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Posted on 25-Jan-2019 Comments  0

Essar Bidding

Why the government is right in preventing promoters from bidding?

The Essar Steel case is taking an interesting turn. The promoters have come up with the highest bid for the assets of Essar Steel after the Arcelor bid was accepted and finalized by the NCLT. The bankers will obviously be interested in a higher bid as is evident from the keenness shown by SBI. What is the road ahead for Essar Steel?

Ruias want to better Arcelor

Based on the NCLT bids, Arcelor Mittal emerged as the highest bidder for Essar Steel at Rs.42,000 crore Against a total outstanding loan of Rs.53,000 crore, that still leaves some room for a hair cut on the total price. However, the twist came when the Ruias, promoters of Essar Steel, agreed to bid for the assets at a price of Rs.53,000 crore. The Ruias contended that with their bid, they would be able to fully pay the financial creditors like the banks and also the operational creditors. Speaking at the World Economic Forum in Davos, Aditya Mittal of the Arcelor Mittal group called it delaying tactics by the Ruias. His question was that if the promoters really had the capability to pay the full sum then why Essar Steel should have gone into bankruptcy in the first place. The final decision has to be taken by 31st of January and it will not only be interesting but also set a precedent for any such cases in future. To understand this case, we also need to understand the SC decision today quashing a petition to change the Bankruptcy Code.

Background to the SC verdict

As per the original regulations of NCLT, promoters and promoter groups are barred from bidding for the assets under NCLT. That is why Essar Steel had opted to go out of the NCLT and work out the deal privately. There was a petition filed in the Supreme Court raising questions over the fairness and equity of not permitting promoters in the bidding process. The SC decision today, quashing the petition, virtually sets the debate to rest. In the Essar case and in future such cases, the promoter will not be allowed to bid for the assets.

Why this is the right path

In a way, the SC decision has hit the nail on the head. Allowing promoters to bid is an invitation to promoters to buy back their own assets at a lower price and putting the burden on the banks. That has to be barred in the interest of equity. Secondly, promoters may also try to create dummy bids by related parties so as to continue to retain control over the company even after their exit. Thirdly, as Aditya Mittal rightly pointed out, if the promoter had the capacity to bid and the intent to repay the loan, then the company would not have gone into bankruptcy in the first place. Lastly, the NCLT is a great idea to put pressure on unscrupulous business owners. Diluting the NCLT will not serve the basic idea of the Bankruptcy Code. The SC is bang on target!

February Policy

Will the RBI shift its monetary stance to neutral?

A recent survey by Reuters had pointed out that while the RBI may not cut rates in February, there was a strong chance of the RBI changing its stance. In the December policy, the RBI had chosen to maintain the monetary stance at hawkish despite maintaining status quo on rates. However, it is expected that the RBI could shift its stance to neutral in this policy. What could this decision predicate on?

Watch the Fed move

An important cue for the RBI will be the US Fed policy, The Fed monetary policy will be announced on January 30th and that gives the RBI enough time to mull its strategic choices based on the Fed outcome. The CME Fed Watch Tool is almost assigning a 100% probability to status quo on Fed rates. If the language of Jerome Powell is also dovish, then the RBI may have an incentive to adopt a dovish tone. The Fed has some real problems on hand. The trade war with China is showing no signs of receding and that is likely to hit growth. China has already given lower growth guidance and the IMF believes that US growth could also falter by 20 to 30 bps in the coming year. In these conditions, the Fed may not have a real appetite for any further rate hikes. The Fed will also worry that another rate hike will make the dollar stronger and do greater disservice to American exports. Fed is most likely to maintain status quo on rates and also talk dovish.

What about inflation?

This could be one of the key factors driving the RBI to change its stance. The CPI inflation for December 2018 came in at an 18-month low of 2.19%. That is close to the lower end of the inflation band that the RBI is happy with. But this low inflation has been achieved on the back of weak oil and food inflation. If the government plans a massive farmer rescue package and rural investment program, then the lagging rural inflation could pick up quite rapidly. Also, oil continues to be the joker in the pack and the last few months have seen tremendous volatility in oil prices. As the swing status shifts from the Middle East to the US, this kind of volatility is bound to happen. The RBI may also want to be watchful on the base effect front with inflation normally picking up around the first half of the year. That could be a tough call.

Strategic shift in stance

The RBI may look to shift its stance to neutral for a very specific reason. With elections approaching, the government would not want to put the banks and NBFCs at risk with higher yields. They are, after all, the last mile for the delivery of the government’s proposed largesse to farmers. Purely as a comfort factor and to keep yields at the lower end, the RBI may choose to change the stance to neutral. That may not be indicative of future rate cuts!

L&T Buyback

Why SEBI was right in rejecting the L&T buyback bid

In a surprising move last week, SEBI rejected L&T’s proposed buyback of shares. L&T had decided to reward its shareholders and had opted for buyback for the first time in its entire history. The total size of the buyback was Rs.9000 crore and entailed buying back 6.1 crore shares of the company at Rs.1,475 per share. This would roughly represent 18.72% of the net worth of the company. So, why was it rejected?

SEBI rejects the buyback

SEBI had a very technical reason for the rejection. As per the buyback rules, the debt equity ratio of the company should not exceed 2 after the completion of the buyback. On a consolidated basis, the debt/equity ratio of L&T stood at 1.77 prior to the buyback. Post the buyback, after extinguishing 18.72% of its equity, the debt equity ratio would cross 2. The logic that if the debt/equity is more than 2 then the primary focus should be on repaying the outside creditors and improving its financial solvency rather than rewarding shareholders with buy backs. But did the massive legal and secretarial team of L&T not know about that? The confusion arises in the definition of debt. The SEBI rules on buybacks are silent on whether the debt considered should be stand alone debt or consolidated debt. L&T had planned the buyback based on standalone debt while SEBI preferred consolidated debt as per its own internal policies. That is what the debate is all about.

Why L&T is wrong here

L&T has contended that since the SEBI rules were silent on the definition of debt, the company had considered standalone debt rather than the overall consolidated debt. If you think about it L&T has made the basic error of form versus substance. The finance teams of L&T had taken a form approach instead of taking a substance approach. A substance approach would clearly point out that if only the stand alone figures are considered then it would be very easy for any large company to shift its loans to the books of subsidiaries and reward its shareholders with regular buyback of shares. In case of L&T, most of the debt is in the books of L&T Finance, which is the NBFC subsidiary of the group. It is surprising that the L&T finance team would have interpreted the rule book so naively.

There is the IL&FS impact

After the IL&FS default, the government has become extra careful on this parent subsidiary demarcation. The whole problem with IL&FS was the convoluted web of group companies that made it difficult to get the real picture. So L&T can keep adding debt in the books of the finance subsidiary and keep doing buybacks at a premium in the parent company. Obviously, that would not be in the interests of the shareholders. It is surprising that the L&T finance team did not think about this!




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