Why should investors stay away from firms facing insolvency proceeding?

Irrespective of market conditions and instruments it is always better to stay away from speculation and manipulation. Jessi Livermore the biggest trader of the last century once said, “The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get rich quick adventurer. They will die poor.”

The market regulator seems to know this. IBC

Small investors are often caught on the wrong side of the trade as a result of speculation. History shows that most crisis-hit stocks in the past including Kingfisher Airlines, Suzlon Energy, KS Oil, IVRCL Infrastructures & Projects and Lanco Infratech are today owned by retail investors as most of the smart money has already left.

Far from reality

The ongoing crisis in stressed companies, which are going through insolvency proceedings, needs special attention. Investors hoping that some of these companies might turnaround after their acquisition has attracted a lot of investor attention. But the fact that acquirers and banks would in most possibility leave little or nothing for existing investors would only compound issues for existing investors.

For instance, Bhushan Steel valued its 5.5 million tonne steel capacity around Rs 35,000 crore. Tata Steel acquired 72 percent stake in the company for Rs 35,000 crore. It also offered 12 percent stake to lenders and about Rs 1,200 crore to operational creditors. After this, the value of existing equity was diluted by over 90 percent, leaving very little or negligible equity for existing shareholders.

For stressed companies, the existing guidelines on delisting after acquisition and open offer norms have been relaxed. The norms mostly facilitate the acquirer, who would be the largest beneficiary of any future turnaround. That apart, even if there is an open offer, investors would have to surrender their shares at fairly low prices. For instance, in the case of Electrosteel Steels, Vedanta, the acquirer, wanted to delist the company. Under the scheme, existing shareholders received around 2 percent equity, while the rest will be held by new promoters and bankers.

Recently, Adani Wilmar and Patanjali Ayurved abided for the Ruchi Soya’s assets. Adani offered Rs 4,300 crore to lenders and infused Rs 1,700 crore in the form of equity. This is a huge infusion as against its current market capitalisation of Rs 400 crore, which would certainly mean a very high equity dilution, leaving little or no value for existing shareholders. This means that share prices, which rose initially due to the speculation, would drop.

In most cases, there is a lack of information and investors are often seen acting based on rumours and news. Share prices become volatile and often swing widely beyond their actual value thus causing a greater risk to investors. It is in this light that investors would be better off trading cautiously and stay away from any leveraged trades in these securities.