Cash-Stripping from Ambuja by Holcim-VRK100-25Jul2013

Rama Krishna Vadlamudi, HYDERABAD      25 July 2013
www.ramakrishnavadlamudi.blogspot.com

In the last 24 hours, Indian stock market is debating the consequences of a complex capital restructure among Holcim Group, and two listed entities, namely, Ambuja Cements Ltd and ACC Ltd. At present, Holcim holds majority stake in Ambuja and ACC. The proposed restructure is seen as a major loss to minority shareholders of Ambuja Cements, because Ambuja will pay Rs 3,500 crore to acquire 24 percent stake in Holcim India. This parting of Rs 3,500 crore cash is perceived as an indirect way of stripping cash from Ambuja Cements by its promoter Holcim. Let us analyze the proposed restructuring deal and its consequences:

The Details of the Restructuring Deal Are:

o  The boards of directors of Holcim India Pvt Ltd (HIPL) and Ambuja Cements made this announcement on 24 July 2013

o  Ambuja Cements will buy 24% of HIPL for Rs 3,500 crore

o  Afterwards, HIPL will be merged into Ambuja Cements, with the result that the latter will hold 50% in ACC (As of now, majority stake in ACC is owned by Holcim; but after the deal, Ambuja will hold 50% stake in ACC) 

o   The merger swap has been fixed at one Ambuja share for 7.4 shares of HIPL

o   Ambuja Cements will issue 58.4 crore new equity shares to Holcim

o  After the merger, the equity capital base of Ambuja will increase by 28%

o   Holcim will then own 61.4% in Ambuja, which in turn will hold 50% in ACC

o  Over the next two years, Ambuja will invest Rs 3,000 crore to increase its stake in ACC by 10 percentage points

Why this Deal is Seen as a Rip-off by Markets?

Asset-stripping or dividend-stripping is not uncommon in corporate India. The market regulator, SEBI, had in March 2013 barred six promoters of Zenith Infotech after charging them of stripping company assets for personal gains. The matter is yet to be settled. The open offer document of United Spirits Ltd contains a clause that enables the sale of company’s assets and investments by Diageo of the UK (the acquirer of USL) within two years. In 2008, the erstwhile promoter of Taro Pharmaceuticals (Israel) had tried to sell its Irish assets to ward off the takeover of the company by India’s Sun Pharmaceuticals, though Taro did not succeed in its efforts.

Even Government of India often resorts to cash-stripping by forcing public sector companies to declare higher dividends in an effort to shore up its coffers. But in this case, the minority shareholders too are benefited with higher dividends.

The arguments against the restructuring deal among Holcim, Ambuja and ACC are:

• Rs 3,500 crore cash will go out of Ambuja Cements to Holcim of Switzerland
• The deal benefits only the parent company, Holcim
• The deal is detrimental to the interests of the minority shareholders
• Ambuja will become a holding company. Generally, holding companies trade at a significant discount to their intrinsic value.
• It is not that a holding company cannot create value for companies in which it has a stake, provided the holding company has superior financial, technological or managerial capabilities. But in the present case, there is no clarity on the synergies, when both Ambuja and ACC will continue with their own branding and marketing—though Ambuja claims that the deal will result in synergies. Ambuja and ACC will continue to operate as independent companies.
• The deal is not EPS-accretive. The earning per share will be adversely impacted as the company’s paid up capital will go up by 28% after the deal.

The Market Reaction is Brutal:

The stock market has already given a big thumbs down to Ambuja Cements, with its share price losing around 15% of its value in the last two days. Very strong reactions have been expressed by several market participants against the deal.

The current shareholding pattern of Ambuja is as follows: Swiss promoter Holcim: 52%, FIIs: 29%, insurance companies: 9% (out of which LIC of India: 5.6%) and mutual funds (UTI MF, Birla Sunlife and Canara Robeco): 1%.

Reports indicate that Ambuja Cements has not expanded its capacity in the past five years, saving its huge pile of cash on its balance sheet even as the company has lost its market share in cement business.

How to Avoid Such Delinquent Companies?

Is there any way investors can avoid companies that are likely to cause heartburn to minority shareholders in future? The answer is very tricky. It is amazing to note that with only 50% ownership in Ambuja Cements, Holcim has been able to gain access to 100% of cash available in the former’s balance sheet. In such scenarios, small investors have no say in company’s affairs and they are left to fend for themselves. Promoters or top management have full access to a company’s resources, but individual investors have access only to dividends, if any, declared by the management.  

This deal is a wake-up call for individual investors (including the author) who see unutilized cash in the balance sheet as a company’s strength. I think we need to change our view about cash balances with a company. A specific company may have negative operating cash flows, or it may suffer losses in future eroding the cash balances. The only way we can protect ourselves is that we need to analyze the business prospects and other relevant factors thoroughly before making investments in a company’s equity shares.

What Should Investors Do?

Ambuja Cements board of directors consists of some independent directors of repute, namely, Nasser Munjee, Shailesh Haribhakti and Dr Omkar Goswami. Key independent directors on ACC’s board are Ashwin Dani (of Asian Paints) and Shailesh Haribhakti. It will be interesting to watch how these so-called independent directors will react to the negative commentary the company has received among the economic agents.

The companies’ bankers/lenders also will see red in the deal because it may impact their debt covenants. Regulators usually frown upon promoters who resort to asset-stripping that disadvantage the minority shareholders. The European Union and the US SEC have implemented regulatory curbs on asset-stripping, especially, by hedge funds and private equity funds. I would be curious to know how SEBI or for that matter Competition Commission of India will react to the Ambuja deal.

The stock has been punished very severely. The stock may continue its weak trend going forward. Several brokerages have downgraded the stock saying that the merger between Ambuja and HIPL is inimical to the interests of minority shareholders. The stock is down to Rs 171 per share losing 10% of its value on 25 July 2013. In the last one week, the investors have lost 20% of their shareholder wealth (of course, this specific deal is not the only reason for the sharp decline in its share price).

The existing investors may partially offload their holdings in Ambuja Cements and watch the future developments closely for the next few months. It is to be seen how the FIIs and large institutional investors, such as, LIC of India, will react to the deal.

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Notes: Asset Stripping – The process of buying an undervalued company with the intent to sell off its assets for a profit is called asset stripping. 

FIIs – Foreign Institutional Investors, SEBI – Securities and Exchange Board of India, and SEC – Securities and Exchange Commission of the US.

Disclosure: The author does not own any shares in either Ambuja Cements or ACC.

Disclaimer: The author is an investment analyst and freelance writer. His articles on financial markets and Indian economy can be reached at:

http://ramakrishnavadlamudi.blogspot.in/ and www.scribd.com/vrk100

LAF Repo Rate: The Single Policy Rate-VRK100-23Jul2013

  

Rama Krishna Vadlamudi, HYDERABAD      23 July 2013
www.ramakrishnavadlamudi.blogspot.com

As shown in the above graph, Repo Rate under RBI’s Liquidity Adjustment Facility (LAF) has been declining indicating the gradual easing of monetary policy stance by RBI following the moderation of inflationary pressures.

Before the introduction of revised operating monetary policy in May 2011, Reserve Bank of India (RBI) had been using various monetary instruments to signal the monetary policy stance. Since May 2011, RBI has been using Repo Rate as the single policy rate and all the other policy rates are linked to the Repo Rate. Rates that are linked directly to Repo Rate are: Reverse Repo Rate and Marginal Standing Facility (MSF) Rate. Bank Rate is indirectly linked to Repo Rate. Reverse Repo rate is kept at 100 basis points (or one percentage point) below Repo Rate.

Short-term interest rates represented by call money rates and CBLO rates are supposed to move in a range between the Repo Rate and the Reverse Repo Rate. LAF Corridor is the excess of LAF-Repo Rate over the LAF-Reverse Repo Rate. The objective of RBI is to keep the short term interest rates in the banking system within this LAF corridor.

Timeline for LAF Repo Rate:

The following is a timeline of Liquidity Adjustment Facility (LAF) and Repo Rate:

April 1998	The Narasimham Committee II on Banking Sector Reforms recommended introduction of LAF
5 June 2000	RBI introduced a full-fledged LAF
16 Aug. 2004	One-day fixed rate reverse repo was re-introduced while continuing with the 7-day and 14-day reverse repos and overnight fixed rate repos
29 Oct. 2004	The nomenclature of repo and reverse repo were interchanged as per international usage
1 Nov. 2004	The 7-day fixed rate and 14-day variable reverse repos were phased out and the LAF was operated through overnight fixed rate repo & reverse repo

Salient Features of RBI’s LAF:

Ø  Liquidity Adjustment Facility (LAF) is a facility by which the RBI adjusts the daily liquidity in the domestic markets (India) either by injecting funds or by withdrawing them out

Ø  The LAF enables the RBI to smoothen short-term liquidity under varied financial market conditions, ensuring stable conditions in the overnight (call) money market

Ø Repo denotes injection of liquidity by RBI against collateral of eligible instruments. Repo rate is the rate at which RBI lends overnight funds to banks.

Ø Reverse Repo denotes absorption of liquidity by RBI against collateral of eligible instruments. Under Reverse repo, banks park their surplus overnight funds with the RBI and the RBI pays interest to banks at the Reverse repo rate.

Ø Both the Repo and Reverse Repo operations are conducted at a fixed rate

Ø The Repo rate is fixed by RBI from time to time. At present, Repo rate is 7.25 percent. Reverse Repo rate is pegged at 100 basis points below the Repo rate and as such the current Reverse Repo rate is 6.25 percent.

Ø  All Scheduled Commercial Banks (excluding Regional Rural Banks) and Primary Dealers are permitted to participate in Repo and Reverse Repo auctions

Ø   The minimum bid size will be Rs 5 crore and in multiples of Rs 5 crore thereafter

Ø  The LAF avoids targeting a particular level of overnight money market rate due to external factors impacting short-term liquidity, such as volatile government cash balances and unpredictable foreign exchange flows

Ø Repos and Reverse Repos are undertaken in all SLR-eligible transferable Government of India Dated Securities/Treasury Bills

Ø A margin of five percent is required for the above eligible securities. The amount of securities offered or tendered on acceptance of a bid for Rs.100 will be Rs.105 in terms of face value.

Ø In this direction, the LAF introduced in June 2000 has now emerged as the principal operating instrument of monetary policy

RBI’s Measures to Curb Exchange Rate Volatility:

The measures concerning LAF taken by RBI on 15Jul2013 to rein in rupee volatility are:

ü   The MSF rate has been readjusted to 300 basis points (from the earlier 100 basis points) above the policy Repo rate under the Liquidity Adjustment Facility (LAF). As such, the MSF rate is raised to 10.25 per cent from 8.25 percent with effect from 16Jul2013.

ü   With effect from 17Jul2013, the total amount under RBI’s LAF is restricted to one percent of the net demand and time liabilities (NDTL) of the banking system, reckoned as Rs 75,000 crore (Earlier, there was no such quantitative restriction)

Additional measures concerning LAF taken by RBI on 23Jul2013 to curb rupee volatility are:

ü The overall limit for access to LAF by each individual bank is set at 0.5 per cent of its own NDTL. This measure will come into effect immediately, i.e., from 24 July 2013 and will remain in force until further notice.

ü The earlier instructions issued by RBI on 15Jul2013 regarding cap on overall allocation of funds at Rs 75,000 crore under LAF stand withdrawn

LAF Repo Rate: The Single Policy Rate:

As part of the Deepak Mohanty Committee Report (March 2011) on the operating procedure of the monetary policy, the RBI in its Annual Policy statement 2011-12 made the following important changes with effect from 03 May 2011*:

1  The weighted average overnight call money rate will be the operating target of monetary policy of the RBI

2 There will henceforth be only one independently varying policy rate and that will be the repo rate. The transition to a single independently varying policy rate is expected to more accurately signal the monetary policy stance.

All central banks have a single policy rate for liquidity and monetary management. Now, RBI too is following the international norm of a single policy rate. All the refinance facilities (e.g., export refinance and general refinance) provided by RBI are at the Repo Rate. At present, Repo Rate has emerged as the single policy rate to unambiguously signal the stance of monetary policy to achieve macroeconomic objective of growth with price stability.

(* Before 03May2011, RBI was using both LAF Repo rate and LAF Reverse Repo rate as policy rates to signal monetary policy actions).

To Sum Up:

The RBI has over the years has used a variety of direct and indirect instruments to signal monetary policy actions. Prior to late 1990s, monetary policy was conducted with the help of direct instruments, such as, SLR, CRR, and selective credit control.

In an effort to move away from direct instruments of monetary control to indirect instruments in a market-based economy, a fundamental change in the conduct of monetary policy in India was effected through the introduction of LAF in June 2000. Since then, the LAF scheme has evolved in a series of steps taken by RBI to move towards monetary management based on short-term market interest rates.

With the adoption of Deepak Mohanty Committee recommendations, LAF Repo rate has become the single policy rate and overnight call monetary rate has become the operating target for conducting monetary policy in India. 

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Annexure 1:

Direct instruments of monetary control used by RBI in the past were:

§       Prescribing deposit and lending rates of commercial banks

§       Selective credit control over sensitive commodities

§       Sector-specific standing facilities

§       Statutory liquidity ratio (SLR) & Cash reserve ratio (CRR); and

§       Bank Rate

Indirect monetary policy instruments  are:

§       Open market operations (OMO)

§       Purchase and repurchase of government securities

§       LAF Repo rate and Reverse Repo rate

§       Marginal Standing Facility Rate (MSF)

§       Market Stabilization Scheme or MSS (used for sterilization of large capital flows)

Notes: CBLO-Collateralized Borrowing and Lending Obligation of the Clearing Corporation of India Limited. It is a money market instrument through which CCIL imparts liquidity to market participants.

Reference: Report of the Deepak Mohanty committee, other RBI reports and Paper by Rakesh Mohan on Monetary Policy Transmission,

Disclaimer: The author is an investment analyst and freelance writer. His articles on financial markets and Indian economy can be reached at:

http://ramakrishnavadlamudi.blogspot.in/ and www.scribd.com/vrk100

Bank Rate: Is It Relevant Now?-VRK100-23Jul2013

Rama Krishna Vadlamudi, HYDERABAD      23 July 2013
www.ramakrishnavadlamudi.blogspot.com

As the above graph illustrates, Bank Rate had been kept in comatose for almost a decade between 2003 and 2012. Suddenly, one fine morning in 2012 RBI rediscovered the Bank Rate and raised it by 350 basis points (or 3.5 percentage points) to 9.50 percent. Since then, it has been revised on five other occasions as shown in the above graph.  

The reactivation of Bank Rate since 2012 is broadly on the lines of the report (March 2011) of the Deepak Mohanty Committee on the operating procedure of the monetary policy. This article explores the relevance of Bank Rate in the context of monetary policy. 

What is Bank Rate?:

Informally, Bank Rate is the rate of interest charged by a central bank on the funds lent to banks. However, under Section 49 of the Reserve Bank of India Act, 1934, the Bank Rate has been defined as “the standard rate at which the RBI is prepared to buy or re-discount bills of exchange or other commercial paper eligible for purchase under this Act.” Bank Rate is essentially a discount rate.

Since its introduction in 1935, the Bank Rate was revised by RBI on 35 occasions till now. At present, the Bank Rate is 10.25 percent. (Bank Rate was 3.5 percent when it was first introduced in 1935). Bank Rate has been made equal to Marginal Standing Facility (MSF) rate since 13 February 2012 and so whenever the MSF rate is revised, the Bank Rate also gets revised.

Interestingly, the MSF Rate itself is linked to LAF-Repo rate, with a positive spread of 300 basis points (or 3 percentage points) over the Repo rate. So practically, Bank Rate changes whenever the Repo rate is revised by RBI or the spread between the Repo Rate and the MSF Rate is changed. Now, Repo Rate is the single policy rate used by RBI for setting interest rates (monetary management) in the economy. The current rates of RBI’s policy rates and reserve ratios are given below:

RBI’s Policy Rates				RBI’s Reserve Ratios
Rate	%	Effective		Ratio	%	Effective
		Date				Date
LAF-Repo	7.25	3-May-2013		CRR	4.00	9-Feb-2013
LAF-Reverse Repo	6.25	3-May-2013		SLR	23.00	11-Aug-2012
MSF	10.25	16-Jul-2013
Bank Rate	10.25	15-Jul-2013

To know more about MSF and LAF-Repo, just click:

1. Update on Marginal Standing Facility-20Jul2013

2. LAF Repo Rate: Single Policy Rate-23Jul2013

How was Bank Rate used by RBI in the past?

Bank Rate was used by RBI as a general instrument of monetary policy in the past though RBI had used various other instruments also—such as, statutory liquidity ratio (SLR), cash reserve ratio (CRR), selective credit control, open market operations (OMO), and prescribing interest rates on deposits and advances. RBI used to provide short-term funds to commercial banks at Bank Rate against the collateral of eligible instruments.

Bank Rate was also used as a reference rate for various standing facilities, such as general refinance and export refinance, provided by RBI to banks. Bank Rate acted as refinance rate at which liquidity was to be injected to banks and primary dealers (PDs). On a few occasions, it was used for exchange rate management. It was also used for charging penalties on banks for not meeting reserve requirements (CRR and SLR).

The Relevance of Bank Rate Now:

The importance of Bank Rate as an important instrument of monetary control has declined after the introduction of Liquidity Adjustment Facility (LAF) in June 2000 and RBI’s standing facilities to banks/PDs were completely delinked from the Bank Rate. Now, all the refinance facilities are provided at the LAF-Repo Rate, which has emerged as the single signaling rate for monetary policy.

RBI is required to buy or re-discount bills of exchange or other commercial paper at the Bank Rate as per RBI Act, 1934. Since discounting/rediscounting by the RBI has remained in disuse, the Bank Rate had become inactive for several years. Under the revised operating procedure of the monetary policy (since May 2011), the MSF rate has in many ways serves the purposes of Bank Rate as a discount rate.

On 13Feb2012, the Bank Rate was raised by 350 basis points and since then it has been made equal to the MSF Rate. This increase was a one-time technical adjustment by RBI to align the Bank Rate with the MSF Rate and was not to be viewed as a change in the monetary policy stance.

    

The role of Bank Rate is now limited to:

1. It is now used for calculating penalty on default in CRR and SLR requirements as required by Section 42(3) of the RBI Act, 1934 and Section 24 of the Banking Regulation Act, 1949, respectively

  2. The penal interest on shortfalls in CRR and SLR (depending on the duration of the shortfalls) are Bank Rate plus 3.0 percentage points or Bank Rate plus 5.0 percentage points

  3. It is also used by several organizations as a reference point for indexation purposes. For example, under Section 372A of the Companies Act, 1956, inter-corporate loans shall not be made at a rate of interest lower than the prevailing Bank Rate.

For all practical purposes, the Bank Rate has become irrelevant as an instrument of liquidity and monetary management.

Summary:

Over the years, the Bank Rate has had its years of glory and gross negligence. RBI had used it for a variety of purposes—in the process confusing the markets and other stakeholders about the relevance of Bank Rate in liquidity and monetary management. With RBI’s flip-flop on Bank Rate, vague signals were sent to the market. One hopes that in future RBI will follow a consistent policy on Bank Rate. 

Today, the Bank Rate largely plays a technical-but-limited role only. Its role is confined to penalties charged by RBI on banks for not maintaining SLR and CRR requirements. The importance of Bank Rate as a monetary policy instrument has waned after the introduction of LAF-Repo rate in June 2000.

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Notes: LAF-Repo Rate under RBI’s Liquidity Adjustment Facility (LAF) is the rate at which RBI lends overnight funds to banks; CRR – Cash Reserve Ratio; and SLR – Statutory Liquidity Ratio.

Reference: RBI Act, Deepak Mohanty Committee report, other RBI reports and www.mca.org.in.

Disclaimer: The author is an investment analyst and freelance writer. His articles on financial markets and Indian economy can be reached at:

http://ramakrishnavadlamudi.blogspot.in/ and www.scribd.com/vrk100

Update on Marginal Standing Facility-VRK100-20Jul2013

Rama Krishna Vadlamudi, HYDERABAD       20 July 2013
www.ramakrishnavadlamudi.blogspot.com

Indian rupee has been depreciating steeply against the US dollar ever since the US Federal Reserve has hinted at tapering its quantitative easing (QE3) programme. For the first time since its introduction in 2011, the Reserve Bank of India (RBI) has used its marginal standing facility (MSF) to control depreciation of Indian rupee against the US dollar. The measures initiated by RBI on 15 July 2013 to rein in rupee volatility are:

a). The MSF rate has been readjusted to 300 basis points (from the earlier 100 basis points) above the policy Repo rate under the Liquidity Adjustment Facility (LAF). As such, the MSF rate is raised to 10.25 per cent from 8.25 percent with effect from 16Jul2013.

b). Accordingly, Bank Rate has been raised to 10.25 percent with effect from 15Jul2013 (since 13Feb2012, Bank Rate has been made equal to MSF rate)

c). With effect from 17Jul2013, the total amount under RBI’s LAF is restricted to one percent of the net demand and time liabilities (NDTL) of the banking system, reckoned as Rs 75,000 crore

d). RBI would sell government securities to the tune of Rs 12,000 crore on 18Jul2013 as part of its open market operations (OMO)

What is Marginal Standing Facility (MSF)?

The MSF was started by RBI during the Annual Policy statement announced by it on 03 May 2011. The MSF facility was made effective from 09 May 2011.

The marginal standing facility is an additional window provided by RBI to banks, so that the latter can borrow overnight funds from RBI against their excess SLR (statutory liquidity ratio) holdings. MSF scheme is similar to LAF-Repo scheme. The difference between MSF and LAF-Repo is that under MSF, banks will have to pay higher rate of interest to RBI for their borrowings as compared to LAF-Repo.

Banks will look for the MSF window to borrow money from RBI once they exhausted all other avenues (like, call money market, LAF-repo window, Collateralized Borrowing and Lending Obligation or CBLO, market repo, etc.) for overnight money. Under exceptional circumstances, banks will borrow money through MSF window.

What are the Salient Features of MSF?

1. The Objective of MSF:

This facility is expected to contain volatility in the overnight inter-bank money market.

2. Eligibility:

All scheduled commercial banks (SCBs) are eligible to borrow from RBI under MSF.

3. Tenor and Amount:

With effect from 17Apr2012, Banks can borrow overnight funds up to two percent of their NDTL. In general, the borrowing is for one day except on Fridays when the facility will be for three days. Banks can continue to access the MSF even if they have excess SLR holdings. (Prior to 17Apr2012, banks were allowed to borrow funds up to one percent of their NDTL under MSF).

4. Rate of Interest:

With effect from 16Jul2013, banks under MSF have to pay interest at the rate of 300 basis points or three percentage points above the LAF-Repo rate. At present, LAF-Repo rate is 7.25 percent and as such, the MSF rate is 10.25 percent. So, whenever LAF-Repo rate is revised by RBI, the MSF rate will be revised accordingly. Prior to 16Jul2013, MSF rate was linked to 100 basis points above LAF-Repo rate.

5. Minimum Size:

Under MSF scheme, banks will have to make requests for a minimum of Rs one crore and in multiples of Rs one crore thereafter.

6. Eligible Securities:

They are Government of India Dated Securities/Treasury Bills and State Development Loans (SDL).

7. Margin Requirement:

A margin of five percent is required for GOI Dated Securities and Treasury Bills; and for SDLs, it is 10 percent. So, banks will have to offer Rs 105 (face value) worth of GOI Dated Securities and Treasury bills for a request of Rs 100; and Rs 110 (face value) worth of SDLs for a request of Rs 100.

MSF Rates since Beginning:

Graph showing the MSF rates since inception:

Special Repo Window for Mutual Funds:

RBI had on 17Jul2013 provided a special repo window whereby banks can avail funds from RBI to meet the liquidity requirements of mutual funds. Under this special repo window, banks can avail liquidity assistance from MSF up to 0.5 percent of NDTL, which is over and above the two percent (of NDTL) regular MSF window. This additional limit of 0.5 percent of NDTL will be available for a temporary period till further notice.

Off-beat Move by RBI:

By increasing MSF rate to curb rupee volatility, the RBI has acted in an off-beat manner to the surprise of market participants. Though the stated objective of RBI in raising MSF rate is to address exchange rate volatility, the market participants have interpreted the measure as raising short-term interest rates. The bond markets have panicked and bond prices have fallen sharply with bond yields shooting up much to the chagrin of investors. In the equity markets, banking stocks have fallen steeply due to liquidity squeeze and Treasury losses from bond portfolios.  

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Reference: RBI

Disclaimer: The author is an investment analyst and freelance writer. His articles on financial markets and Indian economy can be reached at:

http://ramakrishnavadlamudi.blogspot.in/ or www. scribd.com/vrk100


Note: Please check the comment attached below, made on 05Dec2018 by me, for interest rate on MSF, which is now 25 basis points above the LAF Repo rate.