviality of things. The gross weight of the pledged gold ornaments is 15.5 gms which going by the last closing price of gold (Rs 29,600 per 10 gm)is Rs 45,880. Let's keep aside the arguments about the net weight of gold in the gold ornaments or the price of gold when Imran would have availed the loan. Intuitively, either of the above or both combined would surely lower the value of the collateral. But let's stick to the figure of 45,880. Going by the gold loan scheme, the loan provided is around 75-80% of the market value of the collateral. Thus, the loan which Imran would have taken couldn’t have been more than Rs 35,000.

I am sure ICICI Bank would be spending much more than 35,000 in the costs related to the auction process; which includes advertising in the newspapers. Thus the Net Present Value of this auction process is negative and hence any sensible banker would simply write off the loan. But any such write off by the bank would lead to an avalanche of moral hazard and there would be scores of Imrans and Ankurs who would willingly default on the loans knowing well that the bank wouldn’t even bother them in the event of non-repayment.

Compare Imran with one Vijay Mallaya. This man has defaulted on 7500 crs of loan (21 lakh times the loan availed by Imran) taken from the banks to give wings to his idiosyncrasy called Kingfisher Airlines. Nothing much came out of the airline except that the Kingfisher bird would have lost its reputation in the bird kingdom on being associated with the airline. By now, the bird would have even applied for a name change through an affidavit filed in the birds’ court.

The banks and the financial institutions find them completely helpless in extracting even one single rupee out of the collateral. Though the banks have started talking about the sale of the planes and the Kingfisher villa; I am ready to bet that the bankers wouldn’t be able to even attend the pool parties at Kingfisher villa ; forget about auctioning the villa. Why is it that time and again, financial institutions are helpless and hopeless in recovering their dues from the large borrowers ? The single biggest factor to my mind is nexus between politicians and large businessmen. Both of them like Siamese twins are joined at the hip. Businessman help the politicians during the elections to buy out votes and post the elections to buy out legislators and members of Parliament. Once in power, politicians control the banks and the bankers. And the two ends meet when the businessman is able to lay his hands on the money in the bank and refuses to pay up. And then this vicious cycle goes on.

This problem can be solved if we have iron handed legislature (very unlikely) and iron handed judiciary (very likely) which forces the defaulters to pay up.

There is one example which is noteworthy. QVT Financial is an international hedge fund which invested in the FCCBs of some Indian companies. Companies which ran out of money and luck; couldn’t convert these FCCBs and opted for restructuring of these FCCBs. Wockhardt being the early mover in the recent debt restructuring mela proposed to settle the FCCBs at a 75% discount to their redemption value. Finding it unpalatable, QVT approached the Bombay High Court for a winding up petition against Wockhardt. Wockhardt tried a bit to sob but the learned judges wouldn’t take any of it and ordered the winding up of the company in the event FCCBs remain unpaid. A tight rap on the knuckles can bring a lot of rouge elements in line. Since then Wockhardt has coughed up money and the FCCBs have been settled. QVT has now turned the heat on Zenith Computers and KSL Limited (promoted by Tayal group. Ex promoter of Bank of Rajasthan). Taking a cue from the Wockhardt case, a lot of companies like Hotel Leela, Subex Limited, 3i Infotech etc have redeemed the FCCBs or settled with the FCCB holders at mutually agreeable terms.

QVT example shows that no new laws are required to tackle this menace. What we want is a bunch of tough lenders and a tougher judiciary.

Post Script : I am not sure if Business Standard reaches Najibabad, a small town 170 kms from Delhi. If that is true, Imran wouldn't be able to read the ICICI Bank notice.

Delhi Diary

Where would one normally find bouncers ? Usually discotheques. 

But the place I went to recently had a different setting. It neither had neon lights nor did it looked like a disco. However, more than the numberof ordinary people in the room, there were bouncers or should I say pehelwans. I read the banner carefully and verified with the gentleman sitting next to me. It was indeed the venue of the AGM of R Systems International Limited.

It baffled me that why does a company need bouncers ? Sure we have heard and seen shareholders baying for each other's blood for a box of Haldiram's sweets. But never did any company had to employ bouncers to solve such crises. The crisis in R Systems is much graver than that. This company is facing a hostile take over bid from one, Mr Bhavook Tripathi. I had earlier written about it here and here.

In the agenda items of the AGM, the management had proposed a special resolution which envisaged alterations in the articles of association of the company. The proposed amendments were that nobody except the promoter group can take any decision regarding merger, liquidation of any asset, providing any loan to any other entity, special dividend , removal of executive directors etc. Basically all the ingredients of making the company unattractive for any hostile takeover bidder. But the defeat of this special resolution was a forgone conclusion as Mr Tripathi holds 32% stake in the company and the special resolution would have been vetoed out. Sensibly, the company decided to withdraw the special resolution before the AGM to save face.

Meanwhile SEBI has not processed the open offer made by Bhavook Tripathi and even the committee of independent directors of R Systems has not come out with the recommendations on the open offer.

Though on the face of it the promoters of R Systems own 49% in the company and it is difficult to dislodge them but the discomfort in the behaviour of the company and the promoters seems to tell a different story.

Even Ravana (original character, not Abhishek Bachchan) used to think he is invincible till his younger brother Vibhashana revealed the secret of of his death to Rama. Who knows what secret about R Systems does Bhavook Tripathi has up his sleeve ?

Disclaimer : This does not constitute investment advice and I don't have any position in this stock on the date of posting this entry.

Picking pennies in front of a steam roller ?

At any given point of time, I like to keep around 10-15% of my portfolio in special situations which are not linked to the gyrations of the market. There are triple benefits which I see in process : the tendency to immediately use all of the cash to buy equities is perturbed, the regret of seeing severe draw downs of portfolio in case of a severe market crash is also lesser and thirdly and most importantly I get excitement, happiness and pure joy of spotting an arbitrage and working it out. (There are other workouts like Sudoku and Rubik's cube but I don't find them exciting as I am unable to solve them and also there is no money to be made)

Over the last few years, my thinking has evolved over working on a limited number of special sits and not spreading too thin on a number of them. The criterion which helps me select is that the opportunity should provide at least an annual IRR of 15%, it should have very low correlation to the market, it should have minimal risk and it should be good enough to put a minimum of 3% of my portfolio. If any of these criteria is unmet, I give the idea a pass and wait for the next one to pop on my screen. One source of such ideas is the BSE announcements. I religiously read all the BSE announcements and if I miss it someday, my calendar reminds of those dates which appear as a backlog.

One interesting announcement came on April 26th, 2012 about the NCDs (Non Convertible Debentures) of Jyoti Structures Limited. Jyoti Structures,  a company into the business of telecom infrastructure had come out with a rights issue of 1.02 cr NCDs in Feb 2011. The NCDs had a face value of Rs 120 and carried a coupon rate of 7% to be paid quarterly from the date of allotment till the date of redemption which was 15 months from the date of allotment. Accordingly the date of redemption is May 14, 2012. Between Feb 2011 and now, the NCDs traded in the range of 100-110 bucks thus implying an IRR of more than 20% at different periods of time but the financial position of the company didn't excite me much. The risk of interest not being paid and the possibility of a default on redemption made me stay away from the issue.

On April 26th, the company announced the record date (May 6th, later revised to May 10th, 2012) for the redemption of debentures along with the final payment of interest. The interest along with the redemption amount total up to Rs 122.10 per NCD. The total amount required for payment is 124 crs. One look at the Sep 2011 balance sheet shows that the company had around 580 crs of loan (most of it working capital) and around 1000 crs of net current assets. Apart from it, the company has around 70 crs of investments. Overall, it should not be difficult for the company to raise additional working capital loan of 124 crs against the current assets and redeem the debentures. Additionally, the company has kept up with all the quarterly interest payments on the debentures. It seems that the company is both able and willing to redeem the debentures.

The market price of Jyoti Structures N1 is 120.50. The redemption date is May 14, 2012. Buying an NCD now at 120.50 will yield 122.10 with an average holding period of about 7 days. That's an absolute return of little over 1%.

I see little risk of the payment not being made as the record date has already been announced. But there is never a sure thing. So I am keeping this limited to 4% of the portfolio.

Do you spot a steam roller in sight while I am busy picking up pennies?

Disclaimer : This is not an investment advice. My opinions and views are more or less always biased. If I see some steam roller in any of my ideas, I will surely run away and blog about it later, if at all.

Guess this one ?

Small quiz to the readers. Name and connect these gentlemen.
Clue : Answer to do with investing

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.