NBFCs - the case of the Unknown Unknowables

For a long time, NBFCs in India have been talked about, from both the positive and negative points of view. Positive, because India is such a huge country where a large chunk of population is not served by the banking system. NBFCs therefore have a huge opportunity to serve this un-addressed market. Negative, because of the huge frauds happening, opaque lending practices, allegations of NPA 'management' etc etc. 

In this post, I am talking about 2 NBFCs; First Leasing Company of India Ltd and Tourism Finance Corporation of India Ltd. My objective is not to pass judgement about these companies, but to showcase why investing in NBFCs is full of unknown risks.

Some fantastically managed NBFCs like Sundaram Finance, Bajaj Finance have been huge wealth creators for investors. The case of First Leasing is, well, a bit different.

• First Leasing Company of India Ltd was, well, the first leasing company of India! Started way back in 1973 by Mr.Farouk Irani, the company was the pioneer in corporate leasing industry. 
• Over the period of 4 decades of its existence, the company reported good numbers, gave good dividends, had negligible NPAs and was considered as the benchmark in the field.
• Last week, the CMP of the stock was Rs.32, with a book value of Rs.150 plus and a dividend declared of Rs.1.80, making it a dirt-cheap, attractive opportunity. 
• There were also talks of a sell-out happening, making it even more attractive.
• I had looked into this company earlier and the only thing I found amiss was that long term lending was being done with short term funds. This typically happens when an NBFC falls short of capital and needs funding. However, to be honest, I did not find any 'fraud' in the books, on the face of it.

On this background, it was quite shocking to read RBI's press release.

In the light of the findings of the inspection of the books of accounts and other records as on March 31, 2013 of First Leasing Company of India Ltd., 749, Anna Salai, Chennai 600002, the Reserve Bank of India has, in public interest and in exercise of the powers conferred on it by Sections 45JA and 45L of the Reserve Bank of India Act, 1934, directed that until further orders, First Leasing Company of India Ltd. shall not,

1.  sell, transfer, create charge or mortgage or deal in any manner with its property and assets without prior written permission of the Reserve Bank of India;
2.  declare or distribute any dividend;
3.  transact any business; or
4. incur any further liabilities.

Essentially, RBI has frozen the company's business altogether. This happens only when there is a system level fraudulent issue or there is severe non-adherence to laws and guidelines. Something of this sort happening to a company with a 40 year history, consistently negligible NPAs, great looking financials, great dividends is very shocking indeed. There are such a lot of things about the lending business we dont know and cant know. IMHO, this event will surely have an impact on overall NBFC valuations and the way the market perceives the sector and its companies.

Let me give you another example, that of Tourism Finance Corporation of India Ltd. This is again a listed company with a market cap of Rs.160 cr. Book value is Rs.50, CMP is Rs.20. They have also applied for a banking license recently! :-)

Have a look at this bid document. This is about a company they had lent to which went under and now they are auctioning off that company's assets to recover their dues. On page 11 of the document, details of their exposure are given, which i am reproducing here..

On a loan given of Rs.3.35 cr, there was interest accrued of Rs.109 cr!!! How much of this has been accounted for as income in their books is not known, but the sheer size of one of their loans with respect to the company's overall size is mind boggling. If a large write-off like this one happens, the book-value itself would be massively hit and the stock would no longer look cheap.

Learnings from all of the above:

• The NBFC business is structurally a risky business, where a fine balance has to be maintained between growth and quality of assets. Few companies which sacrifice quality to show growth and adopt aggressive accounting do great for some time, until the bad quality loans catch up with them and then comes a huge huge write-off.
• It is extremely critical to understand what the business is. Merely going by its financials and book-value (which a lot of investors do) will not help. Book value is an accounting concept and can be bloated very easily. If one does not understand how the business is operated, better to not get into it at all. 
• It is also extremely critical to understand the laws governing the NBFCs. The capital and provisioning requirements of the RBI can change the overall picture of a company very fast and one needs to have a good grasp on the same.
• All in all, one needs to acknowledge that there are a lot of 'unknown, unknowable' aspects in the NBFC business. One should therefore not rely 100% on the numbers for taking investment decisions. It is much better to go with a proven management, which is fully transparent on all the aspects of the business and is in a business which one can understand and identify with properly. Good knowledge of accounting and ability to dissect the financial statements is also essential. If investing is risky, investing in NBFCs is, ummm, more risky!

Please do greater due diligence while investing in NBFCs. There are many aspects of the business which we cannot understand by studying the financials alone.

Cheers and happy investing!!!

Disclaimer(s)!!
1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) As a professional investor, I may have positions in stocks discussed.

4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours! 

Sah Petroleums - Bonus Issue

Hello to everybody after quite some time. I have not been able to update the blog in the recent past due to certain reasons, but I am back, with a whimper at least!

I had written on Sah Petro a couple of months ago. Please do go through the same to get some background on the company. Some of my fears like those regarding inter transfer of shares among promoters did not materialise, which is good! But the generous dividend they recently declared is not so good!

Sah Petro's promoter holding stands at about 87%, with Navis Capital (a PE fund) holding 62% and the erstwhile promoters holding 25%. In order to comply with SEBI's minimum public shareholding norms, the company recently announced the issue of bonus shares to non-promoters. In effect, the promoters will be diluting their own holding without getting any money for it. Now why exactly would a PE fund do this is an obvious question, but thats besides the point because, well, they are doing it!

An anonymous reader requested me to write an article on this situation, hence this post!

Whats going to happen?

Click to enlarge

In effect, if you buy 19 shares of the company at Rs.22 (total Rs.418), you get 23 shares extra. Free! So your holding cost for the total of 19+23=42 shares becomes Rs.418, translating into a per share cost of Rs.9.95. If we consider the taxation advantage we get due to bonus-stripping, our cost would be even lower. Current price is Rs.22, resulting in a fairly large difference. (All calculations are based on the current market price of Rs.22, which is a moving number. Since the stock has been shifted to T2T category, there will be some fall in the price probably).

What should one do?

Our holding cost of Rs.9.95 translates into an effective market cap of Rs.50 cr, on the expanded capital. So, in effect, the question to be asked is; would we be comfortable buying Sah Petro for Rs.50 cr? Well, as of March 2013, the company had Rs.60 cr cash on books, which makes it an interesting proposition indeed. (I do have some concerns here, which are detailed in the earlier post on Sah).

Is there an arbitrage opportunity?

The ex-date is about 1.5 to 2 months away. The arbitrage here is simple. Buy the shares before ex-date for Rs.22 (CMP) and sell them off on or after ex-date (for a higher price than Rs.9.95), resulting in a neat profit within a couple of months. Sounds simple, but we need to answer a zillion dollar question; how much will be price fall on and after the ex-date?!
If we do it mathematically, it would be something like this;

Thats a theoretical and mathematical calculation, but what will the market do? To get a clue, lets learn from history. Another company called Warren Tea also had recently issued bonus shares to comply with the minimum public holding norms. The price action in that stock was follows:

• Price before the bonus announcement (21/01/2013): Rs.316
• Price immediately after the bonus announcement (22/02/2013): Rs.373 (price exploded. In Sah Petro too, there was a 20% upper circuit on the day of the announcement)
• Price before ex-date (20/03/2013): Rs.372. (21/03/2013 was the ex-date)
• Ratio: 7 shares for every 10 held, to non-promoters.

If we do a similar mathematical calculation as above, the price on ex-date should have been Rs.334. But what actually happened was quite different.

• On ex-date (21/03/2013) itself, the stock closed on the lower circuit, at Rs.298. 
• After that the slide continued till Rs.215-220, where the stock became stable. (Incidentally, the cost, after considering bonus shares would have been Rs.218!!)
• In effect, if you were unlucky enough not to be able to sell immediately on or after ex-date due to the lower circuits, you would not have made much money on this as an arb trade.
• The sorry price chart of this whole drama is as follows:

Click to enlarge

The market did not price this mathematically, and therefore, we should not assume that the stock will settle at the mathematically calculated price. Traders and arb guys will sell wholesale post ex-date and it will drift a lot lower. Will it come all the way down to Rs.9.95 is something I cannot predict! However, if it settles at even Rs.12-13, an arbitrage opportunity does exist.

So, what can be done?

• This does look like a neat arb opportunity, but I would disregard the same from my mental calculations.
• The only question I would ask is; disregarding the special situation, fundamentally, am I comfortable buying Sah Petro at Rs.9.95 (which is a market cap of Rs.50 cr) and holding it? Are the valuations attractive enough at Rs.9.95? Finally that is the base level question, which gives us comfort in case things do not go as per plan. 
• If the answer to the above is yes, I would surely buy. Arbitrage, if it happens, would be most welcome and an added bonus. (No pun intended)

I feel this is an ok, if not a fabulous opportunity. What do you feel?

Cheers and happy bonus investing!!

Disclaimer(s)!!
1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) As a professional investor, I may have positions in stocks discussed.

4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours! 

Clariant Chemicals' sale of business - no clarity here!

Lets play a small word association game. I will write a word and you say the first thing that comes to your mind upon reading the word..


1. Stock market  (Most of you will probably say high returns, volatility, manipulation, satta, etc)

2. Government  (Most of you will probably say lethargic, corrupt, unreliable, etc)

3. Wife  (Dangerous territory..so no comments from my side)

4. MNC Management  (I am sure most of you will say high quality, clean, professional, fair, etc)


Well, such has been the record of managements of MNC subsidiaries that we generally associate them with everything goody goody. A lot of these companies have been prolific wealth creators for investors over the years. And hats off to these guys.

But, it is not necessary that all MNC managements would be great, fair, transparent and professional. This is not something we can take for granted. Such representativeness bias can be highly dangerous to investors.

Lets take the recent happenings in an MNC subsidiary, Clariant Chemicals India Ltd.

Whenever the name Clariant Chemicals is mentioned, I have always seen experienced investors going gaga about the company. And rightly so. The company has grown profitably and has distributed liberal dividends. So, when the global CEO said in December 2011 that they aim to reach Rs.4600 cr in India sales by 2016/17 (CY11 sales were just Rs.1000 cr), investors sat up and took notice. Of course a management of this quality would have a broad plan under which they were making such claims right? Sadly, that doesn't seem to be the case. Not only have the sales been flat in 2011 and 2012, but recently, the company has announced sale of a large chunk of the Indian business (as a result of sale of the global business unit). Now how will the sales grow to the levels promised is beyond my understanding!!

First, let us look at this deal. The global Textile Chem, Paper Specialties and Emulsions business of Clariant (including Clariant India's business unit) are being sold to SK Capital for about Rs.3000 cr. Since Clariant India's business unit will also be sold, Clariant India will get part of this money. Well, sounds ok.

What is not ok is the way Clariant India has treated minority shareholders regarding this deal.

On 26/03/2013, Clariant India put out an announcement saying that Clariant India will get Rs.209.15 cr out of the total pot for sale of the mentioned businesses. From where did this sacrosanct number come was not given. To be fair, what is being given to Clariant India seems to be a good deal. The global business was sold at about 0.45x sales, while the India business is being given 0.6x sales. We have no idea about the India business profitability though! I was waiting for the postal ballot for this to be published, which would give more details and justification for the deal and what Clariant India is receiving.

I thought that decent clarifications and info will be given when they give out the notice for the postal ballot on this issue. (Since this sale cannot be done without the approval of shareholders).

However, I was absolutely shocked when the postal ballot was put up on BSE. It seems like the management is totally taking the minority Indian shareholders for granted.

Consider this.. the postal ballot is basically to ask the shareholders whether they are ok with the sale of the mentioned businesses for Rs.209.15 cr.
Now, if you want to take a proper informed decision whether to say yes/no on this, you will need info about the business being sold, right?

Shockingly, the explanatory statement to the postal ballot simply states that "TPE business contributes about 35% to the net sales of the company and includes a manufacturing plant for textile products situated at Roha". Thats it!!!!!!!!! It gives absolutely no more details about anything!! So how would you say yes/no to this resolution for selling the business? They are just not giving you any info!!

• So basically, does the Board want us to blindly trust whatever they say as true and fair? 
• Nothing has been mentioned as to who did the valuation, how was the number arrived at?
• We do not know how much profitability will reduce, how much fixed assets will go out? In short, there is virtually no info given on how much would the remaining business be like?
• So what purpose will this postal ballot serve? How does the Board expect shareholders to take a decision, when they are just not providing any info to take the decision?!

The Board does not seem to take into consideration the minority shareholders' opinion for this. It seems as though they are saying 'look this is what we have decided, just agree to this'. Not the best in terms of corporate governance, eh? I would request all shareholders to oppose this resolution and spread the word to everyone you know to oppose it.
This is just not done.

If things like this continue, then the 'management premium' that the valuations of MNCs were getting will soon turn into 'management discount'!!

Cheers and happy desi investing!!

Disclaimer(s)!!
1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) As a professional investor, I may have positions in stocks discussed.

4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours!