M&M Financial Services announced a rights issue with a twist: For every share you own, you’ll have the right to buy one more share at Rs. 50. This is a 75% lower price than the closing market price of Rs. 208 on Friday.
Why has M&M Financial Services done this? Why should they offer rights shares at a 75% discount? That too, when it’s about 50% below Jan highs? Or indeed, even 60% from their 2018 highs?
So What’s The Rights Issue?
With the mega-hit Reliance Rights issue, which saw over 13,000 cr. subscribed in a short while, it’s obvious that rights issues are in vogue. Since then, we have had PVR and Shriram Transport Finance set up rights issues as well. These are usually done because they are “fast track” – i.e. very quick in terms of getting approvals and actual raising of funds. A relaxation was provided in April 2020.
Every shareholder will get a “right” to buy more equity shares of the company, in a rights issue. (See our post on rights issues) In M&MFIN, you get:
- For every share you own, you get the right to buy 1 more share. (1:1 ratio)
- You have to pay Rs. 50 to buy the “rights” share.
- You don’t have the obligation to pay it – but if you don’t pay it, you don’t get that extra share.
Typically, rights issues are done at a discount to the market price. Reliance was at about a 20% discount.
M&M Financial Services is a huge 75% discount to the market price of 200+.
What Happens In This Issue?
On July 23, the record date, all shareholders owning even one share will get 1 “RE” (Rights Entitlement) share.
Between July 28 and August 11, the RE will trade in the stock market. (A symbol like “M&MFIN-RE” will come about). You can either sell it in the market or buy more. Even non-shareholders can now buy the RE.
After August 11, all RE holders will be required to pay Rs. 50 to get a share of M&MFIN. That will then give you a full share of the company, and then you’ll be able to trade it like a regular share.
Will The Price Fall?
Consider this. If you own 1 share at Rs. 100 and then add Rs. 50 to get 2 shares, you’ve invested Rs. 150, for two shares – so the price should fall to Rs. 75, give or take. It could be a little bit higher, and we’ll get to that.
In this case, if you consider the price of Rs. 210 as an indicative price, you have to add Rs. 50 to get a new rights share. That means you invest Rs. 210+50=260 to get a new share. Now you own 2 shares, and you’ve got Rs. 260 as the value = Rs. 130 per share. That’s where the price should fall.
Let’s take another look another way:
- M&MFIN is valued at Rs. 14,000 cr. market cap
- Its net worth is about Rs. 11,500 cr. (“Book value”)
- This is spread over 62 cr. shares (currently). Which is about Rs. 186 per share.
- You’re paying about Rs. 1.2x book.
- With the rights issue, all shareholders pay Rs. 50 per share = Roughly Rs. 3,100 cr.
- That is added to book value which grows to 14,600 cr.
- You still want to pay Rs. 1.2x book = Rs. 17,500 cr.
- But now the number of shares is 62 x 2 = 124 shares (due to 1:1 rights)
- So the price per share should fall to 17,500 / 124 = Rs. 141
This is the range the stock should fall to – between Rs. 130 and Rs. 140.
Put another way – from Jun 22 (the ex-date) the M&M Financial share should fall to Rs. 130 to Rs. 140.
Is This a Steal? Should You Subscribe?
Let’s take two options.
First, if you are already a shareholder: You must subscribe. Or, you must sell the rights entitlement share between 28 July and 11 August.
Why? Because if you don’t subscribe, you will lose the rights share.
The RE should trade at Rs. 80 or so, to cover the arbitrage, so you could sell that if you like.
This is not a gift or a bonus. Your total value should remain roughly the same.
Second, if you aren’t a shareholder, what should you do?
This part requires a deeper evaluation of M&M Financial Services. Is it a good business to buy at all?
The Business of M&M Finance
They mostly make auto loans.
- 17% tractors, 20% cars, and 45% in commercial/utility vehicles.
- 80,000 of these are Uber/Ola kind of cars.
- Many of them have been under moratorium i.e. not paying any or some of the instalments due. This was 75% in May but seems to have fallen to under 40% in July.
- They have made loans worth Rs. 67,000 cr. but have an NPA (bad loans) of 6,200 cr. Which is 9%.
- Even after provisions, they have 3,700 cr. of NPA which is a net NPA of 5.72%
- And this is not including COVID impact – no account that is not paying, after March 2020, is considered an NPA.
- Right now, interest is recorded as “receivable” even if a customer does not pay anything (or even pays a small amount)
- So, interest income goes up. But NPAs won’t go up more, because of the moratorium.
- NPAs start getting counted only from September 2020, so they’ll be visible only in the December results.
Given this already high level of NPA and the fact that a lot of their customers don’t have enough business to be able to repay, this company is likely to use up most of the fundraise (Rs. 3100 cr.) just to meet extra provisions. They only have Rs. 476 cr. of extra provisions for COVID, which is just too little.
At this point, you have to assume the book is further impaired. By how much? Say you consider an Rs. 2,000 cr. hit due to COVID; this will bring the price down to 120 by January (when the NPA situation is known).
So if you don’t own shares, we don’t think it’s a great idea to buy.
The company is going to need capital. The rights issue will give it some, but the situation isn’t very grim. However, this rights issue may be a sign of desperation to raise capital quickly. While the iron’s hot, in the markets.
Note: Don’t consider book value multiples today. COVID has changed the game, as has the moratorium. The book value is not allowed to be hit by NPAs, because people will just use the moratorium as an excuse to not record an NPA. The True “book” is lower, in all financial companies, in my opinion.
Is This a Play by M&M, The Parent?
M&M, the (listed) parent of M&MFIN, owns 51%. They will buy their rights in full (and pay Rs. 50 per share). But they will also subscribe to more shares just in case other people don’t exercise their rights.
This is a good and legal way to increase promoter shareholding – of course, sometimes at the cost of a small shareholder, who may not be aware of the nitty-gritty. People who just buy and forget their own such companies are at a loss because you have to know and follow up and buy more in the rights issue. If they don’t, and other people such as promoters over-apply, it’s then a loss for the small shareholder.
We believe this rights issue may help M&M increase its stake in M&MFIN at a lower price because of any potential under subscription by small retail holders.
Are There Trading Opportunities?
Look, its a crazy bull market, so everything will go up in the short term without giving a reason, so trading is always possible.
But there’s no “arbitrage” if you’re looking for that. We wrote of the Karnataka Bank issue, where the price was at a 50% discount, that there was no change because futures prices would be adjusted downwards. Similarly here, there’s no real point doing something like buying stocks and selling futures.
Note: August futures are trading about 6% lower than the spot price, which tells you that Monday’s 10% rise didn’t convince people looking 1 month ahead.
There’s however one other opportunity we will describe: Saving Tax Through Rights Harvesting. (Premium) A person considering Rights Harvesting has to do it TODAY itself by at least buying M&MFIN.
You could use this process to save capital gains taxes through Rights Harvesting. However, we find the business model, the exposures, and the NPAs to be at a fairly high level and so would avoid a purchase on this share. (Note here: the parent, M&M is very strong, and will likely back their debt completely. So the bonds of this company may still be worth it)
If you own shares, you will get an RE share which you can either sell (July 28 to August 11) or you can pay Rs. 50 and convert it to a full share.
By Wednesday, July 22, the price of M&MFIN is likely to fall to Rs. 130-140.