Why the Rs3,000 Crore Market Cap of 10 of the RBI’s ‘Dirty Dozen’ Defaulters Will Simply Vanish
Two of Reserve Bank of India (RBI)’s “dirty dozen” corporate borrowers, which entered bankruptcy process under the National Company Law Tribunal (NCLT) are unlisted companies. The aggregate equity market capitalisation of the remaining 10 as of 20 April 2018 was a little over Rs3,000 crore. Many financial commentators have expressed surprise at the stock market valuations of these 10 companies. Who is buying these stocks? After all, the bankruptcy process will ensure that these stocks goes to zero.
 
Take the example of Alok Industries. The equity market cap of the company on 20 April 2018 was Rs307 crore at Rs3.14 per share. Last week, we learnt that Reliance Industries’ joint bid with JM Financial Asset Reconstruction Co was rejected by the creditors of Alok Industries. Which means that the company will be liquidated.
 
Now, one problem is that liquidation value is that it is almost always going to be far less than money owned to lenders. In the case of Alok Industries, media reports tell us that its liquidation value is estimated to be Rs4,200 crore while claims of lenders add up to more than Rs29,000 crore.
 
If Alok Industries is liquidated, it is certain that all the money will go to the lenders and they will still not get back most of their money. Under those circumstances, how can equity have any value?
 
I often cite such situations in my class by using an image, which I call “Canine Capital Structure.”
 
Canine Capital Structure
 
 
The dog in the end (the equity owner) will have nothing left over for him if all the food in the bucket is taken by dogs ahead of him in the queue.
 
The same logic applies the cases other than Alok. Whether those companies are liquidated or sold to a successful bidder, its almost certain that lenders will not recover all of their money. And if that is going to be the case, then equity can have no value. In liquidation cases, like those or Alok Industries, this is easy to visualize and understand this. Not so, however, if the company is sold. But as other commentators have pointed out it, it will not matter. Dilution will ensure that current stockholders in these businesses will lose almost everything.
 
Incidentally, this particular behaviour of the market participants is not unusual. Indeed, Benjamin Graham wrote about it in the third edition of this book, “Security Analysis”.
 
When a company has senior issues and common stock, and all its securities are of speculative calibre, the common sells too high. This is caused by the speculator’s frequently exclusive interest in common stocks and his preference for low-priced issues.
 
These overvaluations within a company are not so much in a class by themselves as they are vivid illustrations of the general tendency for speculators to buy regardless of price. When there is a senior issue available for comparison, the fact of overvaluation may often be established almost mathematically.
 
(Sanjay Bakshi is an investor and Adjunct Professor at Management Development Institute, Gurgaon.)
Comments
Mahesh S Bhatt
4 years ago
Alok Equity Holders will go Parlok for returns Amen Mahesh Bhatt
Kamal Garg
4 years ago
Not able to understand the purpose of writing this article. It is a common and accepted doctrine that 'equity' is a risk capital - irrespective of whether you call in 'Canine Capital' or whatever - and therefore comes last in liquidation process. All other claimants will have definite and legally valid 'priority' in terms of distribution of liquidation money. Nothing new. It is everywhere in the world. The same class of equity investors enjoy unlimited returns on their investment if the company does well also.
Arun Marwah
4 years ago
What about companies like Gammon India, Gammon Infra??? Can you please let us know about their status??
Ramesh Poapt
4 years ago
sir, pl share your views on such technical aspects of the stocks
frequently for the benefit of small investors. THANKS
Deepak Narain
4 years ago
I think government should co-opt your expert on the Board of RBI.
Amitabha Bhattacharjee
4 years ago
There is no autonomy of NCLT they are for the Boss
R Balakrishnan
4 years ago
When the ROCE is in single digits, market capitalisation is an illusion. Below borrowing R. OCE, gold plated projects are the hallmark of many great losing ideas. Bankers injected with bribes have filled their pockets and walked on. Illusions are kept on for some time, evergreened or whatever. When the cookie crumbles, even the crumbs are fake
Sunil Kumar Hemnani
4 years ago
Great initiative by Prof Bakshi & Moneylife foundation , a real education for us . Many thanks !
Ramesh Mehta
4 years ago
Looking forward to more articles by Prof Bakshi.
Vivek Naik
4 years ago
Nice to see Prof. Bakshi as an author on Moneylife :)
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