Network18 Preference Shares - Amazing return, amazing risk!

Hello all..

Network18 Media and Investments Ltd is in the business of forming and selling subsidiaries, getting into joint ventures and raising finance. (Ok, that was sarcastic..its broadly a media company)

In March 2008, the company came out with a rights issue consisting of equity and preference shares. The preference shares of the company are listed on BSE (scrip code 700132) and NSE.

The opportunity

• The preference shares have a face value of Rs.150 and are to be redeemed at par in May 2013.
• The preference shares have a 5% dividend payout, which is cumulative.
• Till today, the company has not paid any dividend on the preference shares and it is fair to assume that the entire chunk will be paid along with the principal at the time of redemption.
• So, at the time of redemption, a person holding the preference shares should get Rs.150 (principal) and Rs.37.5 (accumulated dividend @ 5% p.a. for 5 years). Thats a total of Rs.187.5/-.
• The preference shares are presently trading at Rs.105/-.
• So if one buys it at present at Rs.105, then one would get Rs. 187.5 in May 2013.
• Thats a return of 79% in 20 months! Super cool!

The problems

Nothing is for free and same is the case here. Lets just take a look at the risks and the problems...

• Network18 is not exactly a conservative investor's dream. The business is damn difficult to understand, given the fact that it changes all the time due to frequent M&A activities. The profitability has been erratic, with the company making profits just once in the last 5 years. More importantly, cash-flows have been really pathetic, with the company reporting a negative cash flow from operations of Rs.306 cr in FY11.
• The company has Rs.1775 cr of debt but it has about Rs.350 cr of liquid investments too.
• The company keeps on getting money by selling subsidiaries and businesses here n there!
• The company will require about Rs.195 cr to redeem the preference shares (along with dividend), which may not seem out of reach, but considering the large debt and negative cash-flows, seems unnerving, to say the least..
• The biggest risk here is the management. They are no saints, lemme tell you! Just look at this postal ballot they got passed..
• Basically what they did was something like this...the Companies Act confers voting rights on preference shareholders, if their dividend is not paid for a period of 2 years. Since Network18 had not paid dividend, the preference shareholders would have gained voting rights.
• So the company declared that it had received letters from preference shareholders that they would like to waive their extra rights (now why would anybody do that) and hence, through postal ballot, they got these preference shareholders' rights waived. (Promoters must be holding at least 50% of the preference shares, as per my reading)
• So would they pay up at the time of redemption? Or would they find some loophole or the other and do some hanky-panky? Thats a tough one to answer..

To conclude

• Although the possible return here is mouthwatering, there are 2 big risks; the financial position and the management. 
• Both of them scare me to a great extent, to take a meaningful position.
• If one is ok with these risks and one thinks that they are not very material, Network18 offers a great opportunity to make respectable returns in this uncertain market. The preference shares are fairly liquid too. 
• Given my risk appetite, I personally intend to give this one a miss for now, but I would like to keep a watch on future events (like insider buying) to revisit my decision. For the bold and the dangerous people out there, do take a look at this opportunity.

Cheers and happy investing!!

Edited note (added on 03/10/2011): After talking with a coupla legal dudes and taking some serious professional legal opinions, it turns out that in case of unavailability of profits, there is no onus on the management to declare and pay cumulative preference share dividend. In such case, they could very well get away with redeeming the preference shares at Rs.150, and not paying the cumulative dividend at all. Which essentially means, that they would have used the preference shares ka paisa free of cost for 5 years! :-)
In such case, (assuming they honestly redeem it without changing the terms of the issue and all) the return would be about 42% in 20 months..anyway, the risk remains very high and I am not really inclined to get into it..