Whenever a fundamental investor buys shares of a company, then she buys it with an expectation that the promoters/managers of the company will grow the business significantly in the future. She places her trust in the promoters of the company that they will value her trust in the company and their ability. She expects that the promoters will remain shareholder-friendly and will remain committed to the wellbeing of the company.
However, many times, investors get to know that the promoters of the company had prioritized their personal interests over the interests of the company and the minority shareholders. As a result, she finds herself in a situation where the performance of the company suffers and the share price declines. Many times, this results in significant destruction of the wealth of the shareholders.
Therefore, before investing in any company, it becomes essential for investors to look for early warning signs. She should look for signals that may indicate to her whether the promoters are already ignoring the public company for their personal ventures. If she is not able to find such signs before her investment in the company, then she should continuously monitor the developments and the actions of the promoters after her investment so that she may get to know whenever the promoters start ignoring the public company later on.
During our analysis of hundreds of companies for our website and for our personal investments, we have come across many instances where the promoters ignored the interests of their public companies and the minority shareholders. In many such cases, the promoters put their personal interests above the interests of public shareholders.
The current article is an attempt to present such examples that contain potential signs where the promoters might have lost their commitment to the public company and the minority shareholders. An investor should look at the cases to understand the situations and developments that may indicate that promoters now prefer their other initiatives to the public company.
The current article will also help the investor to identify various data points, sections of the annual reports and the data sources that will help her in assessing the dedication of the promoters to the public company.
Signs of Declining Commitment of Promoters to the Public Company
1) Promoters invest money in unrelated businesses when they actually need to spare money for the public company:
While analysing different companies, an investor will come across situations where the public company needs funds for smooth operations. Alternatively, the promoters need to spare money to meet their personal commitments related to the company like repayment of the loans taken by promoters by pledging their shares of the company. In such a situation, if an investor finds that instead of utilizing their money to revive their position in the public company, the promoters are spending money on other unrelated businesses, then it may indicate that the promoters prefer their other business ventures to the public company.
Let us see examples.
A) Omkar Speciality Chemicals Ltd and Lasa Supergenerics Ltd:
Omkar Speciality Chemicals Ltd is an Indian manufacturer dealing in speciality chemicals and pharma intermediates ranging from organic, inorganic and organo-inorganic intermediates products. We had analysed Omkar Speciality Chemicals Ltd on our website in May 2017, before the demerger of Lasa Supergenerics Ltd from the company.
While analysing the company in May 2017, we noticed that in the previous year (FY2017), the company was facing many issues because of the pledging of promoters’ shareholding of the company. The promoters had pledged a significant amount of their shareholding with lenders and the investing community was concerned.
In every conference call after the quarterly results, the analysts would ask the promoters about the timelines for getting the pledge released from the lenders. The management would make some promises about their tentative schedule of releasing the pledge. However, each of their promises remained unfulfilled and the promoters’ stake kept on declining due to selling of shares by the promoters/lenders apparently to meet the repayment obligations of their loans.
i) Management of Omkar Speciality Chemicals Ltd not able to meet its stated commitment to shareholders:
The promoters/management of the company made numerous commitments to stakeholders about the timelines for getting the pledge on promoters’ stake released from the NBFCs:
- First, in July 2016, during a conference call, the management assured the stakeholders that they would be able to release the entire pledge within 4-5 months.
Rushit Parekh: And as you mentioned that it will be repaid in the next four to five months‟ time frame?
Pravin S. Herlekar: Yes, it is.
Rushit Parekh: So if I understand it correctly, your entire shares which have been pledged will become unpledged?
Pravin S. Herlekar: It will.
Rushit Parekh: So after four to five months there will be no pledging left from the promoter side, correct?
Pravin S. Herlekar: Yes, absolutely right.
- Second time in August 2016, the management said that it will get the pledge on its shares released by October 2016.
Mohit Bansal: I am actually sorry, I joined in late, I missed in the management commentary. My first question was regarding the de-pledging of shares in the last con-call which was a month back on this topic, you mentioned that in the next 15 days you would be reducing the stake, the pledge shares by some percentage sir. Where are we on that because we not seen any disclosure on that?
Pravin Herlekar: Yes, see what is happened is there are certain issues about prepayment of certain loans. So there will be penalties on that, etc. So we have deferred that and till such time, this money has been parked in the banks only and to that extent our utilization of CC limit will be going down. So we will be saving on the interest cost.
Mohit Bansal: So what is the timeline on the de-pledging?
Pravin Herlekar: I think it should happen somewhere partly in September partly in October.
- The third time, in November 2016, during another conference call, when the management could not meet the earlier stated timeline, it stated that it would release the entire pledge by end of FY2017:
Dimple Kotak: Okay sir as you commented in your initial commentary that you expect the banks to give you the working capital by the end of December at max, so can we expect by Q4 FY17 the entire de-pledging to come in?
Pravin Herlekar: I can say it is more than 100%.
However, the management could not meet even this deadline as on March 31, 2017, more than 21 lakh shares of promoters were still pledged with lenders.
When an investor reads through the reasons cited by the management for its inability to meet the stated deadlines for the release of the pledge, then she finds the explanation that the loans against shares have a prepayment penalty. Therefore, repaying these loans ahead of schedule would lead to additional cost for the company in the form of the prepayment penalty
Now, an investor is left confused about:
- whether the management had read the loan agreements that it had signed with the lenders before taking loans against shares
- if the management knew that these loans against shares had a prepayment penalty, then whether it took the concurrence of lenders about waiving the prepayment penalty before it started assuring the stakeholders that it would soon get the pledge on the shares released.
Whatever be the reason about the prepayment penalty being the roadblock for the pledged shares to be released, it shows that the management needs to do a bit more homework before it prepares its strategies and communicating it to stakeholders.
ii) Management of Omkar Speciality Chemicals Ltd not able to meet its stated commitment to shareholders again:
By now, in the analysis, it seemed probable that the management of Omkar Speciality Chemicals Ltd led the company into a liquidity crunch situation by commencing a capital expenditure program, which needed funds far in excess of what the company could produce from operations. Moreover, the deteriorating working capital position further complicated the tight liquidity position of the company.
As a result, the promoters of the company had to resort to selling their personal stake in the company to raise funds to ease out the liquidity position of the company.
However, like in previous cases of assessing the funds’ requirement for the started capital expansion plan and assessing the feasibility of getting the pledge of shares released, the management again erred while assessing the exact amount of stake that it might need to sell before the liquidity situation is brought under control.
- In July 2016, when promoters had a conference call about their stake sale, they communicated to stakeholders that they would not sell any further stake. The promoter stake was at 58% at that time:
Siddharth Oberoi: Which you can easily repay.
Pravin S. Herlekar: Yes, which will be anyway generated.
Siddharth Oberoi: So one thing is clear that you are not selling any more stake, right?
Pravin S. Herlekar: We are not.
- The promoter reiterated their resolve of not needing to sell a further stake in the company during the conference all in August 2016:
Dimple Kotak: Okay, but sir, your debt has increased from 207 crores in FY16 to 237 crores for the first quarter?
Pravin Herleker: Yes, now the part of it is by way of loan from the promoters itself. Loan in the books of the company has gone up, but then that has come from the promoters.
Dimple Kotak: Okay sir and sir going ahead, do we see further decline in the share percentage holding?
Pravin Herleker: No, now the holding stands at 58%, was earlier at 67%, though it stands at 58% and it will remain at that level. Now there is no more plan of selling of promoter stake.
- However, the promoters sold more shares later on and then during the conference call on November 8, 2016, the promoters said that their stake will not go down below the majority mark:
Moreover, the EBITDA margins are also reasonably strong and sustainable, hence we decided to make every attempt to reduce the pressure of high pledge, especially with the de-merger process moving ahead. At the end of this exercise, there is some part of pledge left but the promoter’s holding will not go below the majority mark.
The promoters resorted to further sale of shares and as per the shareholding pattern of Omkar Speciality Chemicals Ltd at March 31, 2017, available on BSE website, the promoter’s shareholding stood at 41.01%.
Looking at the above incidences, an investor would notice that the promoter family seemed under a financial crunch where they had raised money from lenders by pledging their shareholding in the company. However, they did not seem certain about the future in terms of how much time it would take for them to repay the loans and get the pledge released. As a result, it seemed that the promoters are losing their shareholding and control in the company.
At such a point of time, an investor would expect that the family would be focused on mobilizing all their resources to repay lenders to release the pledge of their shareholding in the company. However, an investor is surprised that during this apparent financial crunch in the family (Sept 2016), the son of the founder promoter, Omkar Herlekar, made an open offer to buy 26% stake in a securities/broking business, which is totally unrelated to the chemicals business of Omkar Speciality Chemicals Ltd and Lasa Supergenerics Ltd.
iii) Omkar Herlekar made an open offer to buy 26% stake in an unrelated business:
As per the information available on the website of Indiainfoline.com, Omkar Herlekar made an open offer to buy 26% shares of Amarnath Securities Ltd (7,80,052 shares) at ₹16/-, payable in cash. This would entail a cash outflow of about ₹1.25 cr.
All Market Participants are hereby informed that Mr. Omkar Pravin Herlekar (“Acquirer”) have made an open offer to acquire up to 7,80,052 Equity Shares of Rs. 10/- each at an Offer Price per equity share of Rs 16/- each payable in cash, representing 26% of the total paid up equity share capital/ voting share capital of Amarnath Securities Limited (“Target Company”) pursuant to Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and subsequent amendments thereof from the public shareholders of the Company from 15th September, 2016 to 28th September, 2016.
When the founder promoter of Omkar Speciality Chemicals Ltd, Mr. Pravin Herlekar, was asked about this business interest of Omkar, then Pravin avoided the questions saying that it is an independent business interest of Omkar and has nothing to do with Omkar Speciality Chemicals Ltd.
Pratik Bora: Sir only one question, why open offer to Amarnath Securities?
Pravin S. Herlekar: Well, it is a different matter not related to Omkar Speciality Chemicals Limited. And Company has by no way invested anything in any of the business like this. Company Omkar Speciality is fully focused on its own business. Amarnath Securities is acquired by Omkar Herlekar, my son, and he is looking for some, exploring some opportunities in that company. So that is an absolutely independent business and the Company has nothing to do with it.
Pratik Bora: But sir, not Company but sir promoter level also, so when we are reducing our stake in the Company which is doing good and both its promoters are also bullish about the Company’s prospects, about the long-term prospects and contracts and they are reducing the stake in this company at the same time they are increasing the stake in a broking company. So how these are related?
Pravin S. Herlekar: I think let us not mix up the issues, the proceeds received out of sales of Omkar Speciality are fully brought in back through the Company, nothing is invested outside. It is an independent activity which Omkar is trying to pursue which has nothing to do with its commitment with the company, it continues to be a whole time director into the company and fully committed to Omkar Speciality’s business. Like in many cases many of the promoters have divergent businesses and they manage the things independently, there is no mix up of any activity.
There are a few things, which come to an investor’s mind upon analysing these developments:
- An interest in an entirely different business line when the company has just completed the major capex after suffering a lot of liquidity stress/tough time. One line of prudent thinking would expect that the management should now focus completely on realizing the full capacity utilization of the capacity that has been created by getting additional sales orders, expand the business to new customers, geographies, create new teams etc. Such activities would need heightened focus from the management especially the people responsible for Lasa Supergenerics Ltd, where the maximum capacity has been added.
- A cash outflow in terms of the open offer for a brokerage firm at a time when the founder promoter is selling his personal stake in the business to get the pledged shares released from high-cost lenders indicates that this might not be the most opportune time to go for such diversification in an unrelated business.
By looking at the above circumstances, an investor is left wondering. At one end, the promoters had pledged a significant part of their shareholding in the company. Then, promoters did not repay the loans to the lenders and apparently, as a result, the lenders sold the shares in the market, leading to a decline in promoters’ shareholding in the company. Moreover, at such a time, the promoters invested money in an unrelated venture of securities/broking.
One interpretation from this sequence of events was that the promoters are no longer committed to their long-standing chemicals business in Omkar Speciality Chemicals Ltd and the subsequently demerged Lasa Supergenerics Ltd.
There is no wonder that both the companies are currently making losses and the shareholders of both the companies have paid the price.
Share price of Omkar Speciality Chemicals Ltd (2017-2020):
Share price of Lasa Supergenerics Ltd (2018-2020):
An investor would notice that currently, both the companies owned by the promoters, Omkar Speciality Chemicals Ltd and Lasa Supergenerics Ltd are making losses in their business and their share prices have declined by about 80-90% in the recent period.
In 2017, the incidences like raising money by pledging shares of the company, unwillingness/inability to repay the money to the lenders and the subsequent purchase of shares of the securities business might have indicated to the investors that the promoters of the company were losing their dedication to the public company. An informed investment decision at that point in time might have saved the investors from subsequent wealth erosion.
An investor may read our complete analysis of Omkar Speciality Chemicals Ltd in the following article: Analysis: Omkar Speciality Chemicals Ltd
While analysing the above case of Omkar Speciality Chemicals Ltd, an investor would notice that the pledge of shares by promoters to lenders is a good indication that may provide an early warning signal that the promoters have started using the economic value of their shareholding of the company for their personal purposes. This makes the pledging of promoters’ shareholding as another important sign to look for when investors try to assess the dedication of promoters to the public company and minority shareholders.
2) Pledging of shareholding by promoters:
Pledging of shares is an activity where a person takes a loan from a lender and in return provides her shares of any company as security (pledge) to the lender. The person gets the money from the lender and if she is not able to repay the money, then the lender sells the shares in the market and recovers its money from the sale proceeds of the shares. The pledging of shares by the person is equivalent to indirectly taking out the economic value from the shares by way of the loan from the lender.
Over time, multiple incidences have proved that many times, promoters extract the economic value of their shareholding of the public company by way of taking loans from lenders by pledging their shares before they abandon the company.
Investors would remember the case of Satyam Computer Services Limited where on January 7, 2009, the founder promoter of the company, B. Ramalinga Raju confessed to the public that he had manipulated the accounts of the company to present a false (and better) financial position of the company.
A) Satyam Computer Services Limited:
In the case of Satyam Computers, it was learned that the promoters of the company had pledged almost their entire shareholding with the lenders and taken loans against it. When the promoters could not repay these loans to the lenders, then the lenders sold the shares and as a result, the shareholding of the promoters in the company fell to very low levels.
The above article highlights many important points about the developments related to the pledge and the shareholding of promoters of Satyam Computers in the company.
Ramalinga Raju-led promoters hardly have any stake in Satyam Computer Services….. The founders now hold only 3.6 percent in the company after the sale of pledged shares by some of their lenders.
The stake held by promoters-led by Raju has been showing a drastic decrease from 2001 when they held 25.60 percent. It was 22.26 percent by the end of March, 2002; 20.74 percent in 2003; 17.35 percent in 2004; 15.67 percent in 2005; 14.02 percent in 2006; 8.79 in 2007 and 8.74 in 2008.
Before the incidence of Satyam on January 07, 2009, it was not necessary for the promoters to disclose the level of the pledge of their shareholding to the stock exchanges. However, it turned out that it was a piece of very vital information, which was not available to the shareholders until then. Therefore, on January 21, 2009, the regulators amended the guidelines and made it mandatory for the promoters of all the listed companies to disclose the level of pledging on their shareholding.
The article acknowledged that due to the lack of requirements to disclose the level of pledging of promoters’ shareholding, the promoters of Satyam Computers could pledge all their shareholding in the company without the investors knowing about it.
The regulator’s announcement on disclosure of pledged shares comes in the wake of the Satyam scam, wherein promoter Ramalinga Raju had pledged nearly all his shares — whose prices he had inflated by falsifying profits.
However, the case of Satyam Computers is not alone, where the promoters of a public company took out the economic value of their shareholding by way of pledging of shares to the lenders. Over time, many other promoters took out the economic value of their shareholding by way of pledging.
However, despite the increased disclosure requirements from promoters & companies about pledging of shares, the promoters are always able to find out innovative ways to hide the disclosures of the pledge by entering into complex transactions with lenders.
B) Yes Bank Ltd:
Recently, in the case of Yes Bank Ltd, investors learned that the promoter, Rana Kapoor, had taken money from mutual funds and non-banking finance companies (NBFCs) by providing security/comfort of Yes Bank shares. However, the transaction was executed in such a manner that the promoters could bypass the disclosure of pledge to the stock exchanges.
An article in the media highlights some aspects of the transactions between the promoters of Yes Bank and Mutual Funds. (Sources: Livemint, July 24, 2019). Some excerpts from the article:
Last year, MCPL had raised ₹1,160 crore by issuing NCDs to RNAM. …. The loan pact mandates that the value of Yes Bank shares (held by Kapoor and MCPL) should always be greater than double the loan outstanding.
The whole transaction lies shrouded in mystery. For one, it is odd for a mutual fund, which is a custodian of public funds, to lend unsecured funds to a private entity. Having secured the loans now, RNAM needs to disclose the structure of the transaction to the public shareholders because RNAM is a listed entity.
Yes Bank co-promoters Rana Kapoor and his family owned firm Morgan Credits Pvt. Ltd (MCPL) have been forced to pledge their entire 7.34% stake with Reliance Nippon Life Asset Management Ltd (RNAM), asset manager of Reliance Mutual Fund (MF).
Therefore, investors learn that the promoters of Yes Bank Ltd had taken large loans from mutual funds etc. in their personal capacity by giving indirect comfort/security of their shareholding in Yes Bank. Such a transaction was similar in nature to pledging but was designed in such a manner that the promoters did not need to intimate about it to the stock exchanges.
Effectively, the promoters of Yes Bank took out the economic value of their shareholding in the Bank by way of such loans and just like Satyam Computers, they attempted to keep up the price of the shares of the company. One such attempt came from the promoter, Rana Kapoor, when in Sept 2018, he made claims that he will never sell his shares in Yes Bank as these are like diamonds, which are forever and never to be sold. (Source: Rana Kapoor on Twitter)
However, investors learned the hard lesson after some time, when Rana Kapoor’s family sold their entire stake in Yes Bank.
Yes Bank co-promoter Rana Kapoor, and his family-run firms Yes Capital (India) Pvt. Ltd and Morgan Credits Pvt. Ltd, have exited the bank, thus losing all control and voting rights.
In recent times, investors learned about another such case, Zee Entertainment Enterprises Ltd, where the promoters of the company used the economic value of their public company to fund their unrelated personal business ventures.
C) Zee Entertainment Enterprises Ltd:
In the case of Zee Entertainment Enterprises Ltd (ZEEL), the promoters of the company took loans from multiple lenders by giving pledge/security of shares of the media company ZEEL, to fund their unrelated personal infrastructure ventures.
Media baron Subhash Chandra may lose control of Zee Entertainment Enterprises Ltd (ZEEL) as a clutch of asset managers, non-bank lenders and foreign portfolio investors, which had extended loans to Zee’s promoter group companies against share pledges, plans to put their pledged shares in an escrow account in preparation for a sale.
Chandra’s Essel Group companies hold a 22.37% promoter stake in Zee. Of this, 21.48% has been pledged as collateral against finances availed by Essel Group firms through issuance of non-convertible debentures (NCDs).
If the entire pledged holding is sold off, Chandra will be left with 0.89% stake in Zee.
Essel Group has not been able to honour the repayment, forcing VTB Capital to sell the pledged Zee shares.
Promoters of Essel Group have a debt of around ₹11,000 crore. Essel Group companies together owe an additional ₹11,400 crore, according to a 5 October Mint report.
Ultimately, the shareholders of the company paid a heavy price when the share price of ZEEL declined nearly 80% over time.
Therefore, an investor would appreciate that most of the time, the promoters of companies attempt to take out almost all of the economic value of their shareholding in the public company by way of pledge/similar complex structured loan transactions before they abandon the public company and minority shareholders.
Therefore, it becomes essential that investors keep a close watch on:
- Direct disclosures related to pledging of shareholding by promoters OR
- Indirect signal by way of other news items that may indicate that the promoters have taken a lot of loans in their personal capacity to focus on their personal ventures OR
- Signs that the promoters are trying to keep the share price of their company high by making media statements instead of the sound business performance of the company.
From the above discussion, an investor would notice that whenever promoters attempt to take out the economic value of their shareholding in the public-listed company and try to fund their other personal ventures, then as a fallout, they lose their shareholding in the company. Therefore, the declining shareholding of promoters in the company also becomes an important signal that the promoters are losing their dedication to the public company and minority shareholders.
3) Continuously declining shareholding of promoters in the company:
In many of the cases discussed above, an investor would have noticed that the dedication of the promoters to the public listed company declined and they attempted to take out economic value from their shareholding by way of pledge. Such an attempt led to the selling of shares by the lenders and the shareholding of the promoters declined in the company.
Many times, when the data of the pledge of promoters’ shareholding is present in the public domain, then investors are able to know the reasons of the decline in the shareholding and then they are able to make an interpretation accordingly that the dedication of promoters to the public company is declining.
However, we also witnessed some cases above where the data of the pledging of promoters shareholding was not available in the public domain. In the past, it used to be due to weaker regulations that did not require promoters to disclose pledge of shares like in 2009 when the promoters of Satyam Computers pledged almost their entire shareholding but did not need to disclose it to stock exchanges.
In the recent times, it might be that the promoters of the company have entered into complex loan agreements with lenders, which take indirect security/comfort of the promoters’ shareholding, and in turn, the promoters bypass the requirement to disclose such loan transactions to stock exchanges like in the case of Yes Bank.
However, in all these cases, the investors would note that the shareholding of the promoters started to decline steadily and kept on reducing over the years. E.g. in the case of Satyam Computers where there was no disclosure of the pledge of promoters stake.
In the case of Satyam Computers, the shareholding of the promoters declined from 25.60% in 2001 to 3.6% in 2009.
The stake held by promoters-led by Raju has been showing a drastic decrease from 2001 when they held 25.60 percent. It was 22.26 percent by the end of March, 2002; 20.74 percent in 2003; 17.35 percent in 2004; 15.67 percent in 2005; 14.02 percent in 2006; 8.79 in 2007 and 8.74 in 2008.
Therefore, investors would notice that the continuous decline of shareholding of promoters in the company also has the potential of acting as a strong signal that the promoters are losing their commitment to the interests of the public company and its shareholders.
Let us see some such instances in which the shareholding of promoters declined significantly over the years, where the promoters seem to have diverted their attention from the main business of the company.
Among the cases discussed above:
- In the case of Omkar Speciality Chemicals Ltd, the shareholding of the promoters have declined to 27.62% in December 2019 from 65.77% in December 2015. (Source BSE website)
- In the case of Zee Entertainment Enterprises Ltd (ZEEL), the shareholding of promoters has declined to 4.87% in December 2019 from 43.07% in December 2017. (Source: BSE website)
In addition, while analysing the case of Kokuyo Camlin Ltd, an investor notices that over time, the promoter family has reduced its shareholding significantly by selling it to other counterparties. Currently, the founding-promoter family has sold their almost entire shareholding in the company and the family members are happy being the employees of the company instead of owners.
A) Kokuyo Camlin Ltd:
Kokuyo Camlin Ltd is a leading manufacturer of stationery & related products owning brands Camel and Camlin. The company was founded by an Indian family; however, it is now a subsidiary of Kokuyo Co. Ltd of Japan.
The founding family, over time, realized that the stationery business is very difficult to run without any sustained competitive advantage. The promoters realized that this business is very expensive/cash consuming to maintain.
i) Tough business; Camel and Camlin very expensive brands to maintain:
The business performance of the company has been very challenging over the years. During FY2012-FY2014, despite all efforts of the management, the company could not avoid losses. Despite a huge amount of investment in plant & machinery as well as in advertising & promotions, the company is not able to ensure consistent profitability.
Since FY2010, in the next eight years (FY2011-2018), Kokuyo Camlin Ltd spent an amount of ₹160 cr on advertisement and sales promotions. However, if the investor notices the result of this expense of ₹160 cr on the profits of the company, then she realizes that in concrete profitability terms, there is no value addition.
In FY2010, the company had reported a net profit after tax of ₹12 cr. After spending additional ₹160 cr on advertisement and promotions over the next eight years (FY2011-18), the net result was that Kokuyo Camlin Ltd.’s profits had declined to ₹10 cr in FY2018. In the meanwhile, the company also reported losses in FY2012, FY2013 and FY2014.
Our analysis of the company showed that the company suffers when raw material/commodity prices go up as it lacks the pricing power to pass on increased costs to customers. The company suffer again when the commodity prices go down as the already cutthroat competition intensifies further and the company has to reduce the prices of its products.
The company’s business has been consuming cash at a fast pace. Apart from entire business profits, the company consistently has to feed the business with additional funds from debt as well as equity just to maintain nominal growth of 8-9%. Despite such significant funds infusion, the business has not generated surplus cash for its shareholders.
ii) Promoters sell their almost entire stake in the company and prefer being Employees rather than Owners of the Company (i.e. prefer paycheque to the dividend cheque):
Without a doubt, the stationery business is a tough business to operate and the promoters seem to be happy to let the Japanese company Kokuyo take up majority stake when the opportunity came in FY2012. Kokuyo infused money in the company by preferential allotment as well as gave an opportunity for the promoters to sell a significant portion of their holding at a premium to the prevailing market price.
However, the stake sale by the Indian promoters did not stop in FY2012, when they sold their 20.27% stake to Kokuyo. The Indian promoters kept on selling their stake to Kokuyo year after year. During FY2014, when the company came out with the rights issue, then only the stake of Kokuyo Co. Ltd went up in the company from 50.5% in FY2013 to 65.8% in FY2014. During the year of the rights issue, the stake of Indian promoters declined from 13.4% in FY2013 to 9.2% in FY2014. It indicates that the Indian promoters did not participate in the rights issue.
It seems that the Indian promoters have decided to completely exit from the company as shareholders as they are continuously selling their stake to Kokuyo year after year and as disclosed below and their current stake in the company at meagre 0.6%.
An investor would appreciate that since the sale of the majority stake, the Indian promoters of the company have only earning salary/remuneration from Kokuyo Camlin Ltd as the company has not declared any dividend due to meagre profits.
Looking at the above table, the investor would notice that selling their stake in the company, the remuneration of the Indian promoter has been consistently on the rise. The total remuneration taken by the Indian promoters from Kokuyo Camlin Ltd has consistently increased year on year from ₹1.9 cr in FY2013 to ₹3.2 cr in FY2018.
This is despite the fact that the profitability of Kokuyo Camlin Ltd has been very fluctuating during these years. The company reported losses in FY2013 and FY2014 and the company reported a significant decline in profitability in FY2017. However, it seems that by selling a stake in the company and taking over the role of employees, the Indian promoters have ensured that their economic benefits stay healthy irrespective of the financial/business performance of the company.
As a result, in the case of Kokuyo Camlin Ltd, the commitment of the promoter as measured by “putting your money where your mouth is” went down. Overtimes, the promoters sold their almost entire shareholding to the Japanese company and themselves became the full-time employees of the company.
Therefore, an investor would notice that the promoters are now less concerned about the business performance, dividends of the company as they have ensured steadily improving salary payouts to themselves irrespective of the performance of the company.
Therefore, investors may note that the decline in the shareholding of the founding-promoters’ family in the company from 38.16% in March 2011 to 0.6% in March 2018 is a significant indicator that the commitment of the founding-promoter family to the business has declined.
It comes as no wonder that the stock price of the company has declined more than 70% over recent years and the shareholders have paid a significant price.
Investors may read our complete analysis of Kokuyo Camlin Ltd in the following article: Analysis: Kokuyo Camlin Ltd
Until now, in the article, we have seen cases where the promoters reduced their dedication/commitment in the business of the public company and in turn started investing in unrelated personal business ventures like securities/broking business in case of Omkar Speciality Chemicals Ltd or infrastructure business in the case of Zee Entertainment Enterprises Ltd.
However, many times, investors come across cases when promoters divert their focus from the public-listed company and start a competing business in the same industry.
4) Promoters own personal companies competing with the public-listed company for business & profits:
Over time, while analysing companies, we have come across instances where the promoters liked the industry in which the public company was operating, so much that to gain more personal benefits, the promoters established personal companies in the same industry. These personal companies of the promoters started competing for business and profits from the public company.
Such instances also represent situations where the dedication of the promoters for the public company and minority shareholders reduces. This is because the promoters now focus more on their personal gains from personal competing companies.
This is also known as “conflict of interest” in business/legal language.
Let us see some examples.
A) Shri Jagdamba Polymers Ltd:
Shri Jagdamba Polymers Ltd is an Indian company producing technical textiles, polypropylene/polyethylene woven sacks & fabric and geo-textile products etc.
While reading about the company, an investor gets to know that the promoters of Shri Jagdamba Polymers Ltd (SJPL) have another company, Shakti Polyweave Private Ltd (SPPL), which is in the same business line. The promoters of SJPL run the entire business operations of SPPL.
February 2019 credit rating report of CARE for Shri Jagdamba Polymers Ltd:
The promoters have also promoted the other company; Shakti Polyweave Private Limited (SPPL; rated CARE BBB+; Positive/ CARE A2) which is also engaged in similar line of operations. Both these companies operate under the common management and have business linkages.
While reading about Shakti Polyweave (Website), an investor gets to know that it produces the same products as Shri Jagdamba Polymers Ltd and is a much larger player in terms of manufacturing capacity.
With the growing demand and “constant self evolving” attitude of directors,three divisions were formed within the marketing group relatively termed as AGRO-TECH FABRIC, SPL CONSTRU-TECH FABRIC, SPL PACK-TECH PRODUCTS With the help of this focused marketing approach, company has reached a production level of 30000 tonnes annually and targeting another 20,000 tonnes in next 2 years.
An investor would notice that Shakti Polyweave has a current production capacity of 30,000 MTPA in comparison to the production capacity of 12,000 MTPA of Shri Jagdamba Polymers Ltd. Moreover, as per the above screenshot, the promoters are increasing the production capacity of Shakti Polyweave by another 20,000 MTPA.
As per the credit rating rationale of Shakti Polyweave prepared by CARE Ltd in February 2019, the additional capacity is primarily debt-funded.
February 2019 credit rating report of CARE for Shakti Polyweave Private Ltd:
SPPL is implementing a large size expansion project with a total cost of Rs.72 crore (approximately 1.14 times of tangible net-worth as on March 31, 2018) which is being funded through the term debt of Rs.50 crore, and balance through the internal accruals
In light of the above information, an investor should be aware of the conflict of interest that may arise when the same promoters/management take decisions about Shakti Polyweave Pvt. Ltd and Shri Jagdamba Polymers Ltd.
i) Promoters may prefer Shakti Polyweave Pvt. Ltd to Shri Jagdamba Polymers Ltd:
While analysing the past business history of Shri Jagdamba Polymers Ltd, an investor gets to know that previously, the key role of the company was to act as a contract manufacturer for Shakti Polyweave Pvt. Ltd.
September 2010 credit rating rationale of Shri Jagdamba Polymers Ltd by ICRA Ltd:
The company manufactures woven sacks, tarpaulin and geo-textile products on job work basis and large part of the job work is for Shakti Polyweave Private Limited, a group company, which exports most of its production to USA and European countries.
Thus, an investor would note that the key role of Shri Jagdamba Polymers Ltd in the promoter group was to do contract manufacturing for Shakti Polyweave Pvt. Ltd. Shakti Polyweave would, in turn, sell the goods produced by the company to export markets. Such an arrangement raises the possibility that for any export order, the promoters may split the profit between Shri Jagdamba Polymers Ltd and Shakti Polyweave Pvt. Ltd as per their preferences.
If the promoters decide, then they may easily keep a larger share of profit in Shakti Polyweave and pass on a lower share of profit to Shri Jagdamba Polymers Ltd in the form of contract manufacturing/job work charges.
Possibility of such a situation is removed if the promoters only have one company for the business activity. In such a case, all the profits are availed by one company and the possibility of promoters preferring their private company to the public limited company is mitigated.
ii) Promoters decided to do expansion of production capacity in Shakti Polyweave Pvt. Ltd instead of Shri Jagdamba Polymers Ltd:
While doing the analysis of Shri Jagdamba Polymers Ltd, an investor would remember that the production capacity of the company is unchanged at 12,000 MTPA since FY2010. On the other hand, Shakti Polyweave Pvt. Ltd, which is already a larger player with a current production capacity of 30,000 MTPA, is undergoing a further capacity expansion of 20,000 MTPA. An investor would also remember that both Shri Jagdamba Polymers Ltd and Shakti Polyweave operate in the same business segment and produce similar products.
An investor may think that the promoters have decided to expand the production capacity of Shakti Polyweave instead of Shri Jagdamba Polymers because Shakti Polyweave may have reached a higher capacity utilization and in turn, it might need additional capacity.
However, while reading the credit rating reports of both the companies, an investor gets to know that in FY2018, Shri Jagdamba Polymers had achieved 88% capacity utilization versus 87% capacity utilization achieved by Shakti Polyweave.
February 2019 credit rating report of CARE for Shri Jagdamba Polymers Ltd:
The growth in total operating income of the company was largely driven by improving capacity utilisation and increasing average sales realization of its products. The capacity utilisation of SJPL’s products improved to 88% during FY18 from 59% during FY16.
February 2019 credit rating report of CARE for Shakti Polyweave Private Ltd:
The growth in total operating income of the company was largely driven by improving capacity utilisation and increasing average sales realization of its products. The capacity utilisation of SJPL’s products improved to 87% during FY18 from 61% during FY16.
(*please note: we believe that the mention of SJPL in the credit rating report of Shakti Polyweave Private Ltd while describing the capacity utilization is a typographical error by CARE Ltd.)
Looking at the above data, an investor would appreciate that in FY2018, both the companies have achieved a similar level of capacity utilization (88% vs 87%). However, still, the decision of promoters to increase production capacity of already larger company Shakti Polyweave instead of Shri Jagdamba Polymers Ltd may indicate that the promoters have decided to grow the already larger company to an even larger level.
Investors would note that since FY2010, the manufacturing capacity of Shri Jagdamba Polymers Ltd is constant at 12,000 MTPA. The major capital expenditure is done by the company during the last 10 years towards the creation of wind-power generation capacity in FY2014 and FY2016. Moreover, as per the credit rating rationale of the company by CARE in December 2017, the promoters plan to create a solar power plant in Shri Jagdamba Polymers Ltd:
Moreover, As on March 31, 2017, SJPL has windmill capacity of 3.6 Mega Watt (MW). SJPL is also planning to install solar power plant with capacity of 3 MW at the total cost of Rs.13.50 crore, which is expected to be funded through the term loan of Rs.10.12 crore and rest through internal accruals. The installation is expected to be completed by March 2018.
Moreover, investors would notice that the larger of the two companies, Shakti Polyweave Private Ltd was established by the promoters in 1997 whereas Shri Jagdamba Polymers Ltd was established in 1985.
February 2019 credit rating report of CARE for Shakti Polyweave Private Ltd:
Incorporated in December 1997, SPPL is promoted by Mr. Hanskumar R. Agarwal and his family members. SPPL is engaged in manufacturing of polypropylene (PP)/ Polyethylene (PE) woven sacks & fabric, geo-textile products and various technical textile products which find its application in agriculture, infrastructure and packing industry.
Therefore, investors would note that the Shakti Polyweave, which was established by promoters much later than Shri Jagdamba Polymers Ltd has grown to a much larger level and is still being expanded to an even larger level with currently ongoing large capital expenditure.
It might be that Shri Jagdamba Polymers Ltd no longer fits into the future expansion plans of the promoter group. Alternatively, it might be that the promoters prefer to generate more business growth in their privately held company instead of the public listed company.
Investors may note that such a situation of differential treatment would not arise if the promoters hold only one company for doing business in a segment.
iii) Investors of Shri Jagdamba Polymers Ltd are at the mercy of promoters to give any business to the company:
After looking at the promoter group structure, an investor would appreciate that the promoters have two companies in the group to manufacture technical textiles: Shri Jagdamba Polymers Ltd and Shakti Polyweave Pvt. Ltd. Both of these companies are run by the same promoter group/management. As a result, whenever, the promoter group/management gets any new order/business opportunity, then it has the discretion whether to give this order to Shri Jagdamba Polymers Ltd and Shakti Polyweave Pvt. Ltd.
As a result, the shareholders of Shri Jagdamba Polymers Ltd are always at the mercy of the promoters to give it any business by not giving the business to Shakti Polyweave. All the distribution of business between Shri Jagdamba Polymers Ltd and Shakti Polyweave Pvt. Ltd is purely based on the goodwill of promoters. The promoters may decide to give all the business to Shakti Polyweave and only give that amount of manufacturing job to Shri Jagdamba Polymers Ltd, which cannot be manufactured by Shakti Polyweave, as used to happen in the past. This raises possibilities of conflict of interest.
Moreover, from the above discussion, an investor would note that Shakti Polyweave is currently undergoing a debt-funded large capital expenditure. An investor would appreciate that the natural intention of the promoter group may be to utilize the newly created capacity of Shakti Polyweave as early as possible and in turn, pay off the debt raised by them in Shakti Polyweave so that the upcoming interest burden can be reduced.
In light of the same, an investor should be cautious while analysing the future possible situations where the conflict of interest of the promoters of the company by way of their privately held company may interfere with the future prospects of Shri Jagdamba Polymers Ltd.
Investors may note that such a situation of conflict of interest can be avoided if the promoters of public listed companies have only one company for running a business segment.
An investor may read the complete analysis of Shri Jagdamba Polymers Ltd in the following article: Analysis: Shri Jagdamba Polymers Ltd
B) Divi’s Laboratories Limited:
Divi’s Laboratories Limited is a Hyderabad-based Indian pharmaceutical manufacturer, which focuses on making active pharmaceutical ingredients (API) and intermediates as primary business activities.
While analysing Divi’s Lab, an investor notices a corporate announcement submitted by the company to Bombay Stock Exchange (BSE) on August 31, 2016. In this announcement, Divi’s Lab wrote to that stock exchanges denying the claims in the news articles that there has been any import alert against its facilities:
In the letter, Divi’s Lab explained that the apparent import ban by USFDA resulting due to the company refusing to let the regulators inspect the facility, which is being highlighted in the media does not pertain to it but to some other company by the name of “M/s Divi’s Pharmaceuticals Private Limited”
However, when the investor analyses the annual report of Divi’s Lab for FY2016, then she notices that M/s Divi’s Pharmaceuticals Private Limited is an associate company of Divi’s Lab where the key management personnel have significant influence.
This is further evidenced when the investor tries to search for the directors of Divi’s Pharmaceuticals Private Limited. As per the corporate database Zaubacorp, the directors of Divi’s Pharmaceuticals Private Limited include Mr. Murali Divi and Mr. N.V. Ramana.
Two things become evident from this observation:
- The promoters might have other businesses in their personal capacity, which might be competing with Divi’s Lab in the same markets as the facility owned by Divi’s Pharmaceuticals Private Limited controlled by Mr. Divi and Mr. Ramana is being assessed by USFDA, indicating that Divi’s Pharmaceuticals Private Limited might also either be already exporting drugs/pharmaceutical products to US markets or is planning to do the same.
- Despite payment of significant salaries of ₹45 cr. to Mr. Divi and ₹23 cr. to Mr. Ramana, the promoters are not devoting their 100% professional calibre to Divi’s Lab and might be running personal competing businesses on the parallel.
An investor should be cautious while analysing public companies where promoters own competing businesses in their personal capacity. This is because the resulting conflict of interest of the promoters may interfere with the interests of the public company and the minority shareholders.
An investor may read the complete analysis of Divi’s Laboratories Limited in the following article: Analysis: Divi’s Laboratories Limited
C) Bodal Chemicals Ltd:
Bodal Chemicals Ltd is an Indian manufacturer and exporter of dyestuff, dye intermediates and basic chemicals.
While analysing the QIP document, published by the company in Oct 2017, an investor notices that one of the promoters of Bodal Chemicals Ltd, Mr. Ramesh P. Patel- HUF, operates in the same line of business as Bodal Chemicals Ltd.
One of our entities forming part of Promoter Group operates in a similar line of business as we do, which may lead to competition with these entities and could potentially result in a loss of business opportunity for our Company.
Our Promoter Group’ Ramesh P. Patel HUF um in a similar line of business. Ramesh P. Patel- HUF is proprietor of M/s Laxmi International, engaged in the business of export and import of dyes and dyes intermediates. We may have to compete with M/s Laxmi International for business, services and employees. Our Promoter may have conflicts of interest with our interests or the interests of our shareholders and favour this/proprietorship in certain situations, or not direct opportunities to us. Any of the above may impact the trading price of our equity shares, our business, financial condition and results of operations.
Promoters’ shareholding pattern, June 2018, from BSE website:
In such situations where promoters run competing businesses in their personal capacity, an investor should be cautious and do a deeper analysis to understand whether promoters of the public listed company are favouring their personal business interests over the public shareholders.
Such conflicts of interest can be avoided if the promoters of public listed companies have only one company for running a business segment.
An investor may read the complete analysis of Bodal Chemicals Ltd in the following article: Analysis: Bodal Chemicals Ltd
D) Globus Spirits Ltd:
Globus Spirits Ltd is a manufacturer of country liquor (IMIL) and bottler for Indian made foreign liquor (IMFL) having a presence in multiple states with distilleries in Rajasthan, Haryana, West Bengal, and Bihar. The company owns IMIL brands like Nimboo, Narangi, Heer Ranjha, and Ghoomar.
While reading the red herring prospectus (RHP: Source) filed by Globus Spirits Ltd for its IPO in 2009, an investor gets to know that the promoters have a few companies, which operate in the alcohol industry and thus in turn act as competitors to Globus Spirits Ltd.
IPO Red herring prospectus, page 22-23:
Common pursuits: The Company’s Promoter has promoted other companies in similar business within the alcohol industry segment, which may affect Globus Spirit’s growth on account of likely conflict of interests.
The following companies, which are in similar distillery/alcohol business, have been promoted by the promoter of Globus Spirits Limited. Mr. Ajay Kumar Swarup, promoter of Globus Spirits Ltd., may be considered interested in these companies. Being in the same industry, the same may lead to conflict of interest between Globus Spirits Limited and the following companies promoted and/or controlled by him.
The company has highlights three companies in RHP (2009):
- Associated Distilleries Ltd.,
- Rajasthan Distilleries Pvt. Ltd. and
- Northern India Alcohol Sales Pvt. Ltd.
Investors would appreciate that when promoters of any publicly listed company operate competing businesses in their personal capacity, then the promoters may prioritize their personal interests over the interests of the publicly listed company and its minority shareholders.
An investor may read the complete analysis of Globus Spirits Ltd in the following article: Analysis: Globus Spirits Ltd
Therefore, an investor would notice that whenever the promoters of any company establish competing businesses in their personal capacity, then the minority shareholders are in a very precarious situation. The minority shareholders are totally at the mercy of the promoters because the promoters being the managers of the public company as well as their personal companies may decide to generate higher business for their personal companies. This, in turn, will be detrimental to the interest of the public listed company and its minority shareholders.
While analysing companies, another instance where we have observed that the commitment of promoters has declined for the public company and its minority shareholders when the promoters take salary increases even when the performance of the company is declining or the company is making losses.
5) Promoters take salary increases despite losses/declining performance of the company:
An investor would appreciate that if the promoters of a company are working in the company full-time as employees, then like other employees of the company, they would also want to be rewarded with high salaries year-on-year. However, at the same time, an investor would note that increasing salaries of promoters year-on-year are justified only when the performance of the company is improving.
If an investor notices that the promoters of the company are taking higher salaries year after year when the business performance of the company is declining, then she may think that the promoters are keeping their own interests on priority than the business performance of the company. It might be a case where the promoters are treating the company as an avenue from where they need to extract the maximum amount of money possible instead of focusing on improving the performance of the company. This indicates a situation where the promoters’ commitment to the company is declining.
A) Ess Dee Aluminium Ltd:
Ess Dee Aluminium Ltd is an India manufacturer of aluminium foil and packaging products.
While analysing Ess Dee Aluminium Ltd, we noticed that during FY2011-FY2013, the promoter of the company was increasing his salary continuously despite the declining profits of the company. The promoter increased his salary almost three times during FY2011-FY2013 while the profit margins of the company declined from 17% to 10% during this period. Such a salary hike indicated that the promoters have their personal interest in mind instead of the interests of the company or the minority shareholders, which is a sign of the declining commitment of promoters to the public company and its shareholders.
Later on, the company’s performance declined sharply. From FY2017 onwards, the company’s operating income stopped. It started reporting huge losses without any income. The debt levels of the company increased to very high levels of ₹1,166 cr in FY2019 from ₹214 cr in FY2011.
With no income to support, these debt levels and the continued remuneration of crores of rupees charged by the promoter without any income in the company, the stock price of the company declined.
The stock price of the company declined from about ₹750 in Feb 2014 to ₹1.88 in 2020.
An investor can only wish that she could have caught on the early warning sign that the promoters are losing commitment to the company and the minority shareholders and exited the stock, then she could have saved on the huge losses that the company & its stock created for its shareholders.
Therefore, we advise investors to pay a lot of attention to the remuneration taken by the promoters from the company, the trend of increase of their remuneration and the accompanies circumstances of the business performance of the company. It may save them a lot of pain later on.
Therefore, in the cases where an investor notices that the remuneration of promoters is increasing despite losses/declining performance of the company, then she should be cautious and increase the level of her due diligence.
Overall, we believe that the investment by a fundamental investor in the stock market is not a purchase of part ownership in the business of the company. We believe that it is a faith in the shareholder friendliness of the promoters/management of the company.
We believe that if the promoters of any company decide, then they can make sure that the minority shareholders of the company will not be able to benefit from the fruits of the good business performance of the company.
Therefore, it becomes essential for any investor to do the management analysis of any company in detail and ascertain that the promoters of the company are fully committed to the interests of the company and its minority shareholders.
As discussed above, an investor may analyse a company on the following parameters to ascertain whether the promoters of the company are fully committed to the business of the company or they now have their personal interest at high priority:
- Whether the promoters are putting money in unrelated personal ventures while the business of the public company demands money
- Whether the promoters have pledged a large portion of their shareholding in the company
- Whether the shareholding of the promoters has declined significantly in the company
- Whether the promoters of the company have competing businesses in their personal capacity, which compete with the listed company for business & profits.
- Whether the promoters are taking high salaries and increments despite declining performance/losses of the company.
These parameters may help an investor identify whether the promoters of any company are losing their commitment to the public company and its minority shareholders. After doing such an analysis, the investor may make an informed investing decision.
Do you use any parameter to assess the dedication of promoters to the business of the company? If yes, then what parameters do you use for your interpretations? What has been your experience of analysing promoters’ commitment? Has it proved a helpful parameter to differentiate good management from the poor one? It would be great if you could share your experiences with the author and the other readers in the comments section below.
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Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.