Share pledging by founders makes investors jittery
This article was originally published in Scrip
This is one pledge that doesn't seem to go down too well with investors. Indian pharmaceutical companies whose founders have pledged large chunks of their holdings have often seen significant downward price pressure on their stocks, with investors jittery that falling prices in a weak market may see financiers offload some of these shares.
Shares of companies such as Sterling Biotech, Plethico Pharmaceuticals, Orchid Chemicals & Pharmaceuticals and Wockhardt, among others across various sectors, have lost value over the past on Indian markets after their founders pledged shares. Shares are generally pledged as collateral to raise working capital, term loans or to finance other growth initiatives, among other requirements. Pledging is also done by founders to shore up or maintain their holding in a company.
Sterling Biotech, which recently informed Indian bourses that its founders had pledged 886,000 shares, taking the total stake in the company pledged by the founders up to 10.42%, saw a 2.9% decline in its share price on 26 July on the Bombay Stock Exchange. Orchid, where the founders have pledged about 21% of their 31% holding in the company, was down by more than 8% on 8 July on Indian bourses after its founders said that they had pledged a total of 15,745,383 shares out of a total of 70,442,076 outstanding shares in the company.
Manish Jain, director of Axis Holdings, a boutique money management firm for large industrial families in India and overseas, told Scrip that he considers the pledging of shares by founders as a "serious negative", unless these are given as collateral to a bank, in which case "it's still negative but we'd prefer to keep a watch."
Conversely, though, he admits that given the negative sentiment associated with pledging, even firms that are genuinely required to pledge as a collateral (when loans have outstripped their servicing capability) have to bear the brunt of negative sentiment. Pledging is tantamount to debt and whatever form that may take, and it needs to be monitored, he added. In 2009, the Securities and Exchange Board of India made it compulsory for firms to disclose details of pledged shares every quarter.
A report by India's Swastika Investmart in June this year said that the fear that founders would be unable to meet the corresponding increase in interest costs resulting in sales by non-banking finance companies (NBFC), which lend to promoters (founders) against their shares, had resulted in pressure on these companies. "A lot of the promoter funding is done by NBFCs which have an appetite for high risk funding at high interest rates. Their own cost of funding has gone up after the rate hikes and promoters' ability to pay back borrowed money is under question, resulting in a sell-off in many cases," the report noted.
worst case scenario
A leading fund manager told Scrip that in the worst case if shares are sold off by financiers and the founders' holding is very low, the founder could lose control of the company. "Several big business houses have been doing it [pledging] for years, but a lot depends on the lender and the relationship with the founder group. Smart founders are, however, getting pledged shares released," he said.
One expert also pointed to a situation in 2008 when a global financial institution wound up offloading shares in an Indian firm, which in turn triggered margins on the founders. The two broking firms, which were then said to have provided margin funding to the founder of the Indian firm to raise his holding, are said to have divested the incremental holding bought previously, exposing the founder to a potential takeover.
However, companies whose founders have pledged shares say that while investors' concerns are valid, it is unfair to paint all pledging as risky. "Investors need to look at each company separately - the company's performance record, whether the founder has multiple business interests, the founders' track record etc," said the expert, who did not want to be identified.
"If the company's on track in delivering results, the founders' committed to the line of business, there's not much to worry about," he added.