Their pledge is your worry

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In the first sign of strength in equities, promoter share pledges rise sharply. What to make of it?

Their pledge is your worry
If share pledge by promoters

scares you off a stock in a falling market, how do you treat it in a

rising market?

After a slowdown in the first quarter, there has been a bounce in share pledges since the second quarter of the financial year as the market began to rise, and the value of pledged shares as a percentage of their market capitalisation has risen 27 basis points quarter-on-quarter to hit the highest level in four quarters at 10.1 per cent.

The share of pledged equity in India’s total market capitalisation increased from 2.09 per cent in the June quarter to 2.16 per cent in the September quarter, brokerage Morgan Stanley said in a study.

The past two years were replete with scary stories of Kingfisher Airlines, Unitech, GTL, GTL Infra, S Kumar’s, Orchid Chemicals and many others, where either the lenders opted to covert the pledged shares into equity when the stocks fell or investors punished the stocks severely because of heavy share pledges.

In the case of Kingfisher Airlines, the company converted a Rs 1,355 crore loan into shares by allowing SBI and ICICI Bank to pick up 11 per cent stake, while in the case of Unitech, the promoters had to rush to the court to ward off selling of equities pledged by promoters to Morgan Stanley. In a similar situation, IFCI had increased its stake in Koutons Retail from 5.89 per cent to 10.24 per cent by invoking the pledged shares.

Unlike last year, when infrastructure companies were in the majority in promoter share pledges, the healthcare and consumer staples sectors witnessed the sharpest rise in share pledging during the September quarter, while the financials and technology sectors saw the biggest drop.

At the end of the quarter, the consumer discretionary sector followed by materials had the biggest share pledges by promoters in value terms. As a percentage of market capitalisation, share pledging was highest for the utilities and financials sectors. And as a percentage of promoter holding, the percentage of pledging was the highest for energy and the lowest for technology, the Morgan Stanley study showed.

In the BSE 500 pack, 13 companies had more than 90 per cent of their promoter holdings pledged at the end of the September quarter, while 54 had over half of promoters’ stake pledged, Capitaline data showed. In 90 firms, the promoters had pledged one-quarter of their stake.

During the quarter, 43 companies saw promoter share pledges go up by more than 1 per cent, while it rose by over 5 per cent in the case of 30 firms and over 10 per cent in the case of 19 firms. These 19 included names like HFCL, Tulip Telecom, Kemrock Industries, GTL, Cromton Greaves, Gammon India and Educomp Solutions.

Promoters of seven firms saw their promoters reduce share pledges by over 10 per cent while 36 firms had it cut by over 1 per cent. The promoters of Thomas Cook revoked their entire pledged shares. Bilcare’s promoters revoked 85.99 per cent of their pledged shares and that got reduced to 9.31 per cent of their stake in the company at the end of the second quarter from 95.30 per cent in the June quarter.

Aban Offshore, OnMobile Global, IRB Infra, Strides Arcolab were some of the companies where promoters revoked their pledged shares. Shares of OnMobile Global, Bilcare, IRB Infra and Strides Arcolab gained 55.97 per cent, 35.24 per cent, 19.87 per cent and 19.09 per cent, respectively during the quarter.

In February, 2009, Sebi made it mandatory for promoters to make disclosure about share pledges and details of such actions are put up on stock exchanges’ websites.

Share pledging is a normal practice in corporate finance. Promoters regularly pledge equity to lenders to raise loans for working capital requirement, personal needs, other ventures or to fund acquisitions.

The exercise triggers worries when companies get aggressive and put huge volumes of promoter equity at stake, thereby risking retail investors’ wealth.

In a falling market, aggressive share pledging can lead to distress as falling share prices can turn the collaterals cheaper, prompting lenders to either demand additional backup or sell the shares in the open market to protect their assets. Such an action can lead to a sharp drop in market capitalisation, eroding investor wealth. That risk is less in a rising market.

“Whenever promoters pledge shares, whether it is in a falling or a rising market, it always raises concerns. In a falling market, pledging haunts investors as the value of pledged shares deteriorates over time. In a rising market, the concerns are less, but they do remain as pledging destabilises the shareholding structure. Promoters who pledge shares in a rising market run a high risk as a bearish trend can set in the market any time,” said Sudip Bandyopadhyay, MD and CEO of Destimoney Securities

Also, if the books of a company are loaded with too much of debt and it defaults in repayment, the company could face the risk of selling of the pledged shares by the lenders, resulting in reduction in promoter holding and a sharp decline in the stock price. Smaller companies are at a bigger risk in such a situation, especially if the market suddenly turns weak.

Market analysts say while fund raising, or the ability to raise finance, is a positive for a company as it allows the firm the flexibility to run a business smoothly and expand it when required, one must note that share pledging may also indicate high leverage and weak cash flow pattern in a business.

This is what investors should check before taking a call on such stocks. Investors should keep a regular watch on such actions of companies whose stocks they hold.

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