I am anxiously scanning the money market looking for dislocations (if any). The closest that seems to be found is the funding crisis of real estate companies who appear to be facing a cash crunch. I have heard of interest rates going all the way to 36%. These are really attractive returns, but then there is the possibility of default.
I looked up accounting information about one such firm, Unitech, as an example. A glance at the liabilities shows a lot of leverage: net worth of Rs.2143 crore is supporting a balance sheet of Rs.17,327 crore. Current liabilities are Rs.7,069 crore, so there must be a lot of stress rolling these over. At the same time, the market value of equity is Rs.18,000 crore. From this perspective, the leverage is not particularly high (Jayanth Varma had made a similar point recently) even though the stock price has lost 67% in the latest 12 months. In a KMV/Merton model world, you wouldn’t think this firm was particularly likely to go bust.
There is one problem in the measurement of accounting `equity’ capital for some of these firms which needs to be borne in mind. India has capital controls against debt flows. There are many mechanisms for getting around these restrictions, for equity and debt are ultimately intimately intertwined [link, link]. One mechanism is for founders (`promoters’) to sell shares to a foreign investor and have a private contract to buy these shares back at a future date. I have heard that quite a few small Indian promoters have done such deals with private equity funds and other funding sources. These transactions are really debt transactions, being disguised to look like equity transactions.
While such transactions are in flight, the accounting data for `equity’ capital is overstated. And, given the drop in stock prices in recent terms, the cost of this borrowing for the promoter will prove to be very high. Such promoters must be in a tough spot looking for personal money to do the buyback, at a stock price well above the market price.
None of these particularly attenuates the stock price, though, once there is adequate stock market liquidity, for speculators on the market know all these things. So I would still maintain that by market value measures, there is a lot of equity in Unitech. If you have insights to offer on the funding crunch of real estate companies, and why they’re paying as much as 36%, do tell.
Originally published at Ajay Shah’s blog on Oct 6, 2008 and reproduced here with the author’s permission.