3 states of share pledging: Fame, flame and shame

share pledging
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Promoters often pledge their shares to raise money.

Pledging, which otherwise is a routine corporate action, becomes a millstone around shareholders’ necks when it erases years of gains.

Why do promoters pledge their stake?

There are several reasons for promoter pledges, such as additional loans taken by the company for new projects or acquisitions, etc. But a closer look reveals, the majority of such pledges were created at the holding company level, in order to fund private entities of the promoter group, which really do not translate into future benefits for the listed company, whose shares are pledged.

We undertook a study to ascertain the prevalence of this practice, the magnitude thereof and impact on stock price. We covered pledging trends of promoters of BSE-500 companies over the last six years, from March 2012 to December 2018.

Our findings are…

Promoters of 71 of the BSE-500 companies have been ‘chronic pledgers’, i.e., they pledged their shares in all years covered for our analysis.

share pledgingSource: Ace Equity

A key trend that has emerged is the count of companies with more than 10% of their shares pledged (of the total shares outstanding not just promoter holding) has remained in the early to mid-40s (45 in March 2012 to 46 in March 2016, 42 in March 2018 and 47 in Dec 2018).

share pledging

(Source: ACE Equity, Ventura Securities)

The median level of pledge stood at 4.95% in Dec 2016, 4.38% at end-2017 and has risen to 6.69% as per Dec ’18 data.

A further peek into the BSE 500 with shares pledged, revealed most of these companies with an aggravated level of pledges are from the Infrastructure/Power/EPC sector. During December 2017 to December 2018, the share prices of the EPC/infrastructure companies exhibited a sharp fall of up to as much as 68%. It seems markets aren’t as much worried about pledges as long as market conditions are hunky-dory and stock prices hold their ground.

Among business groups, a heightened level of pledge is seen in Reliance ADAG, Future group, Jindal group(s) and Adani group, among others. In most of these companies, with an increasing level of pledging a contraction in EV to EBITDA multiple is also noted. Perhaps, the market punishes chronic pledgers.

share pledging

(Source: ACE Equity, Ventura Securities)

While analysing the reaction of share prices of the companies with respect to the percentage of the shares pledged, in Calendar Year (CY) 2017, we observe 56 companies had a high negative correlation (below -0.5), i.e., the share price fell sharply with a rise in pledges. In CY 2018, only 47 companies exhibited similar high negative correlation.

A key point to note is that only 19 companies are common in both the years.

In other words, almost 36 companies which suffered a steep fall in share price due to the pledge factor in CY 2017 were quite steady in CY 2018, despite a continuing rise in the pledge levels.

What does it suggest?

Once the pledge is disclosed, the market adjustment in terms of a share price is quite swift; thereafter, only a material further rise in pledge percentage causes a further de-rating.

On the flip side, a recovery in share price, post any pledge disclosures, could be a prolonged affair requiring very tangible corporate action and transparency by the promoters.

A few case studies are worth a recap.

Eveready Industries with an increase in pledge from 16.3% in Dec 2017 to 20% in Dec 2018, saw a contraction in (Price-to-Earnings) P/E-TTM (Trailing Twelve Month) from 33x in Dec 2017 to 28x in Sept 2018 but shot up to 53x in Dec 2018 when promoters expressed intent of stake sale to a strategic buyer.

On the other hand, an indication of similar intent by the promoters of Zee caused significant turbulence with its share price plunging 36% before regaining a lot of the lost ground.

In case of Ajanta Pharma, with the increase in pledging from 7.1% in Dec 2017 to 9.1% in Dec 2018, the P/E-TTM multiple contracted from 25x in Dec 2017 to 22x in Sept 2018 and was steady thereafter, despite an increase in pledge.

Companies like Bajaj Consumer, Emami and Jain Irrigation exhibited a contraction in P/E multiple with an increase in pledge levels.

In the case of Atul Ltd, a decrease in pledge from 5.5% in Dec 2017 to 2.9% in Dec 2018 got a thumbs up with the share gaining almost 25% during this period. Despite this, the P/E got de-rated from 33x to 23x.

In the case of Fortis Healthcare, a takeover has been completed and consequently, the pledge has come down to a low of 0.1% in Dec 2018 from 33.8% in Dec 2017. However, the share prices have dipped about 15% owing to the emergence of fresh instances of past promoter irregularities.

A company to watch out for is Himatsingka Seide (current market cap Rs 1,660 crore). Though the pledge level has increased to 8.7% in Dec 2018 from 5.8% a year ago, the company has incurred a capex of Rs 1,042 crore over FY17 to FY18. Arguably, the increased level of pledge is perhaps for debt raised to finance the capex. However, the share price has reacted negatively, dropping 57% over the past fourteen months with the P/E-TTM almost halved from 17X to 8.4X.

Conclusions…

  1. Deteriorating fundamentals and share pledging is a chicken and egg situation. There’s absolutely nothing wrong with this activity. But the trouble starts when the value of collateral erodes or servicing loans raised by pledging shares becomes a herculean task for them.
  2. Market conditions also affect the reaction of investors to companies with heavy pledging.
  3. The stigma of promoter pledge causes an immediate de-rating which lingers for several quarters, till either the earnings performance improves substantially or de-pledging is visible.
  4. The concern over lenders against pledged shares dumping it upon the slightest whiff of volatility does not bode well for long term investors.
  5. Even as many banks are emerging from the trough of the Non-Performing Assets (NPA) cycle, several Non-Banking Finance Companies (NBFCs) (typically the lenders against pledge) are facing liquidity pressures albeit transient (as asset-liability mismatches realign) which means that pledge concerns are likely to remain at heightened levels through CY 2019 and CY 2020 as well.
  6. A pledge of up to 5% of a company’s share capital may be taken in stride by markets but breaching this threshold is likely to have more material and extended implications.
  7. Pledging aggravates the situation for already troubled or richly valued companies but pledging in itself isn’t necessarily a troublemaker. The reverse is true in the case of de-pledging.
  8. To spot the danger, it’s important to understand what the money raised by pledging shares is used for. It would also be crucial to see if RBI (possibly in conjunction with SEBI) works out new norms, including disclosure of ‘ultimate pledge beneficiary’ etc., to soothe the market nerves.

In a nutshell…

Promoters of many BSE-500 companies have travelled the distance between fame and shame by the bullet train of share pledging.

Share pledging is like a flame. Its impact depends on how you use it and for what you use it.

Hopefully, promoters of listed companies in India will stop playing with fire, at the expense of minority shareholders.

Disclaimer: Ventura Securities Ltd has taken due care and caution in compilation of data for its web blog. The information has been obtained from different sources which it considers reliable. However, Ventura Securities Ltd does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Ventura Securities Ltd especially states that it has no financial liability whatsoever to any user on account of the use of information provided on its web blog. The information provided herein is just for the knowledge purpose and shouldn’t be construed as investment advice under any circumstances.

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