Promoters on stake hiking spree

The promoters of Indian companies are hiking their stake through the issue of warrants and preference shares.

A host of small and mid-cap companies such as Webel SL Energy, Madhucon Projects, Alphageo India and Almondz Global (formerly Allianz Securities) have issued warrants or preferential shares to their promoters in recent months.

Companies generally opt for warrants as they are not required to pay money upfront and can redeem them within 18 months, according to experts. With the threat of takeovers looming large, promoters are using the preference and warrant route to increase their stake.

A preferential issue is an issuance of equity shares to the promoter group or selected investors. It covers fully convertible debentures, partly convertible debentures or any other financial instruments that could be converted into equity shares at a later date.

One of the main reasons why companies go for preferential issues is that they can raise money quickly and cheaply compared with other means such as IPOs or rights issues.

However, since preferential issues are meant for a certain class of investors, the retail investors are deprived of investment opportunity.

Sanjay Hegde, Pricewaterhouse Coopers, said, "The main purpose of a preferential allotment is to hike the stake of promoters. Since the promoters do not like to pay a higher price in a falling market, they generally prefer bullish markets. A preferential allotment is the best way to raise stake, because by going for a rights issue the promoter's stake gets diluted."

A preferential allotment benefits promoters and non promoters such as institutions as well as they can buy shares in bulk at a fixed price without any price escalation.

If one were to mop up shares from the secondary market in phases to acquire the required quantity, share prices could go higher due to the surge in demand. Moreover, it is also possible that promoters or institutions would not be able to mop up enough shares due to low liquidity.

For example, during March this year, AV Birla group acquired shares in Hindalco through preferential allotment. This has not only helped AV Birla group increase its stake in Hindalco, but also finance its ambitious growth strategy through acquisitions.

Tata Sons increased its shareholding in Tata Power by 5 per cent in June this year. Recently, the Wadias said they were planning to hike their stake in Bombay Dyeing by issuing warrants to the promoters, convertible at a later stage.

Explains Rajiv Dalal, Partner, Ernst and Young, "The cost of capital has become slightly dearer. It is favourable for a company to raise capital via this route because other forms of equity raising such as rights issue or an IPO are quite expensive. Companies can also bring in a strategic investor through this route. In a fast globalising world, companies are always haunted by takeover threats. And sometimes if promoters are at a vulnerable holding limit, they enrich themselves through a preferential issue."

Many companies go for a preferential allotment on the eve of an IPO. Apart from setting a price benchmark and roping in high profile investors, this also helps in building investor confidence, creating hype around the issue, bringing strategic relationship on the table and building the brand.

By buying shares, the promoters reveal confidence in their own business and future prospects. As a rule of thumb, this means the stock would gain in the medium to long term as the promoters know their business better than any other investors. Hence, their business valuation is considered most appropriate.

Early this year, the promoters of Reliance Industries raised their stake through preferential allotment of warrants convertible into shares at a price of Rs 1,400. At that point of time, this was an all-time high for the stock. Thereafter, RIL's price has gone northwards and is now close to Rs 2000.