Why promoters with pledged shares are sitting ducks

The crash, bang and thud one heard in the share markets on Monday and Tuesday, when specific shares dropped vertically for no apparent reason, have one common link: their high debt levels. In some cases, the problem was compounded by promoters pledging lots of shares with lenders, accentuating market fears that some of these shares may be sold to reduce the outstandings or recover dues.

On Monday, shares of GTL and GTL Infra tanked by 63% and 48.5%, respectively because the latter could not raise capital to reduce debt. On Tuesday, the shares of two more companies were mauled by bears - S Kumars Worldwide and Orchid Chemicals - because the market thought their promoters had pledged too many shares with lenders.

S Kumars Worldwide, a listed textile company promoted by Nitin Kasliwal, tanked 25% on Tuesday before recovering to close just 11.5% down at Rs 51.40. S Kumars has about nine crore shares pledged by its promoters. These account for 33% of the company’s total equity. Kasliwal denied any sale of pledged shares.

Orchid Chemicals’ shares tumbled 20% before recovering to close at Rs 231, losing 11% in value. A sizeable chunk of the promoter holdings are pledged with lenders in this company’s case too.

The fear is that banks may sell more shares if the value of the collateral pledged falls. So who else is vulnerable?

A Firstpost analysis shows that the total quantum of shares pledged by promoters of companies in the BSE 500 index add up to more than Rs 1,39,400 crore, and some of them are particularly vulnerable to rumours of lenders dumping shares.

Among them are Wockhardt, Parsvnath Developers, Ackruti City, Gayatri Projects and Plethico Pharma.

In a market looking for excuses to send share prices down, the quantum of shares pledged by promoters is a good enough reason for some to press the panic button.

It works like this. When the stock market rises, loans against shares soar as banks lend anywhere between 40 and 60% of the value of shares. When the market falls, banks seek either more shares as collateral or more cash to maintain the credit line.

If borrowers are not able to bring in more equity or cash, lenders are forced to sell the securities pledged and cut down exposures. However, this action is taken only when there is a sharp fall in share prices.

This explains why market watchers are looking at the quantum of pledged shares in companies as a cue on which share to sell next in a declining market.

But there is no need to panic in general. Even though the total value of pledged shares in companies constituting the BSE 500 index is Rs 1,39,400 crore, the total market value of the index is over Rs 25,00,000 crore. This means companies have received approximately Rs 70,000 crore as loans against that.

Prominent corporate houses have pledged shares and mobilised resources. The Tata Group appears to have used this method to raise some quick cash to restructure high-cost debt. The group could have raised close to Rs 20,000 crore if one adds up the value of pledged shares of listed companies. Tata Sons has pledged shares of Tata Consultancy Services, Tata Beverages, Tata Communications and others. Tata Coffee, a subsidiary of Tata Beverages, has its entire promoter holdings pledged.

Pledging of shares is a very common phenomenon. But they come with a caveat: if the share prices fall dramatically, further selling of shares is a possibility.

Distress sales could also get triggered in companies where banks are confident that there is no chance of the borrrower bringing in the capital or cash.

There are also situations where a minority investor could pledge shares and see his or her holdings disposed of by banks. This is because he or she has not been able to get more cash or equity as needed when share prices fall.

Here is a list of companies where a large chunk of promoter holding is pledged (more than 50%) with lenders. Any sharp fall in their share prices could put these companies and their promoters in a spot.

Wockhardt: Wockhardt shares fell 5.35% on Monday while the BSE Healthcare index fell only 2%. Pharma stocks are normally considered good for bear markets, but Wockhardt has raised concerns due to the high quantum of pledged shares. The promoter holding in the company is 74%, but as much as 64.11% is pledged with lenders. However, the company’s share price has outperformed the market over the past one year by gaining 169%. The worst appears to be behind this company now.

Parsvnath Developers: Real estate companies are in for a rough ride. Parsvnath Developers, a Delhi-based real estate and construction company, has 56.9% of the promoter holdings pledged with lenders. The total promoter holding in the company is 68%. The company’s shares fell 3% on Monday, more than the average fall in the market. The company is facing a slowdown in demand for housing. The management says that despite rising interest rates and input costs, the company does not see any erosion of margins in the business.

Ackruti City: This is another real estate company where promoters have pledged more than 50% equity. The company’s shares have lost 59% of their value over the past one year. The BSE Realty index is down 36%. This shows how hard the company’s share price was hurt in the falling sentiment. The company’s 2010-11 consolidated revenues were up 17% at Rs 679 crore versus Rs 580 crore. Its profit after tax was up 14% at Rs 186 crore (versus Rs 163 crore). Ackruti City has a market cap of Rs 1,500 crore.

Plethico Pharma: The promoters own 87% in the company. They have pledged 71% of that equity to raise cash. The company’s share has been an underperformer, to say the least. Over the past one year, the share has shed 10% against a 59% rise in BSE Healthcare index. There is obviously something that the company is not getting right here. The current market value is Rs 1,200 crore.

Gayatri Projects: The infrastructure development segment has witnessed difficulties over the past few months in achieving financial closure - that is, when it ties up all its finances. Companies are expecting the government to award road contracts this year. Gayatri Projects bids for roads and irrigation projects and has raised cash from private equity investors over the past few years. The company promoters have pledged almost 90% of their holdings so far. Over the past one year, the share price fell 56%. The company’s market value stands at around Rs 240 crore.