Bond conversion: Where are the 'reports' coming from?

Lets first look at the 'conversion' story. Who triggered this rumour? IFCI officials told the media that they had no 'official' word from the government on the issue.

Then where were these stories coming from? Even after an extensive web-search, I could not narrow the source to any responsible publication. Theoretically though, only two types of entities benefit directly from such rumours-market operators and insiders (in this case government officials). They can take advantage of the price movement that follows such rumours and make a quick fat buck. Investors certainly don't benefit.

True or not, the market is naturally upset at the possibility of such a conversion of bonds to equity. If it actually happens, government holding in IFCI will rise to 42% (market reports suggest the conversion will be at par). The government already holds 28% in IFCI through banks and insurance companies (Life Insurance Corporation of India, General Insurance Corporation, IDBI Bank and Punjab National Bank). And, it clearly stands to gain if it increased its shareholding through a conversion to equity and then offloads a significant shareholding to a 'strategic investor'-which is also being speculated by the trader community.

 In 2007, there was a big brouhaha about government divesting its holding in IFCI. The move was dropped when prospective investors pulled out because of the lack of clarity about government control. That lack of clarity still exists. IFCI ostensibly has autonomy,
but it is an open secret that government has a vice like control on the company.

Restructuring plan: And now a bank

In February this year, the government appeared to have started work on restructuring IFCI with three options in mind-bringing in a strategic investor; merging it with a public sector entity; or allowing it to continue as it is. It has even called bids to appoint a consultant to look at various options and shortlisted three names last November-Boston Consultancy Group, Ernst & Young and Mckinsey & Company-but nothing came out of that.

Of late, the buzz around the IFCI scrip is that it hopes to secure a banking license (most investors have given up on the government finding a strategic investor). This is based on finance minister Pranab Mukherjee mentioning fresh banking licenses for private players and finance companies in the FY11 Union Budget. A banking license could breathe new life into the company, and make it more accountable-a welcome change from investors' point of view. But for all these hopeful rumours about a banking license for IFCI, there are also counter-rumours that the company is uninterested in a bank license.

In June 2009, managing director Atul Kumar Rai had told PTI, "I don't want to say that I would like to be ICICI because ICICI was converted into a bank ... What I would say is, now you see ICICI, after five years there could be an IFCI way also."

Unwilling to share information

The Registrar of Companies (ROC) had issued notices to IFCI on 22 and 23 April, 2009, seeking information on loans-against-shares of promoters pledged by leading business houses. The ROC had sought details such as disbursement of loans, list of non-performing assets, perks of its top officials, etc. RoC had also directed IFCI to furnish information about whether Mr E Sreedharan, MD of Delhi Metro Rail Corporation, had said (in his capacity as a director of IFCI) at a board meeting that he was unhappy with the functioning of the company. It had also hinted at some fraudulent activity in IFCI in the notices. However, instead of providing the information, IFCI moved the Delhi High Court for quashing of the notices.

The company has posted regular (though erratic) profits in the past four quarters and has been more or less consistently profitable from the September 2006 quarter (with only a couple of quarters of losses). In its FY09 annual report, its gross non-performing assets were at Rs51.5 billion, slightly higher than FY08. Its loans and share capital put together was Rs134 billion and investments were Rs41 billion. Its quoted investments (investments in companies listed on stock markets) had a book value of Rs17.5 billion and market value of Rs15 billion. The unquoted investments were much higher-Rs31.8 billion, of which Rs8.2 billion were in equity, Rs5.4 billion in preference shares and an ominous Rs18 billion was in others. Its freehold land was valued at Rs770 million in its FY09 balance sheet but the actual market value could be more.

In November last year, IFCI had said it had plans to offload its holding in some 16 companies including Hotel Paraag in Bengaluru (8.5%), Mela Hotels in Ghaziabad (4%) and Sun Granites Exports (16%). IFCI usually acquires these holdings in lieu of project finance. Sometimes when these companies don't buyback their shares it offers them to the public to recover its investments. Last year it took a Rs1.2 billion hit after the Hindalco rights issue devolved (it had underwritten it) and in June 2008 had taken Emaar MGF to court when the latter refused to return Rs500 million that IFCI invested in it in a pre-IPO placement.

In a December interview to Business Standard, managing director Mr Rai had said that IFCI had been revived but was not very clear about which lines of business it should pursue. He said that it has been lending for the last three years and has created fresh assets of around Rs30 billion each year. Its long-term cost of funds was around 9% and the strategy continued to be to lend where banks do not or cannot. In short a high-risk model.

IFCI has been planning to raise Rs 10bn to finance business expansion, but hasn't done it so far.

For investors, until there is stark clarity about the government's role in this company, how serious it is about inducting a strategic partner or how serious is the company about acquiring a banking licence -- in short, until there is a clear direction -- this stock will continue to be a puppet in the hands of operators and unnamed 'sources' who leak information to manipulate the price.

Disclaimer: The report is based on secondary sources and this writer's own experience of tracking the stock.