CHOICES BEFORE TATAS: RAISE DEBT BY PLEDGING TCS SHARES OR DILUTE STAKE
There are several options before the Tata group to raise funds to buy out the Mistry family’s 18.37-per cent stake in its holding company, Tata Sons. These include buying back the Mistrys’ stake by raising debt through pledging Tata Group shares or selling part of Tata Consultancy Services’ (TCS’) stake. While the final valuation is yet to be negotiated, bankers said the
Tatas could raise $20 billion by selling a 5-8 per cent stake in TCS, selling some group businesses like Tata Capital and insurance venture stakes and/or ask sovereign wealth funds to buy out the Mistrys’ stake with a buyback option to the Tatas after five years.
There are several options before Tata Group to raise funds to buy out Mistry family’s 18.37-per cent stake in its holding company, Tata Sons. These include buying back Mistrys’ stake by raising debt through pledging Tata Group shares or selling part of Tata Consultancy Services’ (TCS’) stake.
While the final valuation is yet to be negotiated, bankers said the Tatas can raise $20 billion by selling 5-8 per cent stake in TCS, selling some group businesses like Tata Capital and insurance venture stakes and/or ask sovereign wealth funds to buy out Mistrys’ stake with a buyback option to the Tatas after five years.
The Mistrys have valued its stake at ~1.78 trillion, but the Tatas have not given any indication on the price they will buy the stake from the family. A Tata official said they will respond in the Supreme Court when the hearing on the case begins by end-october.
A banker said the Tatas can buy Mistrys’ stake-spread over the next few years since the amount is quite significant. “The options before Tatas are to invite sovereign funds to buy Mistrys’ stake and then buy back later from them or raise debt by pledging stake in various Tata-listed companies,” he said.
Whichever option the Tatas choose, the buyback is likely to further strain Tata Group’s already stretched balance sheet. The group’s listed firms had a combined gross debt of ~3.27 trillion at the end of March this year — up 17.3 per cent year-on-year (YOY). This translated into a gross debt-to-equity ratio of 1.1x. The group’s leverage ratio in 2019-20 was the highest in five years. Besides, Tata Sons had a total borrowing of ~22,000 crore at the end of March this year — up 30 per cent on a YOY basis.
The group’s indebtedness and leverage ratio is also up on a net basis. Adjusted for cash and cash equivalents on group firms’ books, net debt was up 25 per cent YOY to ~2.19 trillion at the end of March, while the net debt-to-equity ratio increased 0.75x — the highest in five years.
The Tatas’ financial position is much worse if TCS’ numbers are excluded. Excluding TCS, the group’s gross debt-to- equity ratio jumped 1.53x at the end of March this year, against 1.45x a year ago and 1.16x at the end of March 2018. In the same period, the net debt-to-equity (excluding TCS) jumped from 0.76x in 2017-18 to 1.19x at the end of March this year.
In the past, Tata Sons had pledged shares of listed entities such as TCS to raise debt for funding to provide equity support to the group’s operating companies. However, the amount needed now is enormous and will require a larger volume of pledge than earlier.
“The amount needed to buy out Shapoorji Pallonji (SP) Group stake is significantly large and one that will need external (non-group) financiers. In doing so, the group will get saddled with more debt, thus, increasing its vulnerability,” says Amit Tandon, founder and managing director, Institutional Investors Advisory Services (IIAS).
A debt-finance buyout of SP Group’s 18.37per cent stake in Tata Sons will push the grouplevel debt by around 50 per cent, without contributing anything to the group’s revenue and profits. This could make servicing debt tough.
The other option before Tatas is to dilute their stake in TCS, from the current 72 per cent. According to a calculation by IIAS, Tata Sons will need to sell around 16 per cent of TCS, at the current market valuations, bringing down its shareholding to 56 per cent.
This will mean that Tata Group will continue to control TCS, but its cash flows from the company will be lower than before. For nearly a decade now, TCS has accounted for nearly 90 per cent of Tata Sons’ earnings, allowing it to infuse equity and provide liquidity support to companies such as Tata Motors, Tata Steel, Tata Power, Indian Hotels and the group’s unlisted ventures in telecom, retail, aviation, and construction and housing.
According to IIAS, the sale of TCS shares will restrict the Tatas’ financial flexibility and weaken its ability to hold the group together.
Analysts also say a reduction in Tata Sons’ cash flow from TCS could have implications on the credit rating of Tata Sons and group firms, which could raise funding cost for the group.
The dilution in Tata Sons’ stake and corresponding rise in free-float shares will also weigh on the TCS stock and valuations ratios such as the P/E multiple, pulling down the overall valuation of the group. TCS accounts for nearly 75 per cent of the m-cap of group companies.
This is already playing out on the bourses. TCS’ share price was down 2.2 per cent on Wednesday, even as industry peers Infosys and Wipro ended the day in the green. Tata Steel and Tata Motors also ended the day in the red.
On Wednesday, Tata Sons bought ~63.6 crore and ~22.5 crore worth of Tata Chemicals shares and Tata Motors DVR in a bulk deal in the secondary market.
In contrast, the stake buyback will be a financial windfall for SP Group, already struggling with high debt and cash flow issues for some time now. The proceeds will make the group debt-free on a net basis ad provide requisite firepower to grow faster.
There was sharp jump in share prices of SP Group firms on Wednesday. While S&W Solar hit the 20-per cent upper circuit on Wednesday, Forbes Company hit 5-per cent upper circuit. Gokak Textiles was up 1 per cent.