CONVERSION OF DEBT-TO-EQUITY - WAH BHAI WAH!

By Ruma Dubey

Securities and Exchange of India (SEBI) shows its teeth intermittently and when it does, the teeth shine bright and are sharp, incisive. SEBI has been super busy over the weekend, with Monday morning opening to many new announcements and as expected, all very investor friendly.

First and foremost was the relief it brought to companies reeling under huge debt through conversion of debt-to-equity. A pandemic in India Inc, this new ruling came as a pleasant surprise and it is sure to find many takers. Working in tandem with RBI, SEBI has made it easier for financial institutions to convert debt of a listed company into equity.  This will help kill two birds with one stone – help ease the bad loans pressure on banks and provide companies also with a relatively easier way out, though it would mean servicing a larger equity. At the end of September’14, almost 11% of the total loans were bad and in that context, this is a good move which will help bring down NPAs.

This is an extremely good move and strangely now that it is being put in place, we cannot help but wonder as to why it was not there for so long? That’s how it is – some of the easiest but most effective ideas are the simplest and it is only when it is mooted that we realize that it was right there, in front of your eyes.

Let us take a quick look at the merits and demerits of this move:

First, always the merits (It is very easy to find fault, that’s human nature!)

• It will make it easier for the company as well as the bank to deal with the debt and distressed assets.
• Hopefully, it will bring down the number of defaulters and more importantly, bring down NPAs of banks.
• Maybe, the cases going to Corporate Debt Restructuring (CDR) will now come down
• Companies reeling under debt burden could now get a new lease of life; some stress on the leveraged balance sheets could be relieved.
• The bank can get full control of the company thus reducing chances of insolvency which is better for the shareholders than a closed down shutter.
• Companies will be relieved of paying up hefty interests on conversion into equity thus freeing up precious money for the company.
• This debt-to-equity conversion will be based on pricing formula – allotment price to not be less than the face value of the share. Relief for defaulting companies as banks usually quote below face value price to get big stakes in the company for cancelling debt.

Some obvious demerits:

• Though it will provide more flexibility to the lending institutions to acquire control over the company in the process of restructuring, to the benefit of all the stakeholders – if banks get controlling stake, the mandatory 26% open offer will not get triggered. This does not work in favour of the existing shareholders who are seeking an exit route despite change in management control.
• There is no clarity yet on how the pricing will be worked out; it is to be construed as akin to preferential allotment. And as per that, price would be higher than either the average weekly high/low of closing price during preceding 6 months of the allotment OR average of weekly high/low of closing price preceding two weeks.
• If the price works out too high, it could turn unviable for the banks.
• SEBI did say that the pricing would be as per “fair price formula” but has to be above face value and that, in very distressed and closer to bankrupt companies could prove to be unfairly higher than its worth.
• What happens to minority shareholders right – will their approval be taken into consideration when there is a change in management control?
• Conversion from debt-to-equity could dilute the stake of minority stakeholders.