The earnings impact on account of raising cash through sale of equity will vary across companies.

The improvement in investor sentiment and market valuations, particularly in the last two months, has seen a host of companies announcing fund raising plans, not seen in recent years.

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Excluding the five companies, there are 39 others that have announced plans to raise a total of Rs 53,900 crore through the qualified institutional placement (QIP) route (issue of equity, warrants, etc), while a few others are yet to announce pricing details. This is significant as compared to the previous two years. Like every coin has two sides, the move to raise funds also has its set of pluses and minuses.

In many cases, the mega growth plans drawn by the companies (including acquisitions) had led them to pile up huge debt on their books. The combined effect of huge debt and economic slowdown seen since last year had virtually put breaks on all their activities. So, the change in the environment is now providing such companies an opportunity to raise funds to ease the situation, as well as bring their growth plans on track.

The flip side is that the fund-raising exercise will most likely lead to an equity dilution and hence, the impact on the company’s earnings. Thus, investors need to examine the details carefully to gauge the net impact on earnings. This includes the instrument being used for raising funds, the timeframe and the issue price among a few others.

The other issue arises from the possibility of some companies not being able to raise the proposed funds (due to volatile market conditions) and the willingness of investors to invest at current valuations.

“Given the requirement viz. pricing to be based on SEBI-determined formula, the timing of the deal and market price will be crucial,” says Sanjay Sharma, MD and head - India Equity Capital Markets, Deutsche Equities. Sharma though confirms that the investor appetite for quality companies and good projects has improved.

We looked at some of the larger companies, which have already announced their fund raising plans, to understand their need for funds, the different instruments that they may use and how the deal could impact the company.

Debt worries
A large number of companies want to raise funds to reduce their debt burden. “There is nothing wrong in retiring debt by way of raising funds through equity. In fact it is good. Earlier companies had to raise debt, that too at high interest rates, so that they could finance their obligations and fund expansion, acquisition and working capital requirement. But, that was due to the non-availability of the equity. As the environment is improving, companies can retire their high cost debt,” says Udaybhanu Thakur, assistant VP, investment banking, SREI Capital Markets.

This is especially true for real estate companies, which had borrowed significantly to fund land acquisition and their working capital needs. However, a large part of the funds were borrowed at high interest rates ranging 13-15 per cent.

Take the case of HDIL. The company’s cost of funds was 12-13 per cent on debt of Rs 4,143 crore (debt equity of 0.94) in 2008-09. HDIL is planning to raise funds of Rs 2,800 crore, including through the QIP route. Even if the company is able to repay Rs 2,000 crore of its debt, the interest cost would fall by half from Rs 594 crore in 2008-09, an improvement of 7-8 per cent in net profit margin.

However, analysts point out that this could lead to a significant equity dilution of about 36 per cent (at current prices). In such a case, they believe the savings in interest outgo may not fully offset the expansion in equity, which means a dilution in earnings may occur.

HDIL is not alone. There are nine real estate companies which have proposed to raise nearly Rs 16,000 crore to largely to repay debt and to infuse funds towards reviving revenue flows. This could provide new life to their projects, which earlier could not be completed due to lack of funds.

Since these stocks were beaten down including due to the funding concerns, they have also jumped sharply due to visibility regarding access to funds. But, will the stock valuations hold? That would depend on each company’s ability to sustain revenue growth through improved execution rather than an increase in land bank valuation.

Besides real estate, companies from other sectors including Essar Oil, JSW Steel, Hindustan Construction (HCC) and Pantaloon Retail also have plans to raise funds, part of it for repaying their debt. Essar Oil plans to raise $2 billion to reduce its high debt (Rs 10,300 crore). Here too, at current prices, the equity dilution will be as high as 31 per cent.

On the other hand, if it repays half of its debt, it should end up saving Rs 550 crore in interest outgo. For 2008-09, despite an operating profit of Rs 1,287 crore, the company reported net loss of Rs 423 crore (primarily due to Rs 1,120 crore of interest expenses). Thus, the fund raising move will help it become profitable. For the remaining funds, it could be used to expand its capacities, which would generate income but in the long-run.

So, apart from the advantage of repayment of debt, investors also need to see the impact of the business and net earnings of the company. Also, the impact on the stock’s valuations would depend on how prudently the company uses the funds to its advantage (in terms of adding value) for its shareholders.

Funding expansion
There are many companies, which are raising funds largely to grab the upcoming opportunities in their respective businesses, which in turn would also help them sustain growth rates. A good example is Reliance Communications.

The company plans to raise Rs 2,500 crore for the purpose of participating in the auction process for 3G and Wimax licenses. Such a move, if successful, will help the company enhance its range of value-added services as well as generate higher revenues, given that it is the second largest mobile services player in the country.

However, while the fund-raising exercise is estimated to lead to an equity dilution of about four per cent, investors will need to be patient. This is because the benefits for the company in the form of higher ARPU (due to the value added services), will only accrue in the long run.

A somewhat similar example is that of PTC. But, in this case, the benefits may take a bit longer to accrue. Moreover, the resulting equity dilution due to the fund raising move is likely to be higher. PTC has recently raised Rs 500 crore by way of a QIP at Rs 75 per share, leading to an equity dilution of 22.6 per cent.

Analysts were earlier expecting its 2009-10 net profit to be about Rs 90 crore translating into an EPS of Rs 3.9. But post the QIP, its 2009-10 EPS would effectively come down to Rs 3 per share. This is due to the increase in equity base and also because the gains are not likely to accrue immediately as the company will be investing the money for a stake in power generation projects, which may come up only at a future date.

Thus, the gains in such cases would depend on various factors including the kind of return the company is generating on the money deployed in the business (return on capital employed; RoCE) as well as the when the benefits start adding to the company’s profit and loss statement.

Different strokes
While the issue of equity dilution is proving to be a concern, there are different ways which companies are resorting to to minimise the impact. They are using different instruments including warrants and debentures. Besides, the dilution in equity is also being spread over a period.

For instance, housing finance major, HDFC is raising funds to the tune of Rs 4,000 crore by issuing non-convertible debentures along with warrants. While the debenture gives the investor the comfort of getting a fixed return on the investment, it also gives a right to convert the warrant at a given price (to be fixed at the time of issue of shares).
 

Analysts see this deal as a win-win move considering that the dilution would be minimal at 3.5 per cent or less and, at the same time the debenture is at a relatively lower coupon (interest) rate. Meanwhile these funds will be used to invest in HDFC Bank, which will enable HDFC to maintain its stake in the bank at 23 per cent. The investment in HDFC Bank, analysts believe, will translate into a 2-3 per cent improvement in its net profit for 2009-10.

Among common ways of reducing the impact of dilution is to defer the issue of shares over a given period. And, GMR Infrastructure is one company which is using it to its advantage. The company is raising funds worth Rs 5,000 crore (equity dilution of 14-15 per cent). The company believes that these funds will be raised in tranches and thus, the impact of dilution would not a significant bearing on its earnings.

As the company grows bigger (higher profits) the same will help offset the effect of a larger equity base. Since the company will be using these funds to expand its existing as well as new projects (like BOT road and airport), the benefits from the same would, at some point in time, start reflecting in the financials.

To conclude, the impact of any company’s move to raise funds will depend on various factors (as mentioned above), which will only get more clear as they disclose further details, which investors will need to analyse thoroughly.

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