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Are promoters damaging shareholder value? - Views on News from Equitymaster
 
 
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  • Mar 5, 2012

    Are promoters damaging shareholder value?

    Investing in stocks is like crossing a busy junction in some ways. Safety is the eventual desired end result. Capital protection/ appreciation in case of the former and safely crossing the road in case of the latter.

    On both accounts, an individual would exercise caution before proceeding with the related action. But one can never say when something as puny as a scooter (issues relating to promoters pledging their stake); or a mid-sized vehicle such as a van (FCCB conversion & debt restructuring issues); or even a speeding truck (the big bad recession) may come and hit the individual.

    In this article, we focus on one of the aspect that has been an area of concern for investors in recent times promoters pledging their stakes.

    Share pledging is when promoters use their shares as collateral to raise funds. This usually takes place when the company they hold stake in is in need of capital. However, there are instances when a holding company raises money for meeting its own capital requirements by pledging the shares of its publicly listed subsidiaries.

    Share pledging seemed to have become a trend and ultimately an area of concern post 2008, when the markets began drifting downwards. It is not a new concept and has been happening for nearly two decades. However, investor concerns began to erupt after the Securities and Exchange Board of India made it mandatory for promoters to report their pledged shares. All this took place post the Satyam scandal, wherein the company's promoter had pledged nearly all of his shares.

    One could take pledging of shares as a sign of a company's low credit worthiness. But the same is true only for select cases. Pledging should be studied in conjunction with the health of the company's balance sheet. Raising capital through pledging of shares is an alternative way of raising money. But, it definitely is a less common method as compared to the more traditional ways through debt or equity infusion.

    Investors would do good to be wary of the amount of shares pledged by promoters of the companies they hold shares of. Pledging can pop up as a major concern in falling markets as the value of the shares, essentially the collateral for the loans, depreciate. There are many ways in which a company's promoter loses control of his company. But nothing could be worse than losing it for being unable to cough up the margin money on pledged shares. And this has already happened not so long ago with the promoters of Great Offshore. A more recent example is of KS Oils, where its financers offloaded the company's shares.

    Below is a list of companies (only forming part of the BSE-500 index) with the highest promoter pledged shares (latest reported quarter). Also provided is similar data for the last three years.

    Companies with highest shares pledged by the promoters
    Company Name Dec-11 Mar-11 Mar-10 Mar-09
    Tata Coffee Ltd. 100.0 100.0 100.0 100.0
    GTL Ltd. 96.4 0.0    
    Bilcare Ltd. 95.3 83.4 90.0 96.1
    Jai Balaji Inds. Ltd. 94.4 39.4 4.3 4.3
    Suzlon Energy Ltd. 94.3 62.6 70.0 43.2
    Subex Ltd. 93.8 81.5 50.6 61.2
    Parsvnath Developers Ltd. 91.6 77.9 83.1 79.5
    United Spirits Ltd. 91.5 87.5 85.9 90.8
    Alok Industries Ltd. 91.1 68.2 90.9 63.7
    Kingfisher Airlines Ltd. 90.2 50.6 68.5 66.1
    Data Source: Ace Equity
    *Companies forming part of the BSE-500 Index only

    Considering that the promoters of the above mentioned companies have pledged more than 90% of their stake (entirely in the case on one), it would definitely raise concern for an investor. But ultimately, it boils down to management integrity, the nature of the business as well as the health of the company's balance sheet. In case of these not being of best quality, investors would do well to exercise caution in investing in such stocks.

      Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.

     

     

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