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Telco: A look at the rights issue - Views on News from Equitymaster
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  • Sep 5, 2001

    Telco: A look at the rights issue

    After having posted a record loss of Rs 5 bn in FY01, Tata Engineering (Telco) has embarked on an aggressive plan to turnaround the company. As a first step, it is tapping the secondary market through a rights issue to fund its expansion plans and improve profitability.

    Here we take a closer look at the objectives of the rights issue, where does the company plan to spend the issue proceeds and whether profitability will improve?

    Telco’s rights issue prospectus reads “Objective is to enhance its position and emerge as India's leading automobile manufacturer in all segments in which it operates. The company intends to achieve its objective by further developing its in-house product development expertise and becoming a low cost automobile manufacturer. The Company plans to launch improved variants of its products as well as new products from time to time to satisfy customer expectations…”

    The main objectives of the rights issue are:

    • To finance a part of the ongoing capital expenditure, product development expenses and investments for strategic alliances for the Commercial Vehicle Business Unit (CBU), Passenger Car Business Unit (PBU) and Engineering Research Centre (ERC) over the next three years.

    • To part finance prepayment/repayment of certain high cost borrowings as permissible under loan covenants or terms.

    Where money comes from… (Rs m) (%) Where money will go… (Rs m) (%)
    Convertible debentures 4,160 32% Capex, Product
    Development, Investments
    7,800 60%
    Non-convertible debentures 2,560 20% Repayment of loans 5,270 40%
    Warrants (assuming full exercise) 3,070 23% Total 13,070 100%
    Internal accruals 3,280 25%      
    Total 13,070 100%      

    First of all, what is on-going capital expenditure? One of the key reasons for the fall in profitability in FY01 for auto companies, apart from a subdued demand scenario, was the introduction of Euro-II norms. This forced all the auto majors to upgrade carburetor run engines to Multi-point fuel injection system based engines (MPFI). As we go forward, emission norms are expected to become more stringent. This combined with others requirements like improving safety standards and fuel efficiency would require substantial investments in research and developmental activity. Telco plans to spend Rs 770 m (over a period of three months) towards setting up ERC.

    Break-up of proceeds use…
    Use of funds FY02 FY03 FY04 Total % of total
    CBU* 1,300 1,020 950 3,270 25.0%
    Car project 3,190 570 - 3,760 28.8%
    Engineering research centre 360 380 30 770 5.9%
    Sub-total 4,850 1,970 980 7,800 59.7%
    Prepayment/Repayment 1,950 2,250 1,070 5,270 40.3%
    Total 6,800 4,220 2,050 13,070 100.0%
    *Commercial Vehicle Business Unit

    Telco plans to utilise 53.8% of rights issue proceeds i.e. Rs 7 bn towards product development for its CBU and PBU. Launching new models and variants is critical to boost volume growth, which off late Telco has successfully managed to do. The newly launched variant of Tata Indica, Indica V2, has received enthusiastic response from consumers (sales for August 2001 has increased by 49%).

    Telco’s outstanding debt as of March 31, 2001 stood at Rs 29 bn at an average interest rate of around 14.7%. To improve profitability at the net profit level, Telco plans to utilise 40.7% of issue proceeds i.e. Rs 5.2 bn towards repaying the high cost debts. The company will repay Rs 1,950 m of its debts in the current year itself, which will result in significant savings in terms of interest outgo.

    Though these measures are expected to improve profitability of the company, the core business of the company i.e. CBU, continues to witness sluggish demand. Besides, the exports have also slowed down in recent quarter in light of weakening global economy. However, prospects are expected to improve in the second half of the current financial year and Telco is poised to capitalize of any upturn in demand. On the costs side the company is aiming to reduce operating costs by Rs 2 bn in FY02 (2.8% of FY02E expenses) in a bid to improve its margins and overall efficiencies.

    However, unless there is an improvement in its volumes in 2HFY02, the company's fortunes are unlikely to be better from current levels.

    Should you invest in the rights issue? Well, for that you will need to take a call on the company’s performance over the next 18 months. A fully convertible debenture will be converted into one share of Telco at Rs 65 in March 2002. The warrant attached to the debenture will entitle the subscriber to the issue, to convert it into an equity share at Rs 120 per share at any time within 18 months of the issue.

    Actually, there are two hurdles here. One, the company has to turn in a good performance. And two, more importantly, the stock markets have to reward that performance. So, there is risk involved in investing in the issue. But then who said that you could earn extraordinary returns without taking risks!



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