Servalakshmi Paper is entering the capital market on 27^th April 2011 to raise Rs. 60 crore via public issue of equity shares of Rs.10 each, priced between Rs. 27-29 per share. The issue, constituting 48-50% of post issue paid-up capital of the company, depending on the discovered price, closes on 29^th April.

We have been repeatedly warning our viewers and the investor community at large, against highly-manipulated IPOs being undertaken by promoters in nexus with several intermediaries to trap gullible retail investors. This is yet another issue from the same family of ‘fundamentally unsound’ IPOs with a sole motive to trap retail investors. Stay clear of it!

Established in 2005, the company manufactures newsprint, printing and writing paper, having an installed capacity of 300 tonnes per day (TPD) or 90,000 MTPA in Tamil Nadu. The production unit along with a 15MW captive power plant are newly established with an investment of Rs 280 crore (funded through secured loans) and commenced commercial production only since 1^st April 2010. Hence, the company, with no sales history upto FY10, has presented relevant operating history for only seven months from April-October 2010.

Sales during 7mFY11 stood at Rs. 39 crore with EBITDA at Rs. 2.3 crore. However interest cost towards Rs. 262 crore secured debt lead to interest outflow of as high as Rs. 12.7 crore. This along with Rs. 4.49 crore depreciation resulted in net loss of Rs.14.9 crore for the period, translating to negative EPS of Rs. 6.64 for the seven months. In other words, company lost a rupee per month per share during which it operated, after commencing commercial production.

On equity of Rs. 22.42 crore, as of 31-Oct-2010, company’s networth was Rs. 40.4 crore, down from Rs. 54 crore, as at 31-Mar-2010, due to mounting loss during 7mFY11. Its total debt was extremely high at Rs. 262 crore, indicating a debt-equity ratio of 6.5:1. Post-IPO, debt will be higher, if not at the current levels, as additional bank borrowing of Rs. 18-20 crore will be taken for working capital needs. Thus, on an expanded equity of about Rs. 43-45 crore, networth would rise to Rs. 100 crore, while debt equity ratio will be upwards of 2.75:1, indicating severe pressure on future profitability. Moreover, the 48-50% dilution is very heavy and another matter of concern.

Funds raised in the IPO will be utilized by the company for equipment purchase of Rs. 25 crore to augment manufacturing capacity for value added products by 18,000 MTPA, while Rs. 30 crore will meet working capital requirements. Balance Rs. 5 crore will go towards IPO expenses and a small part towards pre-operative expenses of the company.

The BRLMs to the issue are (i) Keynote Corporate which has a history of bringing low quality issues to the primary market and (ii) Indian Overseas Bank, a new entrant in the merchant banking space, which has potential conflict of interest with the issue as that bank has lend about Rs. 114 crore to the company in loans. The company also has export obligation under EPCG (in respect of Rs. 107 crore duty saved) of Rs. 99 crore to be fulfilled upto Jan 2017, which if unfulfilled, may lead to duty payments along with interest charges.

There is no point comparing PE multiples of listed peers as this company is incurring heavy losses. Also, its high debt levels and heavy dilution do not justify a market cap of about Rs. 125 crore and enterprise value of about Rs. 385 crore, on listing (at upper price band of 29). Thus, the issue is a clear avoid on lack of fundamentals.