Hence, lenders may prefer taking control of the company and sacrificing some interest/debt to ensure that they atleast get back something. Although common stock holders are last in line and would realistically earn zero in liquidation, CDR buys them time for the company to turnaround and for the common stock to carry some value. 'Time is money'-this adage is true for equity owners when CDR is enforced on the company. But investors should not impulsively react on the rumours of a CDR, but should note the following points and get extra information before they respond. This presentation by CA Rajesh Chaturvedi given at WIRC in Feb12 is very useful(http://www.wirc-icai.org/material/Final-CDR-presentation-03022012.pdf) and I suggest people read this carefully as well.
- Does it involve writeoff/deferment of interest or debt? These are equivalent in NPV terms, but often come with added riders like lookback options if company recovers etc.
- Is debt converted into equity-if so at what price? Usually, SEBI ICDR norms mandate pricing of such conversion as if it was a preferential allotment(so last 6months/last 2 week pricing etc). Hence, it usually being at a premium to the market price by force, market should not interpret as lender's faith in the company, but rather that they had no choice to fix the equity price..
- Does the promoter infuse more funds besides sharing sacrifice? Especially in case of promoters with large personal wealth like say Vijay Mallaya, investors may want to see whether they walk the talk by infusing equity as well into the company, or whether they just want others to take a loss without themselves contributing. This is a powerful signal/information source for the market.
- History of the firm with earlier CDR/restructuring:-While this data should have been seen earlier, investors who invest purely based on past 2-3yrs annual reports may have missed out on earlier near-death experiences. Hence, looking back into history with Google News would add that layer of judgement on whether past performance can back the future recovery. Firms like Suzlon/Kingfisher Airlines/Essar group companies with repeated distress may fail this test
- Are lenders holding=>75% willing to go for CDR? The balance sheet would usually indicate lender wise breakdown. If some lenders(especially foreign banks) have other exposure to CDS/equity/FCCBs, they may have conflicting interests which may delay CDR.
- RBI Guidelines affect the potential upside of the shareholders due to following norms
- Unit should be viable within 7yrs/10yrs(in case of infra) quite obvious else not worth it..
- Promoter’s sacrifice and additional funds brought by them should be minimum of 15% of the banks’ sacrifice(but what if the debt equity ratio is more..)
- Personal Guarantee is offered by the promoter except when the unit is affected by the external factors pertaining to the economy and industry(isn't this always the case!!)