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Leverage as a financial perversion b.v.raghunandan

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Leverage as a financial perversion b.v.raghunandan

  1. 1. Leverage as a Financial Perversion -with a reference to Bhushan Steel -B.V.Raghunandan Department of Commerce, St.Aloysius College, Mangalore September 18, 2014
  2. 2. Leverage • Leverage: Having debt in the capital structure of a company • In 1950s and 60s, it was considered to be a magical act through comparison of leveraged company and a non-leveraged company • Effect was considered for profitable companies and non-profitable companies were ignored
  3. 3. Rationale for Acceptance • High corporate taxes caused reduced tax incidence as interest on debt was a business expense • Promoters’ Control was not diluted as debt did not carry voting rights • Equity form of finance like venture capital emerged later • The concept of risk management also emerged later
  4. 4. Reality Check • During a long gestation period of heavy industries and infrastructure projects, it becomes toxic • For the industry having a huge capital cost and huge running expenses like civil aviation, it is devastating • When unexpected risks exist, the tables will turn very quickly • Prolonged trade cycles like mining and metal industries
  5. 5. Warning • Sharia held debt to be a sin • Shakespeare maintained, "never a lender nor a borrower be” and also depicted the cruelest aspect through the character of Shylock in Merchant of Venice • Financial Management considered both equity and debt to be the components of capital structure • Never considered the repayment programme, cautions, warning signals etc as an important exercise
  6. 6. A Carefree World • Corporates did not learn the lesson leading to the development of art and science of bankruptcy • Individuals and families were encouraged to overborrow like housing finance, consumer finance, finance for hospital bills, student loans • Questionable methods employed for recovery including foreclosure • Credit card booms • Empty houses and homeless population
  7. 7. Revival of Equity Culture • A more mature and developed primary market and stock market • Reduced corporate tax rates • Emergence of venture capital and private equity fund • Contribution of HNI and Angel Investors • A Systematic Risk Management and Popularity of debt-free capital structure • Basel Norms for Banks
  8. 8. Rationale for Equity Shares • No need to pay dividend in the absence of profit • Even in the presence of profit, a growth oriented company does not declare dividend • No need to pay dividend during gestation period • Large body of investors to share the losses • Equity shares are the cheapest source of finance • Shareholder Loyalty for other projects and group companies • Huge funds can be raised through IPOs and FPOs • Share Premium as another cheap source of finance • Listed companies having access to cheaper foreign funds
  9. 9. The Fallen Empire-DLF Limited • 1946-Chaudhry Ragvendra Singh promoted • Developer of residential and other complexes in Delhi until 1957 • 1957-Delhi Development Authority banned private developers • It went out to Gurgaon in Haryana to develop a city
  10. 10. IPO Details of DLF Ltd. • 2007-IPO made • 17.5 crore shares of Rs.2 through book-building • Cut-off Price Rs.525 • Face Value of Shares: Rs.35 crore • Share Premium: Rs.9,152.5 crore • Share Price went upto Rs.1000 in 2008
  11. 11. Falling Down from Grace • Forays into Capital Intensive expansion • Hospitality Industry • Wind and other power business • Extensive Borrowings • Debt: Rs.19000 crores • Questionable Trade Practices
  12. 12. Correlation between Interest and Profit of DLF Ltd.(Figures in Rs.Crore) Year Sales Interest Profit 2007-08 14433 310 7,847 2008-09 10,035 555 4,497 2009-10 7,423 1,110 1,709 2010-11 9,560 1,706 1,638 2011-12 9,629 2,246 1,169 2012-13 7,773 2,314 663 2013-14 8,298 2,463 582
  13. 13. Alternative • FPO at the cut-off price of IPO could have brought in a huge amount of cost-free funds • It would have saved the interest • More meaningful diversification • Taking care of quality of building in Gurgaon and maintaining the customer relation
  14. 14. THANK YOU

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