Follow the moneyed: Identifying winners from the Bankruptcy Ordinance

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In a landmark move, the President of India gave his assent to the Bankruptcy Ordinance. The move has unintended consequences. For bidders with requisite financial muscle, it might be a once-in-a-lifetime opportunity. Here’s a look at who could gain from this exercise.

In a landmark move, the President of India gave his assent to the Bankruptcy Ordinance, which has virtually closed the door on errant promoters wanting to regain control over their defaulting companies. While the signalling is strong and welcome and would force promoters of stressed companies to hasten the resolution process, the move has unintended consequences as well. For bidders with requisite financial muscle, it might be a once-in-a-lifetime opportunity. Here’s a look at who could gain from this exercise.

The Ordinance

But first, a look at the Ordinance. Its broad objective is to prevent unscrupulous, undesirable persons from participating in the resolution process – in lay man’s terms to prevent back door entry of promoters who have defaulted. It also puts the onus on the Committee of Creditors (who are mostly going to be bankers) to ensure the viability and feasibility of the resolution plan before approving it.

In a nutshell, the following categories would be out of the bidding process for stressed assets:

    • Wilful defaulters

    • Undischarged insolvents

    • Promoters or sister concerns of companies with non-performing assets of more than one year

    • Persons convicted of an offence with over two-year imprisonment

    • Individuals disqualified as directors under Companies Act

    • Person banned by SEBI from Securities market

    • Persons banned under IBC for fraudulent activities

    • Person who executed enforceable guarantee in favour of a creditor in respect of insolvent entity

The Good

The tweak in the Ordinance at a first glance looks like a great move on the transparency front as domestic and global investors have time and again expressed concerns over meddling promoters in the resolution process.

In the long-run, it will force promoters whose companies are about to default to press for an early resolution to prevent the company from being taken to insolvency by the banker. Promoters are likely to pull out all stops early in the restructuring exercise and unlikely to put the onus solely on the bankers, as the evergreening exercise by banks seldom prevents an ultimate default.

The promoter might themselves take the initiative to refer the company to the NCLT in order to meet the one-year deadline to avoid being barred from bidding for their assets. An early restructuring is in the interest of the system: usually by the time a company goes into insolvency it loses most of its value. An early resolution will minimise the loss, as the haircut on an asset which is still not defunct is likely to be a lot less.

The Ordinance will therefore have a bearing on all future defaults including the cases identified by RBI for the second round of NCLT.

However, the harsher provisions of the Ordinance have a few grey areas and unintended consequences.

The grey 

The RBI might classify an account as stressed even before it has actually become NPL in which case the promoter will have to bring in funds earlier to prevent being called a defaulter for over one year.

Banks often engage in a one-time settlement with borrowers and this has similar characteristics of the promoters getting back control of their assets at a discount.

… & the ugly

As is evident, the Ordinance clearly bars promoters of the first list of twelve cases before NCLT from participating in the bidding process. With the revival of the steel cycle, there is palpable investor interest in steel assets that dominates this list and a couple of other companies (like the auto ancillary company) may also see investor interest.

However, beyond this list, there will be many more assets which might not draw an equal amount of interest from competitors/financial investors. If the promoter is out of the fray, these assets are likely to fetch distressed valuations leading to a higher hair cut for the banks.

We also got to remember that not all defaulters are “wilful” in the sense that stress in many companies may be linked to external/macro factors and a promoter losing business to competitor/financial investor might go against the spirit of enterpreneurship.

As the resolution of India’s great NPA saga moves into high gear, many companies may not find buyers leading to liquidation thereby impacting jobs. Finally, financial investors may not always have a necessary bandwidth to run the show and effect a turnaround in the absence of the promoters.

Now the winners

However, as the system ponders over the nuances of the Ordinance, it clearly gives an edge to the solvent bidders. Global giants like Arcelor Mittal to home-grown competitors like JSW SteelTata Steel and Vedanta will definitely have reasons to welcome the changes. We have a positive long-term view on these potential acquirers.

There is a long list of private equity investors/pension funds and more are likely to queue up in a bid to make money from India’s junk.

In our opinion, yesterday’s tweak of the ordinance is unlikely to be positive for Indian banking sector as a whole. Beyond some of the lucrative assets, the overall haircut to the system in the absence of the promoters is likely to be higher although it is difficult to quantify the same at this stage. However, a bank like Kotak that has recently raised capital (to the tune of Rs 5,803 crore) specifically with an eye on buying stressed assets will be in a vantage position. The bank’s chief expects disproportionate returns from this once in a lifetime opportunity. We have a positive view on Kotak Bank as well.

Other players who are likely to be in the thick of action are the likes of Piramal EnterpriseEdelweiss, Il&FS and Aditya Birla Capital.

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