Promoters of Richa Industries are trying to take advantage of its low share price by making a preferential allotment to certain chosen entities. This will leave minority shareholders of the textile company in the lurch. Will the market regulator act?

Richa Industries has decided to issue preferential shares—nearly half its share capital—to select entities, at a lower share price. The result would be simple dilution of shareholding and lower earnings per share. However, this would also leave minority shareholders, estimated to be 2,449 in number, in the lurch. In addition, since the stock is now classified as ‘illiquid’ (thanks to SEBI’s new regulation), it would be much harder to determine its price as the company is actually doing well.

Furthermore, the entities that will be allotted shares may take advantage of the low share price. Currently, the share price of Richa Industries is Rs18 per share, way below its 2006 initial public offering (IPO) price of Rs30 per share.

According to a filing with the Bombay Stock Exchange (BSE), Richa Industries has come up with a plan to issue as many as 70.99 lakh preferential equity shares. This is about 41.95% of the shares outstanding of the company and it would be allotted to 27 entities, mostly non-promoters except for Garima Gupta and Akash Gupta. Garima Gupta currently holds 45,000 shares and is proposed to hold 6.32 lakh shares, or 2.631% of the shares outstanding post preferential allotment, while Akash Gupta will hold 2.444% stake.

What does this mean for minority shareholders?
Simply put, more shares issued will lead to lower earnings per share (EPS) vis-a-vis dilution, especially when some minority shareholders may have bought it at higher share prices. EPS is nothing but the net profit divided by number of shares outstanding. It is the denominator aspect that will increase instantly.

If the preferential allotment is approved by the Securities and Exchange Board of India (SEBI), then the promoters’ holdings will come down to 53.55% from 69.07% while the stake of non-promoters, including public, will go up to 46.45% from 30.95% of the shares outstanding. At present, minority shareholders own around 18.72% of the shares outstanding.

Performance matters
The company’s fundamentals are sound, reporting steady increase in revenues and if somewhat inconsistent net profit. Its gross sales has increased to over Rs300 crore as of 2012 from Rs97 crore in the year after its IPO, a compounded annual growth rate (CAGR) of 25%. Yet, at a price of Rs21, its price earnings ratio is 5.83 while book value stood is an impressive Rs51.30 per share. The fact that the book value is so much higher than the share price means the market is severely undervaluing the stock.

The prevailing low stock price is a perfect opportunity for the management to take advantage and allot shares to select persons, while leaving out minority shareholders.

Promoters, chosen entities would end up with 80% stake?
The 27 ‘chosen’ entities will get control of nearly 30% of the Richa Industries. Two of the entities from this list, Vedika Finance Pvt Ltd and Narayani Nivesh Nigam Pvt Ltd, had same signatories Vinodkumar Chaturvedi and Manoj Murarilal Pathak. For intents and purposes, if you combine promoter holdings and these 27 entities chosen by the management, the total control comes to over 80%. Thus, the minority shareholders are effectively being shunted out.

The price at which the preferential allotment will take place is not mentioned yet but, according to the company’s filing with BSE, is defined as “Rs two only higher than the per equity share ‘price arrived’ to promoter group at Re one higher than per equity share ‘price arrived’ to persons other than promoter group”. In other words, the company has submitted its price to SEBI for approval but it is not known what the price is. According to the company, the “price arrived” refers to “price calculated on the basis of valuation report carried out on relevant date i.e. 14 May 2013, as per Chapter VII of SEBI (ICDR) Regulations, 2011”. The closing price on 14 May 2013 was Rs21.5, which is lower than the IPO price of Rs30 in 2006. It is not known if this is the price at which the 27 entities will have to pay for.

According to the company’s filing with BSE, the reason for the preferential allotment is to “further strengthen the debt-equity ratio and augment the financial resources of the company”. The debt equity ratio of the company, as at 2012, stood at 2.54.

The result is not just that select people are getting a good deal, but the minority shareholders will see their returns diluted vis-a-vis lower earnings per share, especially those who had bought it earlier on the day of the IPO.

Will SEBI pay attention to this case in the interests of the minority shareholders?