How Patanjali Ayurved created wealth out of thin air in Ruchi Soya

In the history of the Indian stock market, market cap has not risen as rapidly as it has happened at Ruchi Soya, a company that emerged out of bankruptcy a few months ago after Patanjali Ayurved acquired it.

Yes, there is a world of difference in the way the market values a company when it is teetering on the brink of bankruptcy versus when it gets past the hump and emerges with new ownership. But the way this ‘value creation’ has unfolded in Ruchi Soya is shrouded in mystery.

Consider this. Ruchi Soya was suspended from trading on November 14, 2019 and then re-listed on January 27, 2020 after the company restructured itself according to the resolution plan effected on December 19, 2019 wherein 99% of the company’s equity was extinguished. Ruchi Soya’s equity capital was slashed from ₹660 million to ₹6.6 million (face value ₹2), and after amalgamation with the special purpose vehicle created for executing the bid by Patanjali Ayurved, the new paid-up caspital of the company stood at ₹591.6 million.

Here is the twist. On January 17, 2020 exactly a month after the scheme of amalgamation was effected, the company did a preferential allotment of 18.67 million shares at ₹7 (face value ₹2, premium ₹5) that pegged the value of the company at ₹13 billion (₹7 multiplied by 314.4 million shares, the total outstanding equity shares post preferential allotment). The pricing basis for the allotment was the preceding 26-week average traded price from the relevant date.

That’s bizarre, and beats logic any which way you see it – there is a discontinuity in the stock caused by the restructuring, the stock was suspended from trading for two months (the preferential issue was announced during the period when the stock remained suspended) and more importantly, in terms of financial solidity, the old company is not comparable with the new company.

For argument sake, even if we were to consider the historic traded price of the stock as a representation of fair value, then the historic price must be multiplied by 100 to account for the fact that 99% of the equity stood extinguished. That implied market cap of ₹2.13 billion would thus have been ₹213 billion.

But clearly, the allotment is done by the new management and therefore must take into account the new reality in terms of ownership, asset value and future potential. The best reference is the fair value of the company as estimated by the bankers for financing the transaction, which was ₹41.6 billion or simply the bid value (₹43.5 billion) of the new buyer, which is really the private market value of the company.

The question now is – should anyone care at all about the preferential allotment to Ashav Advisory LLP? Did anyone get shortchanged? Normally, when you give away shares at lower price through preferential allotment, it’s the public shareholders who bear the brunt of dilution. Here, courtesy the parabolic rise post re-listing, public shareholders might not have much to complain about, despite the 99% dilution.

The cost of dilution in this case is borne by the new owner, i.e. Patanjali Ayurved. Clearly, the preferential allotment has not been done to hurt them but a favour as inferenced by Outlook Business. Considering that almost the entire promoter holding is pledged to lenders who have financed the deal, they are the only other affected party.

But then, bankers have hardly covered themselves in glory going by how the deal has been financed. The ₹43.5 billion deal has been almost entirely financed by exactly the same banks that took a 50% haircut on existing loans. Not just that, even the equity portion that the bidder was to bring in, has been financed by the banks.

Our story How Far Did Baba Ramdev Stretch To Bag Ruchi Soya? brings to fore how a financially unstable bidder got on board indulgent bankers to acquire a company, committing almost nothing of his own capital.

While leveraged buyouts, where you raise capital based on the future cash flows of the target company, are not uncommon, the prime call lenders have to take is on the ability of the new management to turnaround the business. With Patanjali itself dealing with dwindling market share, a severe cash crunch with burgeoning receivables, and rising debt, the question is what gave bankers the confidence to place faith in Patanjali.

Even if it is only a matter of conjecture at this point, the real danger could be new financing based on the unreal collateral value created on the bourse. At the prevailing price, Ruchi Soya’s market cap stands at ₹225 billion, which creates additional headroom of ₹80 billion (minus existing debt) at loan to value ratio of 50%. There is no ‘selling pressure’ because there is hardly any float in the market; even the shares allotted through preferential allotment will be released from lock-in after a year.

It’s routine for capital market regulator Sebi to send a notice calling for the company’s explanation when the stock price starts venturing into the stratosphere. When replying to such a notice, it is also standard procedure for company managements to feign ignorance about price action. But in the case of Ruchi Soya, everyone seems to be cozily comfortable with what has transpired so far.