Promoters Pledging Shares

When you shop around for paper, add this to your due diligence list, if not done already. Actually this now seems to be the latest reason to dump stocks – bearish as we all are at the moment. Since early 2009, the smart investor set has been wary about of putting their money in stocks which have a high proportion of pledged promoter shares. It was in early 2009 that the market regulator, SEBI, made it mandatory for promoters of listed companies to declare in case they pledge their company’s shares with their lenders. We should thank Satyam’s Raju for ushering in this rule, but how many of you check this aspect before investing? This is certainly a risk, especially in today’s environment of escalating interest rates. The lender might invoke a margin call and affect a massive sell-off of the pledged shares of the borrower thus effectively crashing the price and trapping unsuspecting lemmings like us.

Geetanjali Trading and Investments Pvt. Ltd. (a promoter group company of Asian Paints) pledged c10.85% of total outstanding shares of the company ostensibly for the purpose of using the line of credit to buy back its own shares from the open market (which they indeed went ahead and did)! The move was obviously meant for the gallery – that we have immense faith in our company but this trade looks real risky to me. There are other examples, like GTL Limited, GTL Infrastructure, Orchid Chemicals, S Kumars, etc. I am pointing to falls in the range of 15% – 25% in a single session!! In Dec, 2010, investors fell freely when large brokers/financiers raised margin calls on shares like Ruchi Soya, KS Oil, Karuturi Global and Ackruti City. There are two avenues of risk down this road: one is if the promoter is unable to repay the loans (discussed above) or if stock market crashes (on unrelated news) result in the financiers making margin calls on the promoters, which if unmet, result in dumping of the shares in the open market by the lenders which causes the price to pummel further. This is what seems to have happened in the case of Orchid Chemicals recently.

Here are some names of companies whose promoters have pledged a very high percentage (> 70%) of their shareholding and whose shareholding is by itself quite significant (> 30%):

Gujarat Pipavav; Tata Coffee; Pipavav; DB Realty; Advanta…

I guess the following sanity checks should be performed by Indian lemmings before they invest:

– try to find out what proportion of the promoter’s shares are pledged. If a promoter who owns 70% of the outstanding shares pledges 10% of his bag, it’s not too risky as some of the recent instances where some promoter group entities have pledged as much as 70% – 80% of their lot.

– at what price were they pledged? If closer to the recent highs, then you need to be very cautious.

– has the stock price corrected substantially after the promoter took the loan?

– where did this loan money go? (difficult one to answer, I know)

Be careful of this aspect, in case you were not aware. All types of markets work on leverage…and all financial crises are the effects of extreme leverage.