Hindustan Foods Limited (HFL) is a BSE listed FMCG company engaged in Contract Manufacturing of a diverse range of products including cereals, energy drinks, shampoos and detergents to even leather shoes and pesticides. Clientele includes Hindustan Unilever, Reckitt & Benckiser, PepsiCo, Steve Madden, Flipkart, Marico and more. It was incorporated in 1984 as a JV between Glaxo India Ltd. and the Dempo Group. In 2013 the Vanity Case Group and the Kothari family acquired the controlling stake and run the company.

Initially, HFL was only a one client-one brand company. Over the years its business had declined to the point where most of its net worth was wiped off. After the Vanity Case Group stepped in 2013, with funding and new management it was able to reverse its misfortunes.

The company is headquartered in Mumbai and as a growth strategy has inorganically increased its geographical footprint across 6 locations in India by acquiring manufacturing factories making a diverse range of products. It seems that this scheme is alignment with this strategy.

Avalon Cosmetics Pvt. Ltd. (Avalon), an unlisted FMCG company headquartered in Mumbai having manufacturing sites across 6 locations, is engaged in contract manufacturing of cosmetics like lotion, shampoo, etc. and food products. It was incorporated in 1981 and is owned by the Kothari Family (77%) and Vanity Case India Pvt. Ltd. (23%), who are also the promoters of HFL.

Clientele includes the likes of HUL, Amway Global, Godrej, Emami, Reckitt Benckiser and more.

ATC Beverages Pvt. Ltd. (ATC), an unlisted FMCG company headquartered and having its manufacturing unit in Mysore, is engaged in contract manufacturing of soft drinks and non-alcoholic beverages. It was incorporated in 2004 and is mainly owned by Maxwell Asgari and family (52%) and Hindustan Foods Ltd. (48%).

The company has clients like PepsiCo and O’cean beverages. ATC is mainly involved in bottling and packaging of cold beverages.

Transaction

Appointed date for the transactions is 1 April 2020.

Through the scheme HFL is acquiring the following:

• Coimbatore undertaking of Avalon Cosmetics which is into manufacturing Malt/wheat-based foods and energy drinks. Amalgamating ATC beverages. ATC Beverages manufactures energy drinks and non-alcoholic beverages like fruit juices.

The undertaking businesses getting acquired are from the Food sector and their businesses are similar to HFL’s.

Both the transactions are all equity deals.

Swap Ratios

1. For demerger of Coimbatore undertaking of Avalon:
   1 share of HFL to be issued for every 0.755 share held
2. For amalgamation of ATC beverages:
   1 share of HFL for every 16,228 shares.

Pre and post scheme shareholding pattern of HFL:

Post scheme, promoter holding has gone up because in one of the companies involved in the scheme i.e. Avalon, the promoters (Kothari family and Vanity Case) are holding 99% shares

Rationale of the Scheme:

1. The amalgamation of ATC beverages (Mysore) is beneficial in the following ways:

• Amalgamation proves to be tax efficient. Both companies involved are industrial undertaking asper sec 72A, ITA 1961. Thus, the carried forward losses of ATC Beverages of up to Rs. 35 crore and will be available for set off subject to compliance of stringent conditions under Sec 72A of The Income tax act,1961.
• The acquisition is also in alignment with the overall growth strategy of the company of acquiring manufacturing entities in different products in the food sectors and different geographical locations.
• HFL already had a stake of 40% in ATC beverages which was bought in FY19 for Rs1.42 Crores. Then in early FY 20HFLalso converted, to equity, a loan of Rs.1.75 crore, increasing HFL’s holding to 48%. Now, only a year later, amalgamation of ATC indicates that HFL saw an acquisition opportunity at a reasonable valuation. ATC beverage had a poor financial position Now the valuation given to the company (as per the Valuation report) is about Rs. 11 Lakhs for equity value and enterprise value of Rs 13.11 crores considering unsecured loans of more than 13 crores.
• In fact, in FY 2019, HFL had converted an unsecured loan of Rs.1.75 cores which it had given to ATC beverages into equity shares. This was done despite the poor performance of the company over the previous years. ATC beverages were suffering losses since a few years and unsecured loans were piling on. HFL’s earlier acquisition of 40% stake, the subsequent conversion of the loan of Rs. 1.75 Crore (which brought holding to 48%) and now the amalgamation clearly is a bailout for ATC and its promoters. Besides, ATC has PepsiCo and O’cean beverages as its clients and beverages is a new segment for HFL so this amalgamation might as well be a synergetic business decision also.

2. This is the second acquisition of HFL from Avalon Cosmetics. In 2017-18, its Hyderabad undertaking (manufactures fabric cleaning products like detergents) was acquired by HFL. Avalon is 100% owned by promoters of HFL. So, selling of one Avalon’s businesses to HFL at good valuations benefits the promoters directly. From the point of view of public investors, this staggered acquisition of Avalon avoids a huge cash outflow in one go. Besides, entering one sector at a time helps HFL realize value from each such acquisition.

The related party transactions between both the companies are insignificant barring the purchase of land by HFL for Rs. 2.8 crore in FY 2019.

3. GST benefits:

• With the GST implementation, a trend has been seen with many companies like HUL, Lux Industries, Orient Refractoriesacquiringtheir unlisted manufacturing entities which have businesses same as the controlling entity. This reduces the compliance costs, GST cost because of related party transactions and simplifies the organizational structure. Having entities in different geographic locations also brings the entity closer to the markets and makes it easier to establish a GST efficient supply chain.

Valuation:

Avalon Cosmetics Pvt. Ltd.

Note: Net worth of the whole of Avalon Cosmetics as on 30 Sept. 19 (as per its audited financials) is 58.9 Crores. Valuation given here, for the Coimbatore division, is much higher than book value of entire company. Considering that almost 100% shares are held between the Kothari’s (77%) and Vanity Case Group (22%), who are the promoters of HFL, post scheme the promoter holding % in HFL will).

ATC Beverages

Note: Net worth of ATC Beverages as on 30 Sept. 19 as per its audited financials is 3.82 Crore but it has been consistently making huge losses and has undertaken significant unsecured loans. The valuer has only applied the DCF method and that has substantially discounted the enterprise value of ATC beverages.

Accounting treatment in books of Hindustan Foods:

The demerger will be accounted for using the “Pooling of Interest” Method as per Appendix C of IndAS 103: Business Combinations. Avalon Cosmetics is controlled by the promoters of HFL as the transaction being a common control combination.

Performance Analysis of HFL:

a. Trend of Revenue and EBITDA over the years of HFL:

Source: AR FY 19

Note: The company made 2 major acquisitions in 2017-18 apart from getting new clients and more funding, leading to a dramatic increase in turnover. The acquisitions were of G Shoe Export Ltd.(Mumbai) and a factory of Reckitt Benckiser (India) Pvt. Ltd, on slump sale basis, in Jammu and Kashmir, which makes pest control products for the brand “Mortein”. The J & K unit particularly has huge manufacturing capacity.

b. Long term debt and Non-current Assets:

The company has been growing and expanding its business through acquisitions, and hence needing more funds, and the same is reflected in the graph above.

c. Some financial ratios of HFL over the years:

Source: Ratestar

As can be seen since 2013 there has been a massive improvement across all ratios. This was the year when the Vanity Case Group entered the scene.

Conclusion

Covid-19 has badly hit all companies across all sectors. The Indian economy was already struggling, and this pandemic has worsened the scenario. Hindustan Foods Ltd., being an FMCG manufacturer will see a decrease in business but since many of its products are consumer staples and other essentials it may be in a better position than companies in other industries. This scheme can prove to be helpful since it brings efficiency not only in HFL’s organizational structure but also reduces GST compliance costs and leads to direct tax benefits. With uncertain times ahead, we can expect more such re-structuring and also acquisitions where the big players like HFL absorb the small, struggling players like ATC Beverages. No doubt it will all depend on how quickly HFL is able to turn around the loss-making operations of ATC Beverages and also reduce tax cost by successfully en-cashing losses incurred by like ATC Beverages.

If one looks at Q3 FY20 results of YES Bank LTD published soon after the announcement of the reconstruction scheme, it is crystal clear that the bank net worth is wiped out fully with negative capital hence in common parlance it has collapsed and cannot continue to do its business without augmenting its capital and have the confidence of its creditors including all current, fixed deposit and saving account holders.

Crumbling of a bank this size can have loss of confidence in the whole financial systems which could lead to a collapse of multiple institutions and companies. After the bank on its own failure to get the investors in the last six months to avoid its collapse, the government has no choice but to come out with the bailout plan in the form of the scheme.

The Central Government has notified the “YES Bank Limited Reconstructed Scheme, 2020” (Reconstruction Scheme) in the exercise of powers conferred by sub-section (4) and sub-section (7) of section 45 of the Banking Regulation Act, 1949 which came into force on 13^th March 2020.

Reserve Bank of India (RBI) has the power to make an application to the Central Government for an order of moratorium in respect of Banking Company when RBI is of the opinion that there is “Good Reason” to do so. Banking Regulation Act, 1949 does not list down the specific events on the occurrence of which RBI may make an application to Central Government for an order of moratorium. RBI has discretionary power to make such application to Central Government. During the period of moratorium if the RBI is of the opinion that it is necessary in the interest of stakeholders, it may prepare a scheme for –

1. the reconstruction of banking company
2. the amalgamation of banking company with other banking institutions.

RBI on March 6 placed in public domain a draft reconstruction scheme inviting suggestions and comments from the public including the banks’ shareholders, depositors and creditors before 9^th March 2020. Timeline provided for submitting the suggestions o the draft reconstruction scheme RBI was a too little.

According to the Banking Regulation Act,1949 Reconstruction scheme prepared by the RBI will override provisions of the all other laws or agreements, awards, or any other instrument.

Features of the Reconstruction scheme

• Authorised share capital of the reconstructed bank i.e. YES Bank will increase to Rs.62,00,00,00,000 (Rs. 60,00,00,00,000 Equity shares and 2,00,00,000 Preference shares.
• Shares will be allotted to the investors at Rs. 10 (Face value- Rs. 2 + Premium – Rs. 8). There will be lock-in period of three years from the commencement of this Scheme to the extent of 75% in respect of ––

(i) shares held by existing shareholders on the date of such commencement;

(ii) shares allotted to the investors under this Scheme:

Provided that the said lock-in period shall not apply to any shareholder holding less than one hundred shares.

• There will be a restriction on voting rights on the shares held by the investors.

An investor, other than the investor bank, may exercise voting rights to the extent of

(i) it’s shareholding; or

(ii) nine per cent. of the total voting rights of all the shareholders of reconstructed bank; or

(iii) as may be decided by the Reserve Bank,

whichever is lower. However, RBI has the rights to allow voting rights even beyond 9% but not exceeding 15% to a particular investor.

All investors including SBI has been given capital gain tax exemption which may arise due to subscription under the scheme.

Table 1: Investors of the Reconstructed Bank

• Shri Prashant Kumar, former Chief Financial Officer and Deputy Managing Director of State Bank of India, will act as Chief Executive Officer and Managing Director and Shri Sunil Mehta, former Non-Executive Chairman of Punjab National Bank, will be Non-Executive Chairman.
• All employees of the YES Bank shall continue as the employee of the reconstructed bank after the scheme of reconstruction with the same remuneration. There will not be any change in the terms of services w.r.t retirement, determination of office. However, Board of Directors of the reconstructed bank after following the due procedure can discontinue the service of Key Managerial Personnel (KMP).
• There will not be any change in the offices or branch network of reconstructed bank.
• YBL’s Basel III Additional Tier 1 (AT-I) Bonds of Rs. 8,415 crores have been written down.

Legal Analysis

Insolvency and Bankruptcy Code (IBC) V/s Reconstruction Scheme

The Bank and financial institutions are not covered by Insolvency Bankruptcy Code. So waterfall provisions as given under SEC 53 of IBC  is to be applied and in most cases when financial creditors are not paid in full, shareholders equity, at least of the promoters is wiped out and reduced to nil and in all other equity shareholders are also compelled to lose major part of their equity, if not 100% as in the case Essar Steel Ltd.

Banks and financial institutions are in unique positions. Creditors and debtors both its customers. Their creditors are all unsecured and general public and corporate holding current accounts and savings accounts. Any bail out /resolution plan in a way it is done for all other industries, might not only not work but also lead the bank to collapse resulting in huge destruction of value for all the stakeholders and loss of confidence in the whole banking system. So going by the process of forming of i) Committee of Creditors, ii) announcing a moratorium on withdrawals, iii) getting  Resolution/bailout plan approved by them and iv) finding the resolution applicant and minimum time of 270 days to reach there will be disastrous for the health of the bank and its customers. Leverage is almost ten times of its net worth as compared to around two to three times in any other industry. So even 5% of its assets going bad will cripple the bank severely and 10% of its assets going bad can bankrupt any bank. It has also large exposure inter se with other banking and financial institutions. So, its assets and liabilities components required it to be rescued either by large dose of capital infusion as in the case of public sector banks or merging the bank with some stronger bank.

In any industries business going into financial crisis, one can take some time to take over and revive even if operations are completely closed. But the same is not possible in the case of a bank. Once you suspend or scale down the operations of the bank even for a month,  not only the bank will collapse but it will lead to chaos in the whole financial systems and make them run on the deposits of their retail customers and chancing of recovery from lendees will be diluted substantially.

Considering the rapidly deteriorating financial position of the YES Bank Limited relating to liquidity, capital and other critical parameters, and the absence of any credible plan for infusion of capital (no doubt there were couple of announcements by the promoter managing director and new managing director regarding they are getting LOI from various foreign investors)   necessitated the RBI to formulate reconstruction scheme in the public interest and particularly in the interest of the depositors.

We all know that business as well as the growth of the Banking Company is dependent on the amount of deposits. People consider the bank as the safest mode for parking their surplus funds and in fact use current accounts to manage their business. If YES Bank would have fallen, it would have definitely affected the confidence of the depositor hence the RBI has tried to revive the same through Reconstruction Scheme which is equal to the resolution plan in the IBC which is also beneficial to all the stakeholders.

Though the objective of the reconstruction scheme is similar to the resolution plan under the IBC, there is a difference in the two. Under the IBC resolution plan is submitted by the resolution applicant and the same is confirmed by the Committee of Creditors and then by the NCLT.  Here Reconstruction scheme is prepared by the RBI (post it has identified the resolution applicant) in consultations with proposed investors and comments/ suggestions from the large public are also invited by RBI. In case of the Resolution plan, amount infused by the Resolution Applicant is used to clear the dues of the corporate debtor towards creditors, stakeholders. Amount infused under the reconstruction scheme is used to maintain tier I capital of the bank.

Reconstructions Scheme – Advantageous to the growth of YES Bank and/or Banking System?

YES Bank was in immediate need of funds because of the deterioration in its asset quality, NPA provisioning and mounting losses. As of 31st December 2019, YES Bank has almost Rs. 40,709 crores of Gross NPAs and an eroding balance of deposits. YES Bank could have borrowed money to maintain liquidity, but a stake sale saves YES Bank interest costs, gives it a good buffer to Recover and grow without future cash outflow of debt repayment.

A bank consortium led by a state-run bank will ensure stability in the banking system and can use all the resources at its disposal to recover these loan assets of YES Bank. Collapse of YES Bank would have led to the depositors and even the general public losing confidence in the banks. Swift action by RBI and Government has help avert such dire consequences.

How the scheme is beneficial to all stakeholders of YES Bank?

YES Bank was on the brink of insolvency and if the bank had in fact decided to close down and distribute its assets or sale to any other investor, it is probable that only the priority creditors (employees and other operational creditors, secured lenders, etc.) would be able to recover some or all of their money. Other stakeholders who are lower in the hierarchy like the shareholders, depositors like the fixed depositors, Savings or Current account holders would lose substantial part of their deposits.  (DICGC -Deposit Insurance Credit Guarantee Corporation insures only up to Rs.5,00,000 per account. The depositors with higher balances would have lost the rest).

As of 31^st March 2019 YES Bank employed about 21,200 people. The scheme ensured their jobs for one year without break. YES Bank was able to avoid insolvency because of the scheme and RBI was able to rescue not only, fixed depositors, saving and current account holders, but also the thousands of employees, in one single stroke.

RBI could and probably did try to get Global or Domestic investors or even SBI or any other bank to acquire YES Bank. But given the poor asset quality (as given in table below) of YES Bank, no investor would want to single-handedly absorb the bad assets of YES Bank.

YES Bank has made huge provisions for NPAs till Q3 – 2019. The enterprise value of YES Bank has obviously taken a huge hit. One needs to look at the table of NPA Ratios status as on 31st December 2019.

Table 2: NPA Ratios of YES Bank as on 31.12.2019

Source: Basel III disclosures 31-12-2019

The bank witnessed high slippages from the stressed book and recognised slippages up till March 14, 2020 in the Q3FY2020 results, for which it made accelerated provisions in its Q3 FY2020 results, leading to the depletion of its capital ratios. Post the equity infusion and write-down of the AT-I Bonds, YBL’s capital ratios are likely to improve with CET-I and Tier I of 7.6% and 7.8%, respectively, and CRAR of more than 9.0%. As the regulatory norms require banks to maintain a CCB of 2.5% as on March 31, 2020, ICRA expects additional capital requirements of ~Rs. 9,000-13,000 crore over the next 1-2 years.

Strategy

The government must take care of competing priorities in the interest of the financial systems while coming out with the scheme for the institution, which in some way is considered to be too big to fail. Path selected has been unconventional by inviting competing public sector and private sector banks to join the rescue plan. It made choices like giving control to the largest public sector bank and selecting managing director and chairman who are ex-directors of public sector banks. Next how the restructured YBL is able to operate successfully without losing large deposits and also recovery of all amount lent without any further slippages is the key to the success of the plan.                                                                                    

Previous Such mergers:

The last time when a PSB was brought in to rescue a private commercial bank was in early 2000 when the Global Trust Bank (GTB) collapsed because of its heavy losses in the stock market. The bank had lost a lot of money post the Ketan Parekh scam. In 2004, the RBI designed a GTB merger with the Oriental Bank of Commerce (OBC).

In another instance, in 2010, the RBI encouraged another merger between Bank of Rajasthan and ICICI Bank. The RBI was not comfortable with the Bank of Rajasthan promoter and its inspection unearthed various violations by the bank.

There are some examples in other countries also where other investors have given helping hand to the financial institutions in their struggling period. In the Financial Crises of 2008, in the USA some banks struggled, and Bank of America was the one that was hit hardest. In late 2011, Bank of America was struggling to raise capital, and so Warren Buffett once again stepped up with a deal to invest $5 billion in the bank, getting preferred stock and warrants.

Future of this deal:

Reportedly, SBI is in talks with several Global and domestic investors like investment firms, banks, asset management companies to make investments in YES Bank. And with the recent approval of the Board to raise 5,000 crore capital, seems like the Board may have found new investors

Also, in 2017, 5 associate PSBs of SBI were merged with it. This was, of course, a voluntary step towards consolidation in the Banking sector and it also did benefit SBI. In this case, to avoid a situation like the IL&FS fiasco, SBI was asked by the Govt. and RBI to step in. At present, YES Bank is struggling and this investment doesn’t seem gainful. Nevertheless, over the next 3 years, the consortium may help YES Bank stand on its feet and SBI will take over the bank or they may even hand it over to new investors.

Over the near to medium term, the bank’s ability to improve its deposit franchise and reduce its reliance on wholesale funding will be critical to maintain its scale of operations. The reduced scale of operations could also impact its profitability unless it is able to prune its operating costs as well. Despite the high slippages in 9M FY2020, YBL has overdue advances (SMA) of ~8% of its standard advances as on December 31, 2019. This, coupled with the need to increase the provisions on the stressed investment book, will translate into elevated credit provisioning requirements in FY2021.

The bank’s ability to improve its deposit franchise over the medium term and reduce its reliance on wholesale funding will be critical to maintain its scale of operations as well as profitability. Hence, the profitability will be driven by recoveries from the stressed pool of assets. However, in the near term, the loan book is expected to degrow, which will constrain the operating income growth. The bank’s ability to reduce its operating expenses would be critical for its overall operating profitability. Credit costs will continue to be driven by recoveries as fresh slippages expected to remain high. YBL’s exposure to the corporate sector has been declining but it remained high at 57% of the overall advances as on December 31, 2019 (61.9% as on September 30, 2019 and 65.6% as on March 31, 2019) compared to the banking sector average of ~40%. The high share of corporate advances has impacted the bank’s asset quality.

Conclusion

Not allowing YES Bank to collapse for Indian banking and financial systems is similar to not allowing COVID -19 to infect the large population. The new management needs to define priorities. Identify and communicate the three to five most important ones. Early in the crisis, those might include employee retention, financial liquidity, customer care both depositors and lenders, and operational continuity. Document the issues identified, ensure that leadership is fully aligned with them, and make course corrections as events unfold. Make smart trade-offs.  It may not be easy in any way. What conflicts might arise among the priorities? Between the urgent and the important? Between survival today and success tomorrow? Instead of thinking about all possibilities, the best management should use their priorities as a scoring mechanism to force trade-offs.

The above is possible if the bank name the decision makers. In the central command “war room,” it must be established who owns what. Empower the front line to make decisions where possible, and clearly state what needs to be escalated, by when, and to whom. Your default should be to push decisions downward, not up. The management should embrace action, and not waste time to punish mistakes. In triage situations, it’s crucial to have an accurate, current picture of what is happening on the ground. leaders must get situational assessments early and often. One way is to create a network of local leaders and influencers who can speak with deep knowledge about the impact of the crisis and the sentiments of customers, depositors, employees, and other stakeholders. Technology can bring the parties together; and in fact on online payments and use of UPI, YES Bank is the leader. The success depends on how the management can lead with empathy and handle changing dynamics.

Godawari Power & Ispat Ltd. (GPIL), formerly Ispat Godawari Ltd (IGL), a listed company, is a flagship company of the Raipur based HIRA Group of Industries. Founded in 1999 by Mr. Bajrang Lal Agrawal, company operates in mainly two business segments of Steel and Electricity. The major driver of revenue and profit is the sale of steel and related products. Today GPIL is an end-to-end manufacturer of mild steel wires and in the process also manufactures sponge iron, billets, alloys, captive power, wires rods, steel wires, Oxygen gas, fly ash brick and iron ore pellets. It also generates power for captive consumption.

GPIL mainly functions out of 2 states: Chhattisgarh and Rajasthan. While most of its business is based in Chhattisgarh, it has one 50MW solar power plant in Rajasthan. It has 3 subsidiaries: Godawari Green Energy Ltd. (GPEL), Ardent steel Ltd. (ASL) and Godawari Energy Ltd. (GEL) None of them are wholly owned. It also has a step-down subsidiary called Hira Energy Ltd. (subsidiary of ASL). From its AR – 2019 GPIL says that only GPEL and ASL are functional while GEL’s projects never commenced and have been abandoned. Also, revenue from  Hira Energy is insignificant.

Jagdamba Power and Alloys Ltd. (JPAL) is an unlisted company. It was incorporated in 1999. The company operates in 2 segments: Steel and Electricity. Over 58% of its revenue in 2018-19 came from sale of electricity, which was sold exclusively to GPIL under a short term “Power Purchase Agreement” (PPA). Besides, JPAL also manufactures HB wires (mesh wires of steel) and provides Job work services. The Power Plant became operational in FY 19 only and is a captive power supplier to GPIL.

JPAL is based in Siltara, Raipur, Chhattisgarh and it has no subsidiaries. The company is promoted by Mr. Alok Agrawal.

The Transaction

• Appointed date for the transaction is 1 April 2019.
• GPIL is going to acquire the power undertaking of JPAL in all-stock deal. The swap ratio arrived at is 140: 89 i.e. for every 140 shares held, 89 shares of GPIL will be issued.
• The Power Division of JPAL includes the Electricity and Job Work Services Business. The Non-Power division is the HB Wire Manufacturing Division.
• The scheme provides for a tentative deadline of 31st March 2021 for the scheme to take effect. Beyond this date, the scheme shall stand revoked and cancelled.

GPIL Pre and post scheme Shareholding Pattern

As can be seen, the promoter holding will be diluted by around 5%, but in the process the promoters will also get to hold shares in power business directly.

JPAL shareholding pattern (as on 31st March 2019)

The Major shareholders are Alok Agrawal (30.4%), GPIL (33.97%), Amit Agrawal (23.36%), Sagar Energy and Steels Ltd. (12.26%) and other minor shareholders (3 in number) who together hold less than 1%.

In the financials of JPAL, as well as in the copy of the Board resolution on this scheme, only Alok Agrawal is classified under “Promoter and Promoter Group”. But in the document showing Pre and Post Scheme Shareholding pattern of JPAL all shareholders except GPIL are classified under “Promoter and Promoter Group”. So more clarity is needed to determine as to who is part of the Promoter Group. Nevertheless, in the alternative, the collective promoter holding in JPAL is 66.03%  as opposed to Alok Agrawal’s 30% holding.

Rationale as per the Scheme

1. With the complete integration of the Demerged Undertaking with GPIL, the captive power generation capacity of the GPIL will stand enhanced from 73MW to 98 MW. The availability of much needed additional 25MW of power capacity, to meet the shortfall of electricity, will assure uninterrupted power supply to the steel plant.
2. The Demerged Company currently has business interests in diverse businesses. Post demerger it will achieve greater management focus in other business activities.
3. The scheme will help achieve cost efficiency and help achieve economies of scale, reduction in overheads and improvement in various other operating parameters.

Valuation

Table 1: Valuation of GPIL and JPAL

*Excluding GPIL’s stake of 34%

So, the value of power undertaking (excluding GPIL’s share of 34%) of JPAL comes to about 10.3% of the market cap of GPIL.

Note: In the Financials released by JPAL, which show the allocation of Assets and Liabilities, they have adjusted an amount of 30 Crore by deducting it from the “Other Equity” of Non-Power division and adding it to the “Other Equity” of Power Division and named it as a transfer for “Branch/Division Account”. If we consider this naming, the transfer could either be an adjustment of the general reserve or could be recognition of an amount receivable from the Power Division, maybe a “Loan”. If it is the latter, the Fair value of Net Assets of the Power Division will be reduced to almost Nil and the whole transaction would be payment towards Goodwill and Fair value of long-term assets like Land.

What are  the industry standards for valuing a Coal Power Plant?

1. In 2012, CERC came up with calculations for “benchmark capitals costs” for Coal and Thermal Power Plants. Those calculations were done for plants with capacities 500MW and above, with costs starting from Rs. 5Cr/MW and reducing as capacity increases. This scheme is of a comparatively miniscule 25MW Plant and hence the costs per MW of setting up a new plant in 2019-20 would be much higher. Besides, setting up any new coal plant has been banned in the region due to environmental restrictions. So, this acquisition would not only be beneficial valuation wise but is also necessary for GPIL.
2. Recently JSW acquired GMR Kamalanga Electricity Ltd. (GKEL) for cash consideration of Rs. 5321 Cr. Comparison of this with the GPIL-JPAL arrangement is given in the following Table.

Table 2: Recent Transaction Comparison in Power Sector

*Including GPIL’s share

Accounting treatment in books of GPIL

• All the assets and liabilities will be taken over at fair values in the Financial Statements of GPIL, after following the “Acquisition Method” as per Ind AS 103: Business Combination.
• The Goodwill will have to be recognized as the difference between the consideration and the Fair Value of the Net Assets taken over. It will be a significant amount of about 40 Crores. (Refer working and note below Table 4.2)
• The Share capital will increase by Rs. 3,21,97,020 and the balance consideration of approx. Rs. 71.95 Crores will be recorded as a Securities premium.

Taxation

• The Power division is a business undertaking and has a loss of Rs. 2.23 Crore which will be passed on to GPIL u/s 72A (4), ITA, 1961.
• The Power division also has Deferred Tax Liability of Rs. 1.14 Crore allocated to it.

Analysis

• GPIL’s steel plant generates captive electricity and has a capacity of 73 MW. Steel manufacturing requires a huge amount of uninterrupted power supply. The acquisition of a 25 MW power plant of JPAL helps GPIL ensure its power needs are met.
• The coal thermal power plant of JPAL is in Siltara, Raipur, which is the same industrial area where GPIL’s steel plant is located. No new coal power generation facility can be set up in the area because of environmental restrictions and hence existing power plants in the area are crucial for big steel plants like GPIL. Thus, acquisitions like these are important for steel manufacturers.
• JPAL and GPIL already have a short term PPA between them where JPAL exclusively supplies all its power to GPIL but this acquisition of the Power undertaking will decrease the GST and other compliances.
• GPIL claims that this additional power supply will specifically help it to increase its billet production.

Note: “Billets” are long steel rods used as raw materials or feedstock in extrusion, forging, rolling and other metal-processing operations. Post scheme JPAL’s operations will be reduced to only HB wire manufacturing which accounted for only 9% of its revenue in 2018-19.

Table 3: Segment-Wise Financials of JPAL (All Figs in INR Crores)

*35 crores are loans and advances given to body corps.

Source: JAPL financials : Annexure to Scheme-  (retrieved from GPIL website)

Table 4: Book Value of Assets of Power Undertaking of JPAL (All figs in INR Crores as on 31.03.2019)

Note: This table describes 90% of the assets being acquired by GPIL and most of them have no appreciable value. Considering the valuation given to Power undertaking the Value of Goodwill will be extremely high when it gets accounted for. Net Assets Fair Value should be around 35 Crores. The value of Power undertaking (excluding GPIL’s share) is about 75 Crores.  

So, the GPIL is acquiring the Power division has about 50% of the Assets allocated to it but brings in more than 91% of the revenue of JPAL.  58% of this revenue is from GPIL itself. All the Job Work services are provided to Hira Steels Ltd., a company in which GPIL has Trade investment. Following flow chart explains this acquisition.

Important Metrics of GPIL

Capacity Utilization

*Including supply from JPAL

The company states that one of the reasons for the acquisition is to help augment its billet production. Considering the data above, FPIL has scope for improving capacity utilization. And in fact, in its AR – FY 2019, GPIL claims that because of the power supply from JPAL under the existing PPA signed between them, it was able to increase its steel billet production by 51% in 2019 over its 2018 production levels.

Trend of EBITDA over the years of GPIL:

Note: The EBITDA had an impressive jump in 2017-18. This was mainly because of increase in demand, production volume and market prices across all product lines of the company.

Long term debt reduction in this year till now

GPIL Consolidated – Historical Profit & Loss

Table 5: Profit & Loss of GPIL for last 4 Years

As can be seen, the trends in all the figures is an increasing trend which is a positive sign.

Financial ratios of GPIL (Consolidated)

Table 6: Financials Ratios for GPIL

About the earlier attempt to amalgamate JPAL which failed:

Earlier in February 2019, the companies had filed a scheme for the amalgamation of JPAL into GPIL. The Rationale of the scheme was same at that time too. The swap ratio on that deal was 100: 45 i.e. for every 100 shares held, 45 shares of GPIL were to be issued. But in the subsequent months, till the scheme got the necessary approvals, GPIL’s share price took a beating in the market and the shareholders thought they were getting a raw deal. As a result, the shareholders rejected the scheme at that time.

Subsequently, GPIL entered into a short-term power purchase agreement (PPA) with JPAL for consistent power supply from their 25MW plant. Now, the Boards of both companies have approved this new scheme with a new swap ratio of 140: 89. This is an increase of approx. 20% over the previous ratio.

It still remains to be seen if the deciding shareholders of JPAL (apart from GPIL and Alok Agrawal) who are Amit Agrawal, Sagar energy and Steels Ltd. and the other minor shareholders will approve the scheme or not, especially since the market value of shares of GPIL as of February 2020 (hovering around Rs. 200) is lower than the value as per valuation report (Rs. 233.44).

Conclusion:

The scheme does have some operational synergies as claimed by the management, but the real effect is the simplification of group structure, avoidance of multiple level of compliances and taxes post GST. The increase in the assets of the company without any cash outflow and only dilute the promoter holding by 5%. In addition, Shareholders of GPIL will have direct interest in both the businesses. Shareholders of JPAL will now have an interest in steel as well as other businesses, thereby reducing their risks and giving them liquidity of shares of the listed entity.

Credit Access Grameen Ltd. (CAGL) formerly known as Grameen Koota Financial Services Pvt. Ltd is listed on the NSE and BSE with MCap of approx. Rs. 12,300 Crores. CAGL, founded by Vinatha Reddy and Suresh Krishna in 1999, offers a variety of financial products like Group Lending, Retail Finance and Insurance. It provides micro-credit loans to support business enterprises, home improvement, family welfare and emergencies. As a strategy, they mainly target women borrowers from rural and low-income households. As of September 2019, CAGL has 887 branches, spread across 13 states mainly Karnataka (269), Maharashtra(221), Tamil Nadu(131), Madhya Pradesh(115), and some more including Chhattisgarh, UP, Odisha, Bihar, Jharkhand, Rajasthan, Kerala.

CAGL is promoted by Credit Access Asia N.V., a company incorporated in Netherlands. This company holds around 80% stake in CAGL.

Madura Micro Finance Ltd. (MMFL) is an unlisted NBFC-MFI, incorporated in 2005 by Dr. K.M. Thiagrajan, which provides unsecured microfinance loans to women self-help groups (SHGs) in rural and semi-urban areas as well as to retailers with small shops. It mainly gives 2 types of loans: Group Loans and Individual Loans of amounts ranging from Rs. 15,000 to Rs. 65,000. MMFL was started in Tamil Nadu, it established a strong base there and over years MMFL has around 430 branches in various states like Maharashtra, Karnataka, Kerala, Bihar, Orissa and West Bengal.  MMFL also has a wholly-owned subsidiary called Madura Micro Education Ltd. (It is a very small company with total assets to the tune of Rs. 32 lacs).

Promoters have a major stake in MMFL (43%) while the rest is with the public and employee trusts. Dr. Tara Thiagrajan, daughter of the founder, has 32% stake.

The Transaction:

It is a 2-step transaction. The sellers in MMFL mainly are Dr. Tara Thiagarajan (promoter), AVT Group, Elevar Equity Mauritius and other minority shareholders.

1^st Step – Cash Consideration for 76% Stake

• CAGL proposes to acquire 76.34% of MMFL before filing the scheme. The scheme shall be filed and be effective only after this step.
• CAGL will acquire this stake by cash. It will be a payment of roughly Rs. 662 crores(figure arrived at using valuation report).
• Post this acquisition, MMFL will operate as an independent entity with existing management till the business processes are integrated and necessary approvals for the scheme is received.

Source: All figures from Reports and Results released by the Companies.

2nd Step – Equity Swap for Merger

• Once the scheme is effective, CAGL will issue new equity shares to the residual equity shareholders of MMFL (holding 23.66%).
• For issuing equity share swap ratio being 158 shares of CAGL to be issued for every 100 shares held in MMFL.
• The appointed date for the transaction is 2 March 2020.

Post the amalgamation whether the brand of MMFL will continue as it is or whether it will be merged with CAGL remains to be seen.

Shareholding Pattern

Post scheme the promoter holding will be diluted to 78.5%. As per SEBI rules, in all listed companies the public should hold a minimum of 25% in the company. So, we can expect the promoters to sell off more of their stake in the future.

Rationale of the Scheme:

• CAGL will get access to a large and unique client base of the Transferor Company, specifically in Tamil Nadu.
• Amalgamation would result in the geographical diversification of the portfolio of CAGL and strengthens its leadership position in the microfinance market. The combined loan portfolio would approximately be Rs. 10,000 crores, with approximately 37 lakh borrowers and more than 1,300 branches spread across 13 states and 1 union territory in India (as of September 30, 2019).
• CAGL can leverage the MFFL’S loan book, and its low cost of borrowing can potentially enable repricing of liabilities of the Transferor Company.

Valuation:

The valuation report has valued each share of MMFL to be Rs. 1208. Considering the no. of subscribed and paid-up shares, total valuation of MMFL comes to Rs. 870 Crores (approx.), which is just around 8% of CAGL’s market cap.

Accounting treatment:

• In Books of CAGL – After first step acquisition, all the assets and Liabilities will be consolidated at fair values in the Consolidated Financial Statements of CAGL, after following the “Acquisition Method” as per Ind AS 103: Business Combination.
• The Goodwill/capital reserve will have to have to be recognized accordingly.
• Post step 2 amalgamation, all the assets and liabilities will be transferred at their fair values only (as already recorded in books of CAGL) and Goodwill/Capital reserve will continue to show in books.

Analysis:

1. The impending economic slowdown and the consequent stress on rural households may be a cause for worry for small NBFC-MFIs like MMFL and could be a factor pushing the promoters to exit the company.
2. A cash deal helps avoid dilution of the shareholding of promoters of CAGL. The scheme is going to lead to a dilution of only 1.85 %* in the shareholding of promoters of CAGL. In the alternative of an all stock deal, the promoter holding would be diluted by around 8%.
3. The 76% acquisition of share before amalgamation helps in easing up the vote of approval that is required for an amalgamation u/ 230 Companies Act, 2013.

Synergy benefits:

• The scheme Positions CAGL favourably w.r.t Competition:

*(Source: CAGL Investor Presentation. All figures are as of 30 Sept. 2019)

• Increase in no. of borrowers:

*Adjusted for overlap. CAGL claims there will be an overlap of only 0.5 Lakh borrowers

That is a 40.1% jump and accelerates CAGL’s growth.

• The deal positions CAGL as a market leader in TN with a combined portfolio of Rs 2,300 Cr. This is 2.6 times the current portfolio in TN.
• Helps CAGL in portfolio diversification at an overall level. It lowers Karnataka share from 51% to 41%
• MMFL has had an impressive growth in its Gross Loan Portfolio (GLP) over the years (refer graph below). This transaction should help accelerate CAGL’s growth.

• All the employees are going to continue post-merger, in their existing roles. CAGL has 9817 employees. MMFL has 3312. Post amalgamation the entity will have a total workforce of 12, 129 which is a jump of 33.7%.

Financials:

Table 1: Financials of CAGL & MMFL as on March’19

*(Source Annual Reports of companies)

1. CAGL is operating at a much larger scale than MMFL.
2. Both the companies operate in one segment only and hence there is no segmental reporting as required by IndAS 108 “Operating Segments”.
3. Both the companies have miniscule NPAs.

Table 2: Financial Ratios for CAGL & MMFL (All figs as on March 2019)

Why may have talks between Federal Bank and MMFL collapsed?

By July 2018 there were news reports that Federal Bank was in advanced talks with MMFL to acquire them. Apparently, it had the winning bid but over the subsequent months, by September 2018, the IL&FS crises came to light. This crisis brought the whole NBFC sector into the spotlight. These defaults by such a large NBFC must have alerted the banks against dealing with NBFCs. Federal bank had an exposure of Rs. 210 crores in this scam.

In August 2018. Kerala was affected by devastating floods. Federal bank is headquartered in Kerala and has 47% branches there. While the floods didn’t affect the bank much in terms of revenue, they had a huge impact on the day-to-day operations of the bank.

Both these problems following one after the other, in such a short span, clearly would have de-railed the talks between Federal Bank and MMFL.

Besides, Federal Bank is a listed commercial bank which provides personal, NRI and business banking services. On the other hand, MMFL is an NBFC-MFI whose market base is mainly to rural women and low-income households and is functioning mainly in rural and semi-urban areas. Culturally and strategically the companies are poles apart. Amalgamation of MMFL into Federal bank could possibly rid MMFL of its identity and way of functioning. Also, synergy benefits would be greater if the merger is between 2 companies who are more in sync in their vision, mission and culture. These questions may have arisen in the minds of promoters and directors of MMFL.

Regulatory Hurdles:

RBI has discretionary powers to approve mergers that happen between Banks, NBFCs, etc. This scheme is going to have to pass through the complex web of scrutiny and regulatory mechanism of RBI. In the past RBI has either halted or rejected mergers between NBFCs whether it was Indiabulls Fin. and Laxmi Vilas bank or in the case of Shriram capital. And considering 80% stake in CAGL is held by a Foreign Company promoter, additional scrutiny and regulations are bound to apply.

Conclusion:

Mergers between NBFCs are not very common. This is a merger between 2 very similar NBFCs, functioning in 2 different geographical regions of India. The similarity in their goals will make the merger easier but whether this scheme will be approved by RBI remains to be seen. Another important question will be ease of integration about employees and systems and procedures for loan sanction, credit appraisal of its customers and recoveries systems And after approval, we believe if management spends enough time on these softer aspects merger than only it will likely to be proved to be beneficial to the stakeholders. Will this horizontal merger set a trend in the NBFC sector? Or will it be a one-off case? This will be interesting to observe.