Desperate Move or Smart Maneuver? – Just Another Investor

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The news of Right Issue by Mahindra & Mahindra Financial Services (“MMFS”) at INR 50 per share (1:1) in-order to raise INR 3,500 Crore hit the investors like a thunderbolt yesterday (18th July 2020). The issue price was at steep 76% discount on CMP of INR 208 for the company. This left many investors believe (including us) that the step was a desperate attempt by the company to raise funds on immediate basis to provision for huge losses from Q2 Fiscal 2021 onwards.

However, a closer look at the details of the transactions will make you realize that this isn’t a particularly desperate attempt by the company nor is the transaction very dilutive to the existing investors (considering current situation)

Let us consider a scenario for an investor holding 200 shares of the company holding shares at Current Market Price of INR 208

Scenario for an Investor Post-Issue

The holding price post-issue would drop to INR 129 for the investor and effective P/E on Fiscal 2020 basis will increase from 11.9X to 14.8X post-money, which is a 25% increase. Therefore, ideally there should a 25% correction in prices which will lead to post-money valuation (on P/E basis) being equal to pre-money valuation.

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It is unlikely there will be such a steep drop in price on immediate basis as many investors would be would wait for the allotment through right issue. However, a high single digit correction certainly is a possibility. Also, the capital raise will improve the company’s capital adequacy situation to tide against the provisions and eventual losses due to Covid-19 Pandemic.

Now consider a scenario where company would have done 1:4 rights issue at INR 175 per share, a discount of 16% from Current Market Price. The fund-raise by the company would have been less by around 16% as compared to fund-raise under current structure. Though the dilution would have been slightly lower (at around 21%), the investors may not have been too keen to invest given the Covid-19 situation and possible headwinds in business at INR 175 per share.

Also, even 1:1 issue at higher value say INR 100 per share would have made many institutional investors jittery regarding the capital requirements of the fund apart from the downward rating due to a steeper value correction.

Investors would now have to either increase their stakes or quit the table

For an existing investor of M&M Financial Services, it would be almost criminal not to subscribe to the rights issue. If an investor chooses not to subscribe, his/her equity stake will be diluted by 50% leading to steep value erosion. Therefore, an existing investor SHOULD absolutely subscribe to this issue or sell before the record date.

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To conclude, we believe the move will lead to volatility on the downside on Monday (20th July) and there may be a strong correction, which will likely get bought into by long-term investors gradually owing to interest in Rights Entitlement. This is a good step by the management which works in the interest of all stakeholders of the company for the long-run!

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Saurabh Prabhu

Saurabh Prabhu

Stock Market. Cricket. F1 Enthusiast. Private Equity Professional . Ex- Crisil.
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