Mumbai: Tata Sons Ltd, the holding company of the $109 billion Tata group, is underwriting nearly half of Tata Power Co. Ltd’s 2,000 crore rights issue starting on 31 March, in a rare case of a promoter stepping up to cover the risk of insufficient investor demand for the shares on offer.

Tata Sons, which currently holds a 32% stake in its power subsidiary, will pick up close to 50% of the issue, in case the market does not warm up to the sale of stock to existing shareholders, three people close to the development said. The rights issue starts on 31 March.

The other half of the issue is being underwritten by a clutch of merchant bankers like JM Financial Ltd, HSBC Securities and Capital Markets India Pvt. Ltd, BNP Paribas SA and Kotak Mahindra Capital Co. Ltd.

“A final decision on the amount to be underwritten by the promoters will be taken by the board of Tata Sons over the next few days," said one of the persons quoted above, who did not wish to be named as he is involved in the transaction.

If Tata Sons ends up buying 50% of the total issue, its stake in Tata Power increases merely from 32.47%. as of 31 December to 34.62% (post-dilution).

“The decision of the promoters to underwrite part of the issue should be seen as a sign of confidence by investors," said the person quoted above.

Tata Power did not offer any comments on the matter.

The company is selling 332.2 million equity shares under the rights issue at 60 a share, offering investors seven shares for every 50 held by them.

Rights issues are not typically underwritten by the promoters, although in most cases promoters pick up shares in proportion to their holding.

In two prior instances, promoters have been forced to step in. In 2008, a 5,047 crore rights issue by Hindalco Industries Ltd devolved on its underwriters. In the same year, Tata Sons stepped in to buy unsold stock in a 4,145.8 crore rights issue by Tata Motors Ltd.

“It is not normal for a promoter to underwrite a substantial part of the issue, but if a promoter has chosen to do that, it may be done to signal one
of two things. Either the promoter is trying to give confidence to investors by suggesting that they are willing to commit their own funds, or underwriting can also be seen as a signal that the issue is weak and may need support from promoters," said Prithvi Haldea, chairman and managing director at Prime Database, a market research firm.

Tata Power announced the rights issue on 28 February, five days after the Central Electricity Regulatory Commission (CERC) allowed a compensatory tariff of 0.524 for every unit of electricity generated from its Mundra plant.

According to a Press Trust of India report dated 27 February, the CERC ruling will help in reducing the Mundra project’s annual losses by 1,100 crore. The 4,000 megawatt Mundra project, located in Gujarat, is estimated to be incurring a loss of 1,500 crore annually, mainly due to an increase in the price of Indonesian coal that is used to fire the plant. This has led to an increase in debt levels at the company.

Tata Power posted a consolidated net loss of 75 crore for the December-ended quarter as against a net loss of 329 crore in the year-ago period. Tata Power had debt of 40,178 crore on its books at the end of the December quarter.

To be sure, Tata Power is not the only power firm facing tough times. The power sector in India has been facing hurdles on account of lack of regulatory and policy clarity and input shortages. Slowing economic growth has further hit power demand from industrial consumers in some parts of the country.

Bad loans to the power sector accounted for 20.21% of the total bad loans of 11,409 crore to the infrastructure sector at the end of 2012-13. As on 31 March 2012, banks had loaned 4.03 trillion to the power sector. The economy grew less than 5% for the seventh consecutive quarter in the three months ended 31 December as manufacturing output contracted.

The regulator’s decision to allow a hike in the price of power to compensate for higher fuel costs and an expected improvement in economic growth may lead to a turnaround in the sector.

“Sentiment for the power sector is improving. The company is looking to increase its stake via the rights issue as it expects better prospects for the sector with the new government coming in," said a second person involved in the transaction, who also did not wish to be named.

Vikas Khemani, chief executive for wholesale capital markets at Edelweiss Financial Services Ltd, said, “ Infrastructure is again becoming attractive for investors. The sentiment is improving."

He, however, said that it wasn’t surprising that Tata Power had chosen to get the issue fully underwritten by Tata Sons as a precautionary measure.

According to sector analysts, institutional investors remain reluctant to invest in the power sector, which may dampen response to the rights issue. Institutional investors currently hold over 48% of Tata Power.

“A lot of policy clarity has to come in as far as power sector is seen. Institutional investors may not be very keen in power sector stocks till the time things improve at the ground level," said a senior analyst at Centrum Ltd who didn’t want to be named.

Attractive pricing may lead to strong retail investor demand. The issue has been priced at 60 per share compared to the current market price of 83.15 per share.

At least three brokerage firms—J.P. Morgan Chase and Co., Edelweiss Financial and ICICI Direct.com—have said that the issue is attractively priced and have a “buy" call on the stock.

The pricing of the issue may also help bankers underwriting the issue, in the eventuality that part of the stock devolves on them.

“Since the market price is considerably higher than the rights issue price, there is not much risk in it for the bankers," said Haldea.

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