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Saturday, March 28, 2009

Check the fineprints of companies

The equity market meltdown is giving sleepless nights not only to companies with fragile financials but also to companies with a strong balance sheet. This is because the market fall could adversely impact the balance sheets of cash-rich companies with huge investments in numerous quoted and unquoted companies and instruments and subsidiaries.Generally, investments include money put into various financial instruments such as shares, mutual funds, fixed deposits, bonds, debentures, and portfolio management services (PMS). They also include investments in subsidiaries. Of the total investments of Rs 29413.73 crore of Cairn India, over 98% is invested in its subsidiary Cairn India Holdings, UK. The Accounting Standard–13 (AS–13) governs investment made by companies.Apart from stock market meltdown, another aspect that could impact investments held by companies is the volatility of the debt market last year, with the benchmark yield on government securities touching record highs and lows, depending on the outlook for interest rates: yields fall if interest rates are slated to slide and vice versa. Thus, there is no reprieve for investors either from equities or debt.Companies have to show all investments at current market value (mark to market) and not at book value (at which these have been made). The value of their portfolio would, therefore, come down during a market meltdown. In its notes to accounts for the third quarter ended December 2008, rating agency Icra said: "During the period under review, current investments have been marked to market as on 31 December 2008 and a provision has been made to reflect the diminution (decrease) in the value of the investments." The rating services company has taken a hit of Rs 5.5 crore. This has been tagged as provision for diminution in value of investments. It net profit was Rs 7.7 crore in the quarter. Further details about investment on which it has booked this mark-to-market loss are not available in the notes to accounts.As per the annual report for the year ended March 2008 (FY 2008), Icra's investments grew by around 37% to Rs 120.2 crore compared with FY 2007. Of these total investments, around one-third is marked as mark to market, while the remaining two-third is tagged as current investments. Current investments mainly consist of mutual fund investment: balance and debt funds (income fund, fixed maturity plans and floating rate plans.Companies earn a good quantum of money from dividend income on their investments in other companies. With the worsening economic scenario and tough market conditions, companies would be conserving cash and announcing lower dividend. This would hit the ‘other income' of such companies. Hero Honda earned Rs 6.96 crore as other income in FY 2008 as against Rs 11.96 crore in FY 2007.Apart from reduction in treasury profit, companies that are facing a liquidity crunch and fire-fighting to raise money could be in a spot as they may have to offload their investments at a loss to raise funds. Companies with higher exposure to equity and other equity-linked financial instruments such as equity mutual funds would be badly hit by the market meltdown.As per AS–13, a company needs to provide diminution in value only for current investment. If the investment is marked as long-term investment in the books of account, there is no need to provide for mark-to-market losses. Long-term investment can be subject to mark to market if the decline in value of the investment is permanent in nature. Statutory auditors are known to qualify books of account on this count as companies do not provide or book mark-to-market losses through profit-and-loss account. Many companies float subsidiaries and refuse to write off their equity exposure though the subsidiary is deep in the red and has negative net worth. The management justifies its reluctance to write off by pointing out the investment is strategic, long term or viable in nature.

Following are the different ways companies categorise their investments to avoid marking them to market:

Strategic investment: The statutory auditors of Punjab Chemicals & Crop Protection have qualified the annual accounts for FY 2008 and quarterly results for the period ended December 2008 for not making provision for diminution other than temporary in the value of long-term investments amounting to Rs 1.8 crore. According to the board, the long-term investments are strategic investment and accordingly no provision is considered necessary. The company reported a net profit of Rs 2 crore in the quarter compared with a net profit Rs 7.5 crore in the December 2007 quarter.

Loss pertaining to investment in subsidiaries: Jet Airways has not made any provision for diminution in value of investments. Jet had equity and preference investment aggregating Rs 1645 crore in Jet Lite (India), a wholly-owned subsidiary and an amount of Rs 367.8 crore advanced on account of interest free loans end December 2008. Jet Lite, formerly Air Sahara, has accumulated losses exceeding its net worth. Jet Airways has plans to support the growth plans of Jet Lite, resulting in increase in revenue and, consequently, profitability and net worth.

"A reputed valuer has valued the equity interest in the subsidiary based on its assets and growth model, and disclosed the equity value of the company's investment far in excess of amount invested and dues to the company. The said subsidiary is confident of achieving the target and, in the opinion of the company, no provision is considered necessary at this stage in respect of its investment and loans outstanding", reads the note to account published along with the quarterly results.

Loss on investment as exceptional item: Mangalam Cement has booked loss on sale of investment in mutual funds amounting to Rs 26.99 lakh in the quarter ended December 2009 and Rs 2.43 crore in the nine months ended December 2008. Generally, profit or loss arising from investment is shown under, ‘other income'.

Similarly, Finolex Cables has put the diminution in the value of current investments in mutual funds amounting to Rs 10.17 crore as ‘exceptional item'. The company reported loss of Rs 47.4 crore in the quarter ended December 2008.

Booking of losses pertaining to subsidiaries: A handful of companies that are upfront about booking losses related to investment. JM Financial and its subsidiaries have made a consolidated provision of Rs 221.9 crore in the quarter ended December 2008. It reported a consolidated operating profit before interest of Rs 16.8 crore and loss of Rs 232.7 crore. On a standalone basis, it has provided Rs 3.1 crore towards diminution in value of long-term investments and its loss stood at Rs 2.5 crore. "In the context of the prevailing global financial crisis and its severe impact on the Indian capital markets including the stock markets, the company and its subsidiaries have decided to provide for the diminution in the value of individuals shares in listed companies in the long term investment portfolio where the market value is lower than the cost," J M Financial said in the notes to account.

Similarly, Shoppers' Stop had investments in and given loans and advances to Gateway Multichannel Retail (India) (Gateway), a subsidiary company, amounting to Rs 24.86 crore end December 2008. As it is presently assessing the viability of Gateway continuing to operate in the foreseeable future, the company has made provision for impairment, which is disclosed as an ‘exceptional item'.

Finolex Cables:-booked a loss of Rs 10.1 crore (diminution in the value of current investments in mutual funds) in the quarter ended December 2008. The loss has been shown under ‘exceptional item'.Unfortunately this is limited to a few companies. The ground reality is stocks that are down by 80% to 90% from their peak need to appreciate 5 to 10 times peaks.Here are some companies that have not provided for mark to market value of their investments and their reasoning:

Tide Water Oil Co. (India): Not provided for diminution in value of investment of Rs 60 lakh in the quarter ended December 2007. The company said the diminution is not permanent in nature and, thus, no provision has been made in the books of accounts.As per the notes to accounts for the quarter ended December 2008, "recoverability of the advances of Rs 3.4 crore paid to Yule Agro Industries towards proposed issue of shares and the corresponding provision, as may be required, is not ascertainable at this stage in view of the present status of activities of Yule Agro Industries". Tide Water Oil posted a net profit of Rs 5.2 crore in the quarter ended December 2008.

Bhartiya International:-The auditors have commented on the non-provision for diminution in investment of subsidiary companies. The company has offered following comments to the auditors' observation: "As per the practice followed in past, the company has not provided for diminution in unquoted investments in subsidiary companies as, in the opinion of the board, the investments are long-term strategic investments and such diminution in their value is temporary in nature". Its total investments stood at Rs 62.4 crore and its net worth Rs 100.1 crore end March 2008.

Trigyn Technologies:-Not provided for further provision on its investments in its three subsidiaries over and above the current carrying value of Rs 47.9 crore despite erosion in the net worth of two of these subsidiaries.Extract from the notes to accounts for the quarter ended December 2008: "The board of directors at the current juncture believe that the respective investments in these subsidiaries have been adequately provided for and based on further internal and/or independent valuation to be carried out at a later date would accordingly decide on suitable course of action". The company reported a net profit of Rs 2.8 crore in the quarter ended December 2008.

PVP Ventures (formerly SSI): In its limited review of the results for the quarter December 2008, the auditors have referred to the exposure to its subsidiaries. As per the notes to the account, "the company has investments in equity shares of Rs 1 crore, redeemable fully convertible debentures of Rs 541 crore and it has further extended advances of Rs 229.1 crore to one of its wholly owned subsidiaries. The above funds in the subsidiary are primarily represented by 15.78% investment in the equity holding of the company as a result of the scheme of amalgamation of PVP Ventutes Pvt Ltd with the company. Further advances of Rs. 176.4 crore have been extended by the company to certain subsidiaries and other bodies corporate for acquisition of real estate assets and other Investments".The notes to account further mention: "The adjustments, if any, to the carrying value of the investments and advances mentioned and their impact on the profit and loss account is presently not ascertainable, pending necessary assessment by the management in view of the current downturn."

DIL:-Has invested an aggregate of Rs 1.8 crore in VasKo Glider s.r.o. Czechoslovakia, a joint venture, in the form of basic capital of Rs 1.9 lakh and voluntary capital of Rs 1.8 crore. The joint venture is involved in the manufacture of wheel-chairs based on discoidal electrical motor, the patent for which has recently been registered by the US and Indian patent authorities. DIL believes the investment has long-term potential on commercialisation. The auditors are unable to express their opinion on the carrying value of this investment including Rs 1.2 crore of goodwill reflected in the consolidated financial statement. The company reported a net profit of Rs 1.2 crore in the quarter ended December 2008.

Television Eighteen India:-Has long-term investments in quoted equity shares aggregating Rs 48.5 crore. The value of these quoted investments end December 2008 stood at Rs 16.8 crore — an erosion of 65.3%. The company has termed them as continued long-term strategic involvement and, thus, the management is of the view that no provision is considered necessary for diminution in the value of these investments. The company's net profit stood at Rs 9.4 crore in the quarter ended December 2008.

Aplab:-The auditors have commented about the non-viability of the investments in and advances to subsidiary. However, the company says "with the measures taken by the management and expected breakeven in coming years, these investments and advances are considered good and fully recoverable". No further information is available on these investments such as quantum in the notes to accounts published along with the company's quarterly results for the period ended December 2008.

IBN18 Broadcast:-IBN Lokmat News, a 50:50 joint venture company of IBN18 Broadcast and Lokmat Newspaper, incurred a loss of Rs 7.1 crore and Rs 22.4 crore in the quarter and nine months ended December 2008, respectively. The company's share of loss based on its holding is Rs 3.5 crore in the quarter and Rs 11.2 crore in the nine months ended December 2008.IBN Lokmat News had commenced operations from 6 April 2008. As per the company, due to the long-term investments and strategic involvement, no provision is considered necessary for diminution in the value of investments.

Vaibhav Gems:-The impact of the current restructuring and rationalising operations including closure of operations of some of its subsidiaries across the business of the company on the financials will be known in due course of time. However, a provision of Rs 86 crore (including Rs 22.5 crore due from German subsidiary Der Schmukkanal Deutschland GmbH, which is under liquidation) has been made in the December 2008 quarter as an ‘extraordinary item' as against exposure of the company to subsidiaries. Moreover, the company could make further provision, if required, at the year end.

Conclusion:-An in-depth analysis of companies' investments by scanning through the annual reports is very much necessary to understand the exact nature of exposure such as current and long-term investments, exposure to subsidiaries and the financial health of subsidiaries.

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