Monday, October 3, 2011

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..

13 comments:

Mayur Jain said...

how do i check the price of Preference shares????
Is there any scope for retail investor in preference shares compared to Mutual Fund & Big institute to exploit???

Neeraj Marathe said...

Hi Mayur,
go on bseindia.com and fill in the bse code i have mentioned, to chk the price..
and i didnt get ur 2nd question..
cheers!
Neeraj

Anonymous said...

Saw this long back.
Agree with you. The possibility of No return of capital is high in this case. Promoters & business both are unattractive.

Regards,
Jatin
www.fundoopupil.blogspot.com

Kiran said...

yep, I think this was covered well after the huge gains made on Sakuma Exports Pref shares a while ago :)

Here's a more detailed look and comparison of both companies (not my blog) - http://calculatedwagers.blogspot.com/2010/05/comparison-of-2-quasi-equity-securities.html

Personally, I would stay away - god knows what other loopholes would these guys exploit to postpone redeeming the pref. shares. Better stocks out there.

Neeraj Marathe said...

Hi kiran,
Thnx for the 'more detailed look and comparison'.
Cheers!
Neeraj

Raja said...

Hi Neeraj,

I have some basic doubts on the preference shares.

What rules governs the issue and redemption of such preference shares? May be a bit of theory on how they differ could help newbies like me.

Supposing, the company doesn't redeem them, then what happens ? I mean what are the possible end game scenarios in that case.

Regards
Raja

Neeraj Marathe said...

Hi Raja,
The question u have asked is totally based on law and here is my understanding of the same...
1) after going thru Sec 80 of the companies act, which governs pref shares, one realises that in case the company does not redeem the preference shares, it is liable to Rs.10000 penalty..dats it!
2) since preference shareholders are not 'lenders' to the company (pref shares is not 'debt), in absence of repayment of the amt, preference shareholders cannot demand winding up of the company, as ordinary lenders wud do!
3) Network18 can change the terms of the issue at the 11th hour and maybe extend the redemption some more time..(say 5 years more! :-D )

I shall put up more on this aspect in a separate post..
cheers!
Neeraj

Raja said...

Thanks Neeraj,

That's very educative.

I suppose CNBC TV-18 channel is from the same company.

They are the ones who keep quizzing the top management of different firms on so many different topics.

Did they ever grill their own management on these issues ? :)

Regards
Raja

sameer said...

Whats your view on
1)Arshiya International. Huge Debt & ambitious plans. But positive is FTWZ is fixed cost high margin business. Whats ur view on it?
2)Jubliant Industries
3)Globus Spirits
4)Bilcare -> Really dont know why it is making 52 week low. Recent acqusition should boost their revenue multiple times.They should also comfortably manage their debt from cash generated
5)Orchid Chem -> In last few months Dr.Poonawala has increased its stake in company, as per disclosure on BSE.If pledging is only issue, is it not worth betting at this low valuation?

Neeraj Marathe said...

Hello Sameer,
1) I have been studying the entire logistics sector for the past few days, coz it appears to be at an interesting phase...no view on Arshiya yet, but am digging into it..
2) Jubilant and Globus- hvnt seen, so cant really say much
3) Bilcare is a very interesting case. for a number of years, they have been all talk, but no performance. the new product is a hit-or-miss kinda thing..if its a hit, the company will earn truckloads, if its a miss, it will again disappt the mkt..plus, the promoter pledging is really unnerving the mkt..here, i do not have expertise to take a call on their new product, so i am staying away..
4) Orchid - again, havnt seen, so cant say anythn on it..
cheers!
Neeraj

sameer said...

Hi Neeraj,
You mean to say Nonclonable ID technology as new-product.
If yes then assuming this technology becomes totally flop, they still have well established pharma packaging business. Their recent acquisition of ineos packaging division could boost packaging business.
Whats ur call on existing business of pharma packaging ???

Regards
Sameer

sameer said...

Hi Neeraj,
You mean to say Nonclonable ID technology as new-product.
If yes then assuming this technology becomes totally flop, they still have well established pharma packaging business. Their recent acquisition of ineos packaging division could boost packaging business.
Whats ur call on existing business of pharma packaging ???

Regards
Sameer

Neeraj Marathe said...

Hi Sameer,
I do not have a call on the company as such..coz i have not studied and understood it reasonably well. Somehow, i am not comfy wid the risk profile here..
cheers!
Neeraj