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STOCKMARKET
Perils Of Pledging
Pledging of shares may not be good for promoters as risks loom
RAJESH GAJRA
25 April 2009
One Foreign Institutional Investor (FII) client in a UK-India joint venture equity research firm based in Mumbai told the head of the firm that “if you see what I see in the promoters’ pledged shares market, you would think twice about investing in most Indian companies”. This FII client’s remarks were based on an analysis of the quantum of shares pledged by promoters of over 400 companies since February when the Securities and Exchange Board of India (Sebi) introduced these new disclosure requirements.
The reality, however, is not black and white. BW analysed the disclosures of 28 of the 100 frontline companies belonging to the 50-stock S&P CNX Nifty Index and CNX Nifty Junior Index that had pledged shares. The results: out of the aggregate promoters’ holding of Rs 2,00,284 crore in these companies, 23 per cent or Rs 46,879 crore worth of promoters’ shareholding was pledged. At first glance, this figure seems high. But as a proportion of the Rs 24,17,179-crore aggregate market cap of all 100 companies, it amounted to just 1.93 per cent (see ‘Are Promoters Losing Grip?’).
The data shows that for a major chunk of the frontline companies, the threat of promoters losing control over their companies does not exist, but some do face that risk.
Pledging is not unknown. Individuals pledge jewellery to meet their monetary needs during troubled times. This could also apply to firms under financial distress. “This sort of activity in the pledged shares market tallies with what we are seeing in a range of Indian firms, including a number of the Sensex constituents, struggling with operating cash flow and struggling to meet their debt repayments,” says Saurabh Mukherjea, head of India equities at Mumbai-based Clear Capital, a research advisory firm and a subsidiary of the UK-based Noble Group.
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#Including Apollo Tyres, Dr. Reddy’s Lab, GMR
Iinfrastructure, Indian Hotels, Jindal Steel,
Jaiprakash Associates, Lupin, Moser Baer
India, Mundra Port and Raymond, which had
pledged shares disclosures; *In Rs crore,
as on 7 April ’09; **as of 16 Apr ’09, and as
of end of Feb ’09 for the aggregate balance
of Nifty and Junior Nifty; ***In %, as of 31 Dec ’08
Source: BW Research, Enam Research
and Capitaline Plus |
But the situation is not dire. “If a promoter has pledged, say, only 20-30 per cent of its total 50-70 per cent stake, it still retains a 30-40 per cent stake in the company. And that is still fine,” says Shailesh Haribhakti, executive chairman of BDO Haribhakti Consulting, and also a non-executive independent board member of some listed firms. “So long as there is appropriate servicing of the loans behind the pledged shares, it does not create any risks for the promoters.”
The Sebi-mandated enhanced disclosures do not require companies to disclose the reasons for the pledge. Barring a few, most of the companies that have disclosed this information have not revealed the purpose behind it. “You have to watch out for promoters that have over-leveraged themselves into un-related businesses, particularly real estate (if the company is not into it as a core business),” says Girish Vanvari, executive director-mergers and acquisitions at KPMG India.
Vanvari points out that if the promoters put the borrowed funds back into the company’s core business, investors can still give them the benefit of doubt. But a pharmaceutical company’s promoters putting the borrowed money into land development or real estate should make investors suspicious.
Investors give significant weightage to the commitment of promoters to their companies. Any invocation of their shares (pledged as collateral to lenders) due to non-payment of loans borrowed by the promoters can theoretically lead to the lenders taking control of the company or selling the stake in the open market.
In the Satyam case, some lenders with whom the promoters’ shares were pledged invoked the pledge and sold the shares in the open market. Can other promoters also lose control similarly? “I believe that some will, but most won’t,” says Mukherjea. “Indian promoters are likely to be able to exert control on lenders (through social and business contacts) so that the lenders do not move in to seize control.”
It is believed that some institutional shareholders — particularly insurance firms, banks and financial institutions, but largely excluding domestic mutual funds and FIIs — act as proxies for promoters. This gives power to the promoters to influence voting decisions even if their stakes go below 25-30 per cent.
For instance, if an investor were to theoretically look at the 31 December 2008 shareholding pattern of Mahindra & Mahindra, he would see the promoters’ holding at 26.5 per cent. The company’s disclosures in February revealed that 8 per cent stake was pledged by promoters. Theoretically, if the company’s promoters were to lose the 8 per cent due to any invocation by the lenders, then their stake would fall to 18.5 per cent. Hypothetically, the 23.2 per cent holding by insurance companies, banks and financial institutions could then be used as a proxy to serve the promoters’ interests.
Ironically, the lenders themselves are at risk if the promoters default. “Even if a lender moves in to seize the company, it is left with control of a company which it has no operational knowledge of,” says Mukherjea. “Once the lender seizes control, the stock price will plunge, which will reduce the value of the lender’s security.”
In the West, promoters do not have the flexibility to pledge their shares. “The UK does not have a pledged shares market on anything comparable to the scale we see in India,” says Clear Capital’s Mukherjea. “This is largely because British banks are reluctant to accept listed companies’ shares as security for working capital loans. And I suspect that most of the banks in the developed world hold a similar attitude.”
Companies and market intermediaries are normally wary of regulatory pressures on disclosures. But the issue of promoters pledging shares warrants further tightening. Sebi can ask companies to reveal the end use of funds borrowed through pledged shares. There is also a lack of clarity on the implications of Sebi’s takeover norms on the continuous potential of pledged shares being invoked by the lender. In such cases, a lender ends up acquiring a substantial stake in a company without having to comply with the disclosures of creeping acquisition.
Promoters of India Inc. might be breathing some sigh of relief at the moderate stockmarket rally in April. But smart shareholders would still be watching the status of pledged shares every quarter.
rajesh dot gajra at abp dot in
(Businessworld Issue Dated 27 April-04 May 2009) |
Sensex rises 61 points in opening trade 
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