The fall in the share price of GTL by 74% for the week ending June 25 has brought a sense of déjà vu. It reminds us of what happened towards the fag end of 2008 when the share price of Satyam Computers crashed due to lenders selling the shares pledged by the then promoter B Ramalinga Raju. In the present scenario too, the fall in GTL’s share price that began on June 20 was triggered by rumours that the shares of companies pledged by the promoters had been sold off. The fall continued despite a clarification coming from the promoters that they have pledged only 12.85% of the equity capital of the company and neither the promoters nor the entities relating to the promoters have sold any shares, including the shares that have been pledged.
There are other companies too that have experienced a similar trend like S Kumars. These incidents create room for nervousness in the minds of those investors holding shares of the company whose promoters have pledged their holding. They continuously stare at the systematic risk posed by the sudden offloading of the shares by the pledgee. According to our analysis of 1,500 companies (by the largest market-cap) we have found that at the end of March 31, 2011 there were 565 companies whose promoters have pledged their shares. The%age of shares so pledged of course is different for different companies. So does it mean that one should exit from these companies or what is the tolerable level of pledging by promoters beyond which the shares of the company become untouchable?
We believe that the pledging of shares by promoters does not warrant for panic selling of those counters and this should be only one of the criteria that need to be considered before investing. More than mere pledging, what needs to be looked at is the purpose of the pledging of these shares. Many times banks insist on personal guarantees from promoters before lending money to the company. Many promoters pledge a part of their holding in the company as part of this arrangement to meet such working capital needs or some other requirement of the company. This only acts as a secondary collateral and hence in case of any default in payment, these are not the first that are offloaded.
There are other reasons why pledging by promoters actually bodes well. It shows the confidence of the promoters in the ability of the company, particularly when the promoters pledge shares for raising funds to further increase their stake in the company, either through a right issue or through warrants. Therefore, instead of merely viewing the pledged shares as a threat, one should actually try to know purpose of pledging and the end use of the funds so raised. For example, the promoters of Asian Paints, Ashwin Dani and Ashwin Choksi, pledged their shares to raise their holdings in their respective companies. Dani and Choksi pledged 14.98% of their stake in Asian Paints to increase their holding in the company from 40% to 50%.
Similarly, Rohinton Screwvala, MD & Founder of UTV, pledged close to 23% of his holding in the company to fund the two tranches of war-rants issued by UTV. Moreover, the pledging of shares poses a problem only in a failing market, as has been experienced currently. Nonetheless this does not mean that any and every pledging of shares by the promoters is for good reasons. There are incidences where promoters have raised funds for personal use or to invest in other businesses or for rigging of their share prices. Furthermore, the risk increases if shares are pledged to non-banking financial companies (NBFCs) since they do not fall under the RBI`s purview and the market is unaware of the details of such pledging so that any sudden fall in the share prices triggers a sell-off.
We tried to figure out as to how much of pledging should be tolerable. However, there is no thumb rule which defines how such a benchmark can be arrived at. This means that a company wherein 70% of its promoters’ holdings have been pledged may not be as risky as a company wherein only 15% of the promoters’ shares are pledged. The level of risk depends upon the class of shares, historical volatility of the
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