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.

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 ?