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Hindalco’s rights issue: prepare for more dilution

Hindalco’s rights issue: prepare for more dilution

With credit markets tightening and interest costs rising, India’s biggest aluminium producer Hindalco Ltd and largest truck and bus maker Tata Motors Ltd turned to equity markets to partly fund their acquisitions of Novelis Inc., and Jaguar and Land Rover brands, respectively.

(Value Erosion)

This is not entirely surprising. Hindalco’s share price has fallen about 19% since it announced the rights issue in June.

The company had then said it aimed to raise up to Rs5,000 crore by issuing 40.9 crore shares, which would have entailed an equity dilution of 33% and an issue price of about Rs122.

The issue price is now likely to be Rs96 and the rights ratio will be three shares for every seven shares held by existing shareholders, Reuters says. This means an equity dilution of as much as 43% to raise the same amount of capital.

Although dilution for shareholders is so high, the addition to the firm’s earnings is insignificant in the near term.

So far the Canadian company Hindalco acquired has been posting losses because of its exposure to low-priced, long-term supply contracts with aluminium can manufacturers. One such contract still holds. Benefits from integration and cost-cutting will accrue only in the long term.

The upshot: Hindalco’s earnings per share will take a beating until Novelis’ contribution to earnings becomes significant.

Sebi’s primary market reform continues

The announcements of the Securities and Exchange Board of India, or Sebi, on Wednesday contained none of the reported big-bang decisions such as changes in norms for participatory notes and securities lending. Nevertheless, its decision to ease norms for equity capital raising is creditworthy.

Fund-raising through preferential allotments and qualified institutional placements (QIPs) become almost non-existent in the bear markets, because of a Sebi rule that such issuances should be the higher of the average of the weekly high and low of the closing prices of the shares during the two weeks or six months preceding the relevant date. For most stocks, the six-month average is far higher than prevailing prices, thanks to which there are no takers for such issues. In overseas markets, most issues are done at the same day’s traded price. Sebi has now said the floor price would be only the average of the last two weeks’ price.

QIP issuances were quite popular with both corporates and investors, and the change in guidelines should revive it, although it must be noted that fund-raising is generally slack during a bear market. In fact, policymakers must look at applying similar rules for foreign currency convertible bonds, which suffer from similar restrictions.

Another measure by Sebi was on rights issues, which now take more than three-and-a-half months to complete. This not only keeps investor funds stuck, but also exposes them to the risk of a sharp drop in share prices. From Indian companies’ point of view, the long process is not only cumbersome, but also involves a long gap before funds are made available for the required purpose. In the past, Sebi tried to tackle this by approving fast-track issuances for follow-on and rights issues by companies meeting certain criteria. But the criteria was so stringent that only the top 30 or so traded companies qualifies for such issuances.

Sebi has now reduced the timeline of rights issuances to less than one-and-a-half month. True, as even Sebi admits, there is room for more reduction. But cutting the timelines by two months is a good start by all means.

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