The gravy train just slowed down

Last fortnight Tata Motors announced a plan to raise funds to partfinance the $2.3-billion acquisition of Ford’s iconic auto brands Land Rover and Jaguar. The latest proposal is slightly different from one the automajor announced in May: That it would raise Rs 7,200 crore via three rights issues. There’s no change in two proposed issues to raise Rs 4,200 crore.

Ratan Tata, Chairman, Tata Group Company: Tata Motors Raising funds for: Financing acquisition of Jaguar-Land Rover Original plan: Announced plans in May to raise Rs 7,200 crore via three rights issues. Rs 4,200 crore was to be raised via an issue of ordinary equity shares, and an offer of equity shares with differential rights; and Rs 3,000 crore through five-year convertible preference shares with a coupon rate of 0.5 per cent Revised plan: To issue convertible preference shares dropped last fortnight. Will raise Rs 3,000 crore through a divestment of stake in group companies

However, the Tatas have dropped a third rights issue of five-year 0.5 per cent convertible preference shares to raise Rs 3,000 crore. Instead, the commercial vehicles and car giant has opted to raise that amount through a divestment of its stakes in group companies.

Around the same time, Aditya Birla group company Hindalco became another Indian mega-corp— which had also made a multi-billion acquisition, of aluminium giant Novelis for $6 billion—to rejig its capital-raising game plan. In June, the Birla aluminium major had proposed to raise Rs 5,000 crore by issuing one rights share for every three held, at a price of Rs 120.

Last fortnight, the Hindalco board decided to scale down the issue price to Rs 96, and changed the ratio to a seemingly more attractive three rights shares for every seven shares held.

Blame it all on the current sluggish market conditions and battered valuations. If the bellwethers of Corporate India are being forced to go back to the drawing board in their quest to finance their big-bang growth plans, it’s largely because the downturn in equities has upset their fund-raising programmes.

For instance, analysts point out that perhaps the finance honchos at Tata Motors weren’t too sure that a rights issue of low coupon-bearing preference shares, where returns would accrue to investors after 3-4 years, would find many takers. Ditto with Hindalco, which had to factor the bearish investor sentiment into its rights issue.

Tata Motors and Hindalco are just two corporations at which the Chief Financial Officers (CFOs) are burning midnight oil to ensure there’s adequate, and affordable, capital to keep the growth engine humming. Across India, a rash of promoters, big and small, has earmarked capital expenditure that runs into thousands of crores.

According to the Centre for Monitoring Indian Economy (CMIE), Corporate India has investments totalling Rs 71,10,334 crore lined up. The trillion-dollar question is: Where is all that money going to come from?

The subdued sentiment on the D-street is taking its toll on all forms of equity capital-raising: Initial public offerings, follow-on public offerings, private placements and depository receipts.

Ashutosh Agarwala, CFO, Strategic Finance Company: GMR Group Raising funds for: Expansion of energy business Original plan: Raise around Rs 3,500 crore via an IPO Revised plan: IPO plans on hold. Will partly fund expansion through proceeds of a qualified institutional placement (QIP) done in December 2007. Exploring other options to raise money

Rights issues have been a relatively popular avenue for corporations, but as the tinkering in the Tata and Hindalco blueprints indicates, such fund-raising isn’t without its share of hiccups.

Debt may seem a better option, and lending by banks has galloped ahead in 2008 so far; but as corporate chieftains (like ICICI Bank MD K.V. Kamath) have warned, rising interest rates (which haven’t yet peaked) threaten to throw a huge spanner into the mega-expansion plans of Indian promoters.

What’s more, the higher cost of debt will result in interest costs rising further, eating more into India Inc.’s profits (interest expenses as a percentage of sales have already begun rising in the quarter ended June 2008, compared to the previous year’s corresponding period).

The threat of deterioration in the investment climate—coupled with lower profit growth—may not be yet visible, but it is very real. As S. Ramesh, COO, Kotak Mahindra Capital, points out, the impact will be felt with a lag effect. “With deterioration in macroeconomic and business conditions, new investments can drop and credit demand could slow down from the current elevated growth to more reasonable levels. The investment slowdown is more likely in the next financial year than the current one as the pipeline of investments this year remains strong,” explains Ramesh.

Pawan Agrawal, Director for Corporate and Governance Ratings at credit rating agency Crisil, indicates that early signs of trouble are beginning to show: “Demand in consumer-oriented sectors is slowing down. However, economic growth is still healthy, driven by investment demand. Projects are being implemented in power and infrastructure sectors and capacity expansions are underway.

Companies that are highly leveraged and operating in capital intensive and cyclical industries are more vulnerable.” Agrawal is concerned about the increase in the use of debt, what with banks’ nonfood credit soaring nearly 20 times between January and July (over the previous year’s corresponding seven months) to close to Rs 66,000 crore.

Kumar Mangalam Birla, Chairman, Aditya Birla Group Company: Hindalco Raising funds for: Repaying a bridge loan of $3 billion taken for the acquisition of Novelis Original plan: Announced a rights issue of Rs 5,000 crore in the ratio of 1:3 in June and at a price of Rs 120 Revised plan: Altered the share ratio from 1:3 to 3:7 in August and reduced the price to Rs 96

Small wonder then that Crisil flashed the amber light in May when, for the first time in five years, its number of rating downgrades was more than its upgrades for 2007-08. This was mainly on account of the high debt exposure and big-ticket acquisitions of Indian companies.

One till-recently-red-hot sector that’s been scalded badly is real estate. Banks are reluctant to dole out loans to developers, and the erosion in their stock prices (by as much as 70-75 per cent in a few cases) puts raising equity out of bounds, too. “The business growth over the past 3-4 years was almost volcanic as many developers expanded much beyond their scale.

With the scenario changing over a short period of time, the same developers find themselves in overleveraged positions,” says Ajoy Veer Kapur, MD, Saffron Group, a real estate investment fund. Indeed, the scenario is desperate enough for a few real estate promoters to pledge their shareholding in lieu of loans. And interest costs continue to rise.

The Delhi-based Unitech’s interest cost as a percentage of net sales doubled to 18 per cent in the June quarter (over the previous corresponding quarter). For Ansal Properties & Infrastructure, the corresponding figure went up from 2.75 per cent to 9 per cent.

Sajjan Bhajanka,Managing Director Company: Century Plyboards Raising funds for: Expanding capacity of cement division, entry into new business segment Original plan: Raise Rs 300 crore through QIP/private placement Revised plan: Dropped the placement plan. Looking at private equity and promoter contribution

Another high-growth industry that’s feeling the chill of high interest rates is infrastructure. In a recent meeting with equity analysts in Mumbai, a research note by Enam Securities reveals, engineering and construction behemoth Larsen & Toubro (L&T) indicated that “given the recent rise in interest rates, a slowdown is imminent and that it was already visible in its product business in the first quarter of this fiscal”. The L&T management for its part stressed that despite these conditions it was confident of a 30 per cent growth in order flows.

Sumeet Agarwal, analyst, HSBC Securities and Capital Markets, cites higher interest costs and an increase in debt-equity ratios, due to lack of equity financing, as near-term risks associated with the infrastructure sector. It has duly reduced its profit estimates for the sector.

Promoters in such core sectors are scampering for alternative sources of financing. Both JSW Energy and GMR Energy had planned to raise Rs 4,000 crore and Rs 3,500 crore, respectively, to fund their power plant expansions. The companies have put their IPOs on hold.

Seshagiri Rao, Director Finance, JSW Steel, the promoter company of JSW Energy, is counting on internal accruals. “We had planned a capex of Rs 11,000 crore for JSW Energy, of which Rs 3,000 crore has been funded through internal accruals. The IPO will be considered for the next growth phase,” says Rao.JSW Steel has lined up capital expenditure worth Rs 14,700 crore till 2010. But Rao isn’t biting his nails as the company has achieved financial closure for Rs 6,000 crore and has tied up funds worth Rs 8,000 crore through rupee loans and foreign currency convertible bonds issued in July 2007.

Yet, the cost of rupee loans, at 11-11.5 per cent, is nearly 2 per cent higher than earlier projections. “In the environment of higher interest rates, the only way out for a CFO is to take a floating rate loan with refinancing options,” says Rao. Ashutosh Agarwala, CFO, Strategic Finance, GMR Group, doesn’t seem worried about his IPO getting delayed. “We would have used the IPO funds over a period of 3-4 years. The immediate funding for GMR Energy will be done through the proceeds of a Rs 4,000-crore qualified institutional placement (QIP) done in December,” says Agarwala.

Seshagiri Rao, Director-Finance Company: JSW Steel Raising funds for: Capital expenditure in the energy businesses Original plan: Raise Rs 4,000 crore via an initial public offering (IPO) Revised plan: IPO shelved as of now; will use a mix of internal accruals and rupee loans instead

The GMR group had achieved financial closure for its projects in March and could manage to hedge its debt borrowings by locking interest rates for 3-5 years.Perhaps more badly hit than the big boys are the medium enterprises. Consider the Rs 1,200-crore Kolkata-based Century Plyboards, which had plans to raise Rs 300 crore via a QIP to fund a cement plant expansion, set up two plyboard plants and to enter a new segment of medium-density fibre (MDF). Since the QIP didn’t take place, the MDF expansion has been put on hold.

“For the other two projects, we plan to use internal accruals, contribution from promoters and a 10-15 per cent stake sale to private equity players,” says Sajjan Bhajanka, Managing Director, Century Plyboards.

But private equity may not be a quick-fix. “If a promoter was willing to dilute, let’s say, a total of 10 per cent in an IPO, he’s likely to dilute a smaller percentage to a private equity player at this stage, so that he maintains an overall target of 10 per cent whenever he goes public,” says Ranu Vohra, MD & CEO, Avendus Advisors. However, there may not be too much of a choice. Rao of JSW Steel is candid when he says CFOs have to make a choice—either take on more debt or sacrifice a stake.

Investment bankers for their part are attempting to design products that are a hybrid of equity and debt in a bid to balance out risk. An example: Structured debt instruments, which carry a low coupon rate and an option to convert into equity at a future date, either at a predetermined price or a price linked to the performance of the company.

Since January, at least three companies have raised funds through optionally-convertible or fully-convertible debentures. Explains Kishore Srinivasan, Executive Director, Structured Finance, Avendus Advisors: “A low coupon rate ensures that the profit and loss doesn’t get strained because of a higher interest outgo; and the conversion to equity acts as a sweetener.”

With the bitter pill of highcost debt and low valuations staring them in the face, such sweeteners may be just what the doctor ordered for India Inc.