Why you need to stop buying bankrupt companies [Podcast EP48]Why you need to stop buying bankrupt companies [Podcast EP48]

[podcast]

 

What happens when a company goes bankrupt? Why do investors buy such stocks that are headed to zero? In this episode, we explore how the Insolvency and Bankruptcy Code (IBC) has changed the game.

Deepak explains the many nuances of current regulations and how they've evolved. We dive into examples such as Bhushan Steel, Sintex, and Ruchi Soya - which we hope will give you clarity. Listen in and decide. Would you stay the hell away from such stocks, or start hunting for bargains?

Understanding Bankruptcy

Businesses are tough and the best ones survive. There are ample failure points for a business that can drive it to bankruptcy. One or a combination of factors such as economical, social, regulatory, political, geographical, etc can drive a business suddenly to the ground or induce a slow death. Such companies eventually stare at bankruptcy. We discuss -

1. What is bankruptcy?
2. Does everyone lose money when companies go bankrupt?
3. Who gets what when the company is sold for parts?

Learnings from the Sintex saga

Sintex Industries, the Ahmedabad-based company, that boasts of tanks covering the skyline of most cities of India, was dragged to bankruptcy courts after it defaulted on a meager payment of ~15.4 crores towards principal and interest on its NCDs. This was the final nail in the coffin for the firm that had mismanaged its finances for too long. We discuss -

1. What Sintex does as a business
2. How the company was re-structured (through demerger)
3. How its issues snowballed to lead the company into IBC

Eventually, the IBC ( Insolvency and Bankruptcy Code) tribunal was able to keep the company running and also got a successful bidder to buy out the stressed company. That’s good news for almost all of its stakeholders. Except for its shareholders who will lose all of their equity in the company. So they get nothing. Zero.

So How does IBC work? Why do existing shareholders lose everything?

The short answer: Because existing shareholders contribute nothing to the upcoming growth of the company, they get nothing. The company that these existing shareholders bought into eventually went bankrupt. So the story for existing shareholders ends here with a big zero in their hands. Sounds unfair but that’s how it is. We discuss -

1. How does the IBC process work?
2. Every existing stakeholder (debtors, employees, vendors) gets some part of the new entity. The current shareholders should also get a piece no? \\
3. What actually happened to Sintex shares?
4. How did things use to happen before the IBC?

There are a lot of examples discussed in this section that explain different aspects of the bankruptcy process and also highlight how each bankruptcy case is different.

But, existing shares of Ruchi Soya went up "to the moon" while it was going through bankruptcy

All bankruptcies are different and unique. Ruchi Soya was trending on social media recently because the company came back strongly from bankruptcy and its investor (Patanjali) seems to have made a killing on its investment. There’s lots more to the whole revival story. Deepak explains -

1. How regulatory rules change impacted the Ruchi Soya bankruptcy process
2. The bidding by Adani and Patanjali
3. Interestingly. they kept 1% of the company listed. Why?
4. How does Patanjali make Ruchi Soya operating cash flow positive?
5. The positive impact of Covid
6. Why is a company that makes only 800 Crores has a market cap of 31000 crores?

Does investing in distressed companies work?

We all love investing at its theoretical best - buy extremely low and sell high. We also keep repeating Buffett's quotes like “Buy when there is blood on the street”. Distressed companies feel like a value buy all time but they are almost always value traps or falling knives or whatever. We briefly touch upon this before we wind up the podcast -

1. A quick reference to Buffett’s investing in the Salomon brothers
2. Brookfield & Hotel Leela deal - distress investing

Let us know if you enjoyed our podcasts on Twitter or write to us at premium [at] capitalmind [dot] in!

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Full Transcript

Shray Chandra: Hi everyone and welcome to Episode 48 of the Capitalmind podcast. In today's episode, Deepak looks at the phenomenon of people buying worthless stocks, names that are clearly going to zero but would still manage to get investor interest anyway. We talk about when a company is bankrupt and whether bankrupt companies always go to zero. Deepak brings in his learnings from the Sintex episode. We then bring up the IBC or the Insolvency and Bankruptcy Code and how it's changed the game. We contrast this with what used to happen before. We then bring up why Ruchi Soya isn't quite the counterexample you might think it is. And then finally we end with some learnings and observations around what could be generally called distressed or distressed company investing. So listen in and decide whether you want to stay the hell away from this or start bottom fishing soon. Deepak, on the weekend you had this bizarre Twitter exchange and even bizarre by Twitter standards, where you continued to warn people about how it's now official and that this company, Syntex, you shouldn't buy their shares because they're worthless and it's going to go to zero. And you were apparently actually warned about this a couple of months ago.

Shray Chandra: And now this was your moment of, look, folks, I told you, but now don't make this mistake. But then come Monday, Nithin Kamath of Zerodha. He said that despite them showing a nudge on their kite platform where they're like, just, are you sure you want to be buying this or something like that? Even then, people were out there buying it. And I think you told me that something like 50 lakh shares still got traded on the lower circuit. Now, people, you know, investing I know it may not work out, but it's supposed to be pretty simple in theory, right? You buy something and then hopefully you sell it for more later. Here, the whole world is telling you that it's clear as day this is going to zero and people are still buying it. So what's going on? Why do people look at you saying this and say, you know what, all that is fine, but I'm going to take my chances. So my first question, look, how do you find this so-called worthless company? And is a company like this, which is apparently going through bankruptcy, is a bankrupt company really worthless?

Deepak Shenoy: That's a brilliant question Shray. In fact, there isn't an easy answer but let me start with the conceptual understanding of what bankruptcy is? A company is only bankrupt if it has debt. That means it owes people money and it can't pay them back. Whether it can't pay the interest back or the principal back is not relevant. It just can't pay them back. In technical terms, it means the debt can't be serviced. So what happens now is that let us say if you're a person who has lent money to another person, that person can't take it to pay you back, what do you do? You have to either go to that person and say, listen, what's happening? Why can't you pay me back? At some level you might say, that guy might say, listen, I'm out of a job, I need some time to find another job. So you give him some time, you give him what is called a restructuring and thought process like that, where you say, instead of paying me back now you pay me back six months later, I'm still okay with it. Six months later, he still hasn't found a job and you're like, okay, dude, I can't wait for my money anymore. And you told me you can get the money. Now, what do you do after this is you sit down with this person and you say, Well, you know what? You owe me a 100 rupees.

Deepak Shenoy: You can't pay me back even that interest on this 100 rupees. So at some point maybe what I can do is take whatever assets you have, your TV or whatever it is and sell it. And then the 100 rupees can be kind of you know, distributed among the lenders and we'll say, okay, whatever we've got, we've got, the rest of it is gone. It's okay. You know, you should think of companies as debt. So there's a company, there's a bit of a bunch of bankers who lend them money or NBFCs who lend them money. And they're having these discussions with these companies all the time. A worthless company or a bankrupt company, simply one that has reached a point where the debt holders are saying, listen, you're in trouble, we need to figure a way out of this. You can't continue to operate the way you are, so we need to make some changes. The interesting point about this is the order of claim. So when you're saying this, the company is in trouble, what does the company owe money to? So it earns a rupee, where does that rupee go to first now? It has to first go back to service what are called the senior secured shareholder. So if I take debt and say, listen, whatever the [00:05:00] company earns or owns is liened to you, it's pledged to you.

Deepak Shenoy: So you're secured with whatever the company's assets are. So you are senior secured debt holders, you are effectively the highest. Of course, there may be someone higher than you, which may be a court-ordered thing or a tax payment, which may be even more senior to this. So you look at the seniority of $ that claim. So when money comes, the company has to start paying from the top, all the way down. The top is perhaps the government income tax payments or whatever it is. The next layer will be the senior secured debt. Then there is unsecured debt. As an individual, you take credit card debt, it is unsecured, you take a home loan that is secured. So if you can't pay back the home loan, they can take your house and sell it. If you can't pay back a credit card loan, they first ask you to find the money. And only in the craziest of circumstances can they ask you if you have a house and then you know try to take possession and all that stuff. So the unsecured comes a little bit lower in terms of the hierarchy of claims, the next set of claims are preference shareholders and equity shareholders. So you think of them as $ the bottom, scraping the absolute bottom of the pool is the shareholder. So when we think of risk, the risk is like this, if you're a shareholder you $ take the highest amount of risk because you get paid last.

Deepak Shenoy: After all the money else is used to pay everybody else above you, you get paid with whatever's left. If the company cannot pay you somewhere, someone in the higher above you, you get nothing technically. So a bankrupt company should be worthless to shareholders if it cannot pay back anybody above the hierarchy. And there are some odd cases where they can be worth something. So for instance, there was a company called Essar Steel, and when it went bankrupt, people came in and they started bidding for this company. Now for some strange reason, the cycle of steel started to change to the point where when people bid for when Arcelor bid for it he gave in the end of value that was higher than all the debt holders of the company had claimed on. That means they said this, you want a 100 rupees, somebody bid a 110 rupees so they could get paid a 100 and there will be 10 more rupees left over. The shareholders would have gotten that. So it's very rare that that happens where a bankrupt company can be worth something to shareholders, but it's definitely worthless if it's not covering whatever debt can be covered. In India, things haven't really worked this way and I'll come to that later. But let's still take the example of what we just talked about, Sintex.

Shray Chandra: Yes. So what happened with them, if you could get into some specifics and this is not the company that makes the overhead tanks?

Deepak Shenoy: No. So Sintex is an interesting story and you know, at one time we had an investment in it as well. It used to make both the overhead tanks, the Sintex tanks and also a bunch of auto parts, they acquired a bunch of companies doing that, but also originally the tex part of it is about textiles. So they were a textile company, so they demerged the textile unit and that's called Sintex industries and there is Sintex, the one that makes the tanks and all of the stuff was called Sintex plastics. It just moved into different subsidiaries, a different company. They were demerged. That company is also in trouble and we won't go into detail about that right now. But essence of all the trouble was they took a bunch of debt, not just from local sources, but also from foreign investors and that debt was not sustainable. And what happened and we won't go $ into specifics, but essentially Sintex couldn't pay its debt. Now, it's not like Sintex is a bad company. It's just that I mean, it has actual assets, it actually has spindles and all of this stuff. It's built a new factory, which is relatively more state of the art compared to the rest of the things it's in Gujarat. Unfortunately, even if that capacity was fully utilized, it would still not be able to generate enough capital in terms of amount of cash flow to be able to repay the debt.

Deepak Shenoy: As it stands today, of course, they may need more debt to operate it. So that's a different topic. But there's good news and there's bad news. This company can't pay its debt. The lenders have said, listen, you know what? They've even taken over all the shares that the promoters had and attempted to sell them as well. There is no way that this company can't pay and the promoters now own like 1 or 2% of the company. It's just a scattered shareholding among the rest. What happens now is that there is a process that happens. The good news in the end part of this process is this process come to a conclusion in the sense that after everything a company called Reliance, The Reliance Industries with another company called ACRE, which is [00:10:00] a asset reconstruction kind of company, have together bid for this company. They're paying some 4, 5, 4, 4000 something crore or some number like that, and then they are going to take over the company. Sounds great, Sintex shares are listed, people should be happy. Bad news, they should not be happy because as part of this resolution process, the share is going to zero. But let me explain before that what happens in the bankruptcy process. There is a, you know Insolvency and Bankruptcy Act. And this act, if you looked at the numbers at how the system works, once you get into this bankruptcy situation and the bankers, the lenders, they could be bankers, they could be bondholders, they could be whoever.

Deepak Shenoy: They all come together. And they call themselves the Committee of Creditors. Now, they say dude this company is bankrupt, what do we do? And then everybody drinks a swig of coffee and says, let's you know take this company to the, through the IBC process. Now, IBC process is new, so we have to explain it. But the IBC process is like this, the current promoters can no longer run the company so we will appoint a person called a resolution professional. He effectively becomes the new CEO, $ slash, Chairman, $ slash, whatever of the company. He's now responsible for the company's future. His idea is this, keep the company's lights on. Make sure that the company can continue to operate in the meaningful but minimal way. That means I'm not going to new CapEx. I'm going to try and service whatever current orders I have. I am not going to push marketing to try and get more orders. I'm not, I'm just going to try and run the company as lean a fashion as possible without burning cash. Because I don't have cash and I can't borrow any more cash because there's a this is an IBC process. If I receive any money, I'm not going to use that money to pay back any lenders. I'm just going to keep it in the company until the resolution process is complete. More importantly, I am also going to remove, I'm also going to ask all the lenders, guys, if you think this company owes you money

Deepak Shenoy: Everybody, please tell me exactly how much you think this company owes you. You may, so the idea is that, you know, I could accept as a resolution professional, I could accept or reject those claims. Now, why would I accept or reject them? So, for instance, if you said, you know what, these Sintex guys said they were going to give me a 100,000 I don't know, 100,000 Kgs of yarn, and they didn't. So I was inconvenienced so maybe the company owes me 1000 crores and you look at them and say, dude, that was not in the part of the agreement. I'm not going to give it to you. I'm not going to accept this $ claim. Now other fellow says, no, I actually sent you all these spindles and you didn't pay me for it. And you know what? You're right. You've got a bunch of invoices, everything to back up your claim, so you're accepted. So people claim and in general in India, it's like, you know, it's the opposite of bargaining, right? So if you go somewhere and you look at a sofa and he says 5000, you will say 4500. Here he says how much do you, does the company owe you? You say 10,000? And then the RP comes back and says, wait, wait, you can only produce documentation for 8000? Yeah, yeah of course it's 8000. So you claim as much as you want, which is how the banking system works, the ulta of the bargaining process. And then the R.P.

Deepak Shenoy: kind of resolution professional kind of take this forward. Now what happens here is, the committee of creditors gets together and says, listen, we've got to figure out what this company is worth so that we can try and figure out how much we can recover from it. Now, it's possible that the promoters in certain companies may have overstretched themselves. For instance, you thought you'll make a 1000 crores by putting in a new plant, so you borrowed $5,000 in the new plant, but then the plant can only sustain 500 crores. Now for 500 crores, if you take a 15% interest rate, I can service a 1000 crores of revenue, but I can't service a 500 crores of revenue. So obviously you've screwed up. Now this could be a natural failure because the market fell somebody started making yarn by the I don't know by the ton in Kazakhstan and because of that the world yarn prices fell and you had nothing to do. So this is like it could be a natural business calamity or it could be fraud by the promoters where the promoters said, I built a 1000 crore plant but actually built a 500 crore plant and pocketed the 500 crore for themselves. It's possible. Now, we don't know what that is, and right now we're going to argue about that because we don't, that's a investigative thing right? So the question is, the company can't sustain 5000 crores of debt. It can only sustain 3000 crores of debt. So somebody who has lent the 5000 crores

Deepak Shenoy: among all of the people who have, they have to take a haircut on it. So the first thing that the committee of creditors might want to do is first, of course, establish their claims. And second, they might want to say, listen, we've got so much you know let's see what this company is valued at. So they might go and appoint a valuer and in confidentiality, the valuer will come and [00:15:00] tell them, look, I think the fair value of the company is 4000 crores, but liquidation value, that means if you take all the stuff that they have, the spindles, the coffee cups, the tube lights, the bulb holders, everything in this company, and you sell each one piece by piece, you are going to get only 2400 crores. It makes sense because you are, A, you are dismembering a business and selling it part by part, which is obviously going to be less than a running business but the running business has a value in the sense at the bare minimum it can service this much. At the bare minimum cost can be this much. So the fair value is likely to be a little bit higher. Now they don't tell what this liquidation value is to anybody else, and then they invite bids for the company. And the idea of the concept of insolvency is you want to protect the company because otherwise the company could have borrowed, let us say, 100 crores against a house and 200 crores against some other smaller asset.

Deepak Shenoy: The 100 crores guy might actually take the house and sell it, in which case the 200 crore guy is saying, listen, how can you sell his asset? It was also pledged to me because I own, I have been pledged the overall assets of the company. So the idea of the insolvency process is to bring all the creditors on the same platform and whatever recovery happens, everybody gets a pro-rata kind of a thing saying if it's a 300 crore thing, there's one guy with 200, one guy with 100. But I can only recover, say, I don't know, 50 crores because it's too, there's nothing left in the company. Then that 50 crores divide gets divided two-thirds for the first guy, one-third for the second guy if it was able to recover 60. So what is this recovered concept? The idea being that you call for bids. people look at the company and whatever information they can get they take it and then they say, well, you know what, I'm willing to bid X amount for the company. Now, this bidding is like this, I want to revive the company. I want to keep it whole, which means I'm going to take this business as a whole from you then I'll do whatever the hell I want with it. I may merge with one of my companies, I might do something else and all of this stuff. So it is a resolution plan that I submit, and that resolution plan should help revive the business, but also offer the current set of creditors as much money as possible for them to take home in the sense that they can take it only if anything is left after that do

Deepak Shenoy: any other shareholders or any of the other creditors get anything on it. Now, think about it from a perspective of somebody buying it, listen, this company can't even sustain its current debt. That means it can't even pay enough interest or principal remaining to cover its current debt. So I'll obviously pay less for the company because if I want to run the same company and it had the same amount of debt, then I also wouldn't be able to run it. So I bring it down. So if I'm asking the debt holder that I can't pay you fully, anybody below that in the hierarchy is dead, essentially finished. So there are people like operational creditors, employees whose salaries haven't been paid. The resolution plan can say, listen, I understand the employees haven't been paid. And you know what? I want to revive the company so I can't tell the employees sorry, you can't, you've got to forget about the salaries, so I'll pay them a little bit. And the secured creditors may say, Listen, you can't pay them so much money and pay me little. So you have to make sure that you pay me enough and pay them also a little bit, but not so much that you know I am inconvenienced versus them.

Deepak Shenoy: So these operational creditors may get something. Shareholders usually end up with the lowest $ ownership, but they're no longer relevant in this whole thing. If I'm spending so much money to buy this company, why should I share those proceeds with you? You invested as a shareholder in a company that's now bankrupt, so you don't deserve any of the future of it. I deserve all of it because I'm the one that's rescuing. This is the thought process behind $ resolutions. That's why I think what's happened with Sintex is that in part of the resolution, Reliance-ACRE has come to them and said, listen, we are going to take over this company. We are going to do this, we are going to do this for the employees, we're going to do this for you know operational creditors, this for the secure creditors, this is the 4300 crores that goes here and so on. How I get the money is a different question, but I'm going to say that what is going to remain in this company as debt is probably going to be about 3000 crores. Now, the 3000 crore debt, I can choose to give it from my pocket. I will give the company 3000 crores and then you'll get paid effectively. Or I could say that you guys please continue to lend the company 3000 crores and I'll put in a extra amount of equity money, but you'll have to write off whatever is above 3000 that the company owes you.

Deepak Shenoy: So if the company owes you 7000, you would write off 4000 crores. What does write off mean? You will never get it back. It's a loss. So every lender takes that loss and says, Thank you for resolving this company, and let's move on. This process means the debt [00:20:00] holders take a haircut. Shares, on the other hand, shareholders might, Reliance may say, listen I'm asking their debt holders to take a haircut. Guess what? I'm also going to give them in this particular case he has given them 15% of this company. It's not listed anymore because what he said is all the current holders go to zero. I own 85% of the business, banks and all the other finance guys own 15% of the business and I give them 4300 crores. So effectively he's giving them 15% plus 4300 crores. He might have actually chosen, have chosen not to suggest that. And in fact, he said, I'll give you 5500 crores with no equity at all, or I could give you 4000 crores and 20% equity. So there are lots of permutation combinations that happened here, and it's usually a negotiable process. Everybody talks to each other and says what's happening? But existing shareholders who've participated in the company before it went bankrupt are being effectively told you guys are zero. I'm going to give new shares to the lenders. I'm going to take most of the remaining shareholding for myself. I don't need to share any of this with you.

Shray Chandra: So what happens to my shares if I own it right now?

Deepak Shenoy: So you think of it as there's a bunch of shares, that shares is a liability and in a company, in a concept of a company, it's like this, If I own shares of a company, I am entitled to a portion of its profits. The company has no reason to pay me back at all, but it does have to pay me a dividend or it is answerable to me. When it's bankrupt, someone else is taken over the shareholding completely. The company does not want to have to share with me any more of the profits. My shares become worthless because they can just take those shares and says I throw them out. They have become zero. You no longer own any piece of this company. This has happened before. So you can see the entire share of the capital of a company like DHFL or Lakshmi Vilas Bank, both of which went through their financial companies. DHFL was a non-banking finance company and LVB was an actual bank. In both the cases, there was a big haircut to the lenders of these company, of these banks. In LVB's case, maybe there wasn't so much of a haircut because DBS came and took it over. But both these cases, the resolution plan that was submitted in DHFL's case, there were multiple resolution plans. There were four, I think, competing resolution plans. In LVB, the DBS was selected by RBI. All of these cases, the shares were going to zero.

Deepak Shenoy: In fact, all the four resolution plans of DHFL and I had seen them at the time had a clause that said shares go to zero. There's a reason for this is because these companies were listed. LVB was also listed, yes, but so was DHFL. When you keep a company listed, it creates more obligations because now there are small shareholders and so many small small things can happen. You have to keep reporting all these things, I have to, if I add more capital, I have to go through SEBI guidelines on adding capital. The company may need it. I don't want to deal with all that stuff, so I just throw them away and the share capital can actually go to zero. And the shareholders that currently exist tomorrow, they don't exist. So they cannot no longer say, I want to vote on this, you're gone. You know, there's to be these cartoon where Tom would get this glass of milk. Jerry, who became this invisible Jerry would use an invisible straw and suck out all the milk. So you saw all the milk just vanish and he was left with an empty plate. That's precisely what's happening over here. It's not like somebody is stealing it from you. It's that company has already been stolen from you. You think you own something, but you don't. It's just gone. It's poof.

Shray Chandra: Well, okay, but from what I understand, this is different from what used to happen before, right? I mean, you've said the things have changed. So what used to happen earlier I mean, earlier people didn't go to zero. I mean, or not as often.

Deepak Shenoy: What happened earlier, there was no Insolvency and Bankruptcy Act, which meant that companies simply couldn't declare bankruptcy. Now, there's a fundamental difference here in the bankruptcy code. They ask for resolution applicants. They ask for people to submit a resolution plan. That somebody cannot be part of the current promoter group, which means that the current set of promoters loose the company to somebody else. It is a requirement in India, it's not a requirement in abroad and all of those things. So what used to happen in India was a very interesting concept. Companies used to take debt they used to go to banks after a while and say, listen, I can't pay it back. The banks just say, okay, you can't pay it back. What can I do? Of course, if you and I go to the bank and say we can't pay it back. $ There's some tax on us, right? But it's the concept of if you owe the bank a $100,000, it's your problem. If you owe $100 million, it's the bank's problem. So now the banks are like, Oh, shit, this guy's not going to pay back is my problem now, what [00:25:00] happens? So well, the guy says, listen, I don't know, I own some airplanes, give me more money. And the bank should be like, How can I give you more money? You just lost all you said you don't. Oh, if you don't give me more money, I can't pay you back.

Deepak Shenoy: Now, the banks $ would get this and saying, listen, if I don't, maybe I should give this guy more money. So they used to do this concept called evergreening. So you give the guy more money so that he can use that new money to pay back the old money and therefore think that is there. But your just debt is ballooning. This happened for a while and then people said, okay, well, this is not sustainable, right? Because this can keep happening. Well, what's next? Then the guy says, listen, you know what? I do need more money, but I can't sustain these higher amounts of debt. So why don't you do one thing? If you lend me 100 crores, let's say you lend me only 70 crores. So the bank would be like, excuse me, what happens to the 30 crores? Well, it's gone poof, like that. The way the shareholders go poof now, that time they used to make the debt go poof as well and now also it goes poof. But the point then was they would say nothing else changes. You don't take a, you take this 30 crore debt to make me whole. I will only repay you 70 crores. And guess what? Because of the kindness of my heart, the 20 crores that I have siphoned away from this company in the past, which you don't know about, but rather you pretend not to know about

Deepak Shenoy: I will put that back into the company as my equity. So what I own is 50% ownership now become 70% ownership. But you, I will, you are dead, you're finished. Now you're probably thinking wait, wait, wait. If I have to write down 30 crores, why can't I as a bank also own some of the equity? Because, you know, why should I write it down and why don't I convert it to equity? The problem was at that time RBI had a rule that said you can't own more than 10% of a company, which means that if they converted some of these loans to debt, they would end up owning 10% of this company. And there were lots of rules against it. And then, you know, voting rights and this and that and all sorts of other stuff that was there. So Banks said, listen, we can't own your company anyways, so you know what? Forget it. Don't give us any equity. If the share was listed, essentially, what did you buy? You got a company, it's gone to its bank, the bank has written down its debt without touching any of the shareholders, without diluting the shareholders. Maybe the promoters put in some more money of his own. The company has got an infusion of capital from the promoter, an infusion of capital by not having to pay back another 30 crores of debt or whatever it was.

Deepak Shenoy: So just this write down, they used to go through these debt recovery tribunals and all that stuff. It used to happen all the time and people misused it like nobody's business. So for instance, there were companies that would simply go and say, listen, I can't pay back the debt. What happens now? Oh I'll tell you what, forget about this debt. Let's subtract half of it. You take it as a loss and call it an NPA, and over five years you write it off. Now what happens then is then after about say six months, the guy comes back to you and says, I want a new loan, now you are looking wait, wait, wait. I just gave you a loan, you didn't pay it back. That was the past. Give me a new loan. Okay, I'll give you a new loan. And then it reaches a point again where you come back to me and say, I can't pay back all these loans. Can we cut this to half again? So I do it, and they used to do this all the time. That's why the banking system was so bad, because the banking system survives on capital in the sense that every time they write off a bad loan that affects their capital. So they lose the money, they lose the capital, and then the bank has to go raise fresh capital.

Deepak Shenoy: So banks also wanted to write down as little as possible. So when they did all these debt restructuring things, they did they called it restructuring. They said, oh, we will try to recover this later and all sorts of things, would almost never happen. So RBI starts setting a set of rules saying, listen, if you can't recover for two years, you have to write down 100% of it. If you can't write about it for one year, at least 40% of it has to be written off. So a bunch of rules around NPA started to come into place, in the 2010s, I mean, eights and tens, that's when most of these things happened and the IBC happened, of course, about six or seven years ago. Interestingly, of all of the stuff that used to happen earlier, the promoters use to take the maximum advantage because they continue to retain control of the company, only the bankers lost. Now, the promoter loses, the shareholders lose, the bankers lose, but they ensure that everybody else has lost as well, and the new person that comes in gets control of this company. You take an example of a company called, say, Windsor Machines. Now, Windsor Machines was this company that you know existed a really long time back and still exists. It's at one point in time it was in trouble. It went into this debt recovery $ trouble. It's a listed company. When people start to get news that, oh, this company is going to get resolved soon, the share price shot up to ₹100.

Deepak Shenoy: So people are like, Oh, great! And the promoter comes in, his [00:30:00] concept was, listen, this company is dead. You can liquidate it if you want. You'll get nothing. Instead, here's a deal. I'll put in 20 crore. That 20 crores will, I don't know if it was 15 or 20 or some number like that, but I will buy shares at ₹15 per share. Which makes sense because the company is worth nothing. He can buy shares at whatever price he wants and increase his ownership. He increases ownership and the banks wrote off part of the loan, but the share price tanked after that because obviously new shares are getting issued at 15. So people were really angry and I'm like, why are you angry? Because this share should have been worth zero, it was worth a 100. And who told you to take it to a 100? It's complete and utter nonsense that it should have gone to 100 in the first place. The problem with Windsor machines was that the shareholders decided that they needed to be compensated for the fact that the price went to a 100 and then fell back because the promoter didn't buy shares at a 100. Why would a promoter buy shares at a 100? It makes no sense. It should have been bankrupt and the bankruptcy could have been good for it, but they didn't exist at the time.

Deepak Shenoy: Take the newer companies, Bhushan Steel. Comes in, the bankruptcy court started off this way right. So you had this issue of what happens now? Nobody knows. So they said, okay, we'll resolve it. Let's put in a bunch of things. Tata Steel comes and places a bid, bunch of others come and place in their bids. The rule, SEBI rule, because Bhushan still is listed, it says the listed company cannot have more than 75% owned by a promoter. Tata Steel says, well, you know what? I'm putting all this money and I am not bloddy going to own only 75% of it. Are you crazy? And I have 50,000 crores, I am not. So well some bright person came and said, listen, let's do 75% in actual shares and then 20 odd percent in what are called you know, optionally convertible preference shares and compulsorily convertible debentures and all sorts of things. So they own 75% of the share capital, but they also own the right to own another 20%, which was convertible whenever they wanted, at a price of ₹2 per share. So the price was 20, 25 or something like that. They also told the current shareholders, listen I can't, there was no rule that, available at the time to write them off completely in the sense that, that rule evolved only after time. And that rule did not apply to SEBI listed companies. And since you, if a listed company if you wanted to take their share Capital to Zero

Deepak Shenoy: There were certain takeover regulations that said, oh, you can't do this by just doing something like this. You have to make an open offer to everybody else at whatever price you're buying the share. And then you have to go through a de-listing process and so on. All these rules were a pain in the neck, but TATA Steel still, because you had to live with the framework, it said ok I'm not de-listing the shares, I'm going to continue to own it, but I'm going to have this you know, 20% extra that's available to me on demand whenever I want it. And then they revived the company, but they told the current shareholders listen, you're not, you're going to get diluted out of $ this because I'm $ your current shareholders owned 5% of the company or let's say the current owners owned 50% of the company. But you created more shares. So if there were a 100 shares, 50 shares were owned by the public, 50 shares by the promoters. Let's assume you wrote of the promoter shares to zero. Tata Steel issued itself 1000 new shares. Your 50 shares are now 5% of a larger company. In fact, in Bhushan Steel, they were as low as 2 or 3% because the bankers got a bit of shares and a bunch of things. So in this entire process, there was learning that a lot of SEBI rules stymied the process.

Deepak Shenoy: SEBI also changed its rules, it said, listen, I understand you want to write down the company to zero and you know we don't allow you to because we have all these rules. So we'll take away all those rules. So write down a company to zero. Please feel free to delist the company also automatically. You don't have to pay the shareholders a single rupee. That's exactly how the bankruptcy process is supposed to be. Why should the shareholders participate in a recovery when they are not putting a single rupee of that recovery in the process and if they want, they should go bid as a group for as large individuals. But you don't get to dictate that the new promoter who's coming in should definitely take care of $ shares. What happened in Bhushan was also interesting. He was trying to do the same stunt. The Bhushan Steel promoter was trying to do the same stunt of going to banks and say, I need to roll over these loans. Tell me what it's going to take to, therefore, you know not pay you back and can you take a haircut and all that stuff. RBI stepped in and said, no, you can't do these restructurings or whatever the stuff you should do earlier. Let's take them to IBC. It's a new thing, I know, but let's do it. They created a list of ten or 15 companies. Bhushan was one, Monnet Ispat was another.

Deepak Shenoy: There was a bunch of these companies. The early set of companies, the shareholders didn't go to zero because of [00:35:00] the SEBI laws, but they went close to zero. So if you had so for instance, one of the companies, if you had I think 10 or 15 shares, you got one share instead. So that means they converted 15 shares back to one and they did this for a bunch of companies where they said, listen. So the share price doesn't reflect that the share price is 30, it remains at 30, except if you had 15 shares, now you have one share. So that 30 is equal to 450 for you. In the sense, for you, you bought the share at 450, its current price is 30. You've lost 90% of your money, which is exactly what a shareholder should be losing in case of a successful resolution. So the concept earlier was that shareholders would get paid the last after, I mean, would get paid regardless of whether there was a debt recovery or not. In the sense they continue, the share continue to list as it was and everybody made merry. Today, the new funda is with the IBC, banks if banks lose, the resolution applicant is allowed to say even the shareholders lose completely and even the unsecured creditors lose and definitely the promoters lose because they don't get to access the new company. So this I think has been the change.

Shray Chandra: But in our Premium forum and all I see, Slack channels I see there are, there is a recent counterexample, right? I think it's Ruchi Soya and apparently it was like something like a 300 bagger. It went from like three and a half bucks to 1200 rupees and at some point we might have owned a little bit of it as well. So isn't that sort of like a counter to what you're saying that things do sometimes work out for these bottom fishers and so on?

Deepak Shenoy: Yeah, in fact, in this particular case, Ruchi Soya has you know generated a lot of attention because it has been bought by this, this company called Patanjali Ayurved, which is, you know, it's an Ayurvedic company and it's an FMCG company also, and a bunch of things. What's interesting about this company is that when they suggested the bankruptcy plan, now a bunch of things have happened. This SEBI easing up the laws happened a little bit before Ruchi Soya's resolution. Ruchi Soya had about I think 7000 crores of debt, maybe because the earlier promoter had bet on a bunch of things which didn't work out and that debt got saddled, the company got saddled with that debt. The only way that company could sustain was with about 3 or 4000 crore of debt at max. Everybody else knew this. So when they did this round of IRP and asking for resolutions Patanjali came in and said, we'll pay 4000 odd crores for it. Adani was there. Adani said we'll pay something and then eventually Adani said, I don't want any piece of this. I'm done. I'm withdrawing my bid. And it went away. Patanjali got to own the company. What they did was quite interesting. They said, listen, we'll keep the company listed. You allow us to own more than 75% because you relaxed the rules. So we will own 99% of the company by issuing new shares to ourselves. We keep the rest of the company listed.

Deepak Shenoy: Now when you have only 1% of the company listed, even that added another specter of this. They said, if you have a 100 shares, it is now worth one share. That means everybody takes a hit of 99%, which means if you own, I don't know, 5000 shares now you have 50. So for you, the 3 rupees 50 paisa is actually worth 350. So you may think of it as oh 350, but you know what? 350 also became 1200. But that's roughly what midcaps have done in the last two years from 2020 to 2022. Some midcaps have done 5 X as well. So, but there's also another important thing that happened after that with the lower debt not only could Patanjali afford to pay the interest, Patanjali also then used some of its profitable biscuit businesses and merged them with this company so that it could earn more operating cash flow and therefore pay its debt. So it was able to get debt positive by, even by the lower amount of debt also by putting into a, going into a better business and then COVID hit. COVID actually created a huge opportunity because palm oil prices went up. It ended up creating a lot of opportunity for this company, which the regular piece of operations are, the lower prices that were there earlier was not profitable. But now you suddenly had a larger profit pool to play with.

Deepak Shenoy: And within three years, its generated a profit of about 800 crores per year. Now 800 crores per year includes about 300 crore. I mean, it's after they have paid 300 crores in interest on the current set of loans. So the company's value at a ₹1,200 is 31,000 crores. Now, that's a lot of money. Even for a company that makes 800 crores in profit, it makes no sense. But why is it worth 31,000 crores? Because only [00:40:00] 1% of the company is in the public domain. So when you have only 1%, that too that 100 shares have become 1 very few people who own your shares. When you have a very small amount of supply and even somebody was looking and saying palm oil ka price badha hai, Ruchi Soya ko khareedna chahiye or you know, I should buy in Rcuhi Soya because palm oil price have gone up, that person can't buy, find shares to buy because at 3 rupee 50 paisa there is no seller, at ₹7 there is no seller, at ₹10 there is no seller. It's on upper circuit every single day. It stops from the upper circuit only when it reached ₹700. Now, there's a reason why that 700 is interesting, because after that it went all the way to 1200, now about ₹1,100. But Ruchi Soya has announced that it will issue more shares. It's going to follow on public offer so that it can repay whatever is remaining of the debt itself. That follow on public offer is going to be priced at 600 odd rupees per share.

Deepak Shenoy: So this price is based on the more fundamental concept that an 800 crore company should be valued, perhaps at 15, 16,000 crores in that space. And then they can raise another 4000 pay back the debt. Once you pay back the debt, of course, if you have raised 4000 crore and you are 16,000 crores pre-money, you are now 20,000 crores post-money. But your profit pool is increased from 800 to a 1000 because your 300 crores of profit of interest, minus the tax that's payable on it, bumps your profit up to 1000 crore. So you are actually paying 20 times earnings, which makes more sense in an age like today where you have this thing. So your evaluation of Ruchi Soya happening was because of, they say, the stupidity of SEBI that allows such deep levels of dilution while being listed in the first place. But it's okay. I mean, because you need some kind of relaxation. Second, these are outliers because Ruchi Soya benefited from this massive change in the cycle. And it was not just that the, you know, but even then even like let's look at Jet Airways. Jet Airways was resolved. A bunch of people took a haircut. They decided not to write down the shares. The shares continued to trade although Jet has not had a plane in the sky for I don't know how long.

Deepak Shenoy: Nobody flies Jet anymore. I mean

Shray Chandra: It doesn't exist.

Deepak Shenoy: It doesn't exist. So what do you do now? Because if Jet doesn't exist, how come people are buying its shares? Because they are listed. Once you list a piece of paper, it becomes, I don't know, like cryptocurrency, right? It doesn't need to have a value underlying it. People are just trading it for like, oh, I think it's really worth so much Jet doesn't have landing slots, Jet doesn't have planes, Jet doesn't have an operation. It probably doesn't even own its logo anymore. It probably owns part of its Miles program, which it may or may not own. I don't even know if it does own it after the resolution but by now, anybody who's ever had Jet Privilege Miles, is probably looking at them with this $ fond sense of, at one time in life, I used to fly this airline. That's pretty much what it is. So your problem with this is, these are outliers. They have allowed these companies to be listed despite a resolution plan. But in general, a bet on such companies should not work from a first principle basis and does not work in most cases. In Sintex, it was obvious in January because there was a paper article by Economic Times which actually said that, you know, all the resolution plans say it's going to go to zero.

Deepak Shenoy: So I tweeted that. I said, guys, why are you buying this share? It's going to go to zero. And then I got these brickbats about how, oh, you don't know what you're talking about. Look at Ruchi Soya, look at this. I said, no, that's Ruchi Soya but this is Sintex. It's the, there are so many nuances. I'll give you three more examples and this is where we are right now. Yes Bank, great share, was a great share at ₹80, was a great share at ₹60 and at ₹50, at ₹18. It, they block the deposit holders from taking out money and then they say, well, you know what? We'll issue new shares at ₹14. Now it's got to be a great buy, right? It's been resolved. Three, it's been two years now the shares price is ₹14 or less. I don't even know what it is right now, but I'm sure it's even lesser than. So you didn't make money in a bank despite the company's share not being written down to zero. New shareholder coming, in fact, that was not even a bankrupt company. Technically it couldn't pay back its debt, but it was rescued before it was, it went into an IBC. So because of that, the shares were, you know, are continuing to be listed. And yet there's no problem at all. There's no I mean, there's no growth in your share price at all.

Deepak Shenoy: So that bet didn't work. Think of a company like Coffee Day, fantastic company in terms of, oh, they have outlets all over the place. They probably still serve coffee. I don't know, I haven't been to one lately, [00:45:00] but I did go to one a couple of months ago. I would go to a bunch, I still go on the highway. I use their services except the share trades. It probably makes some money, but there's no noise about it. It's, it owes a lot of money to a lot of people and yet it trades. There may be a tail event where some big guy comes and buys a chunk of it, but it doesn't appear like that company is going anywhere. So you might call this a distressed company, but it's not a bankrupt company yet. So it doesn't you know, there are companies, there are people that this company owes money to. Those companies, those banks or those lenders haven't taken it to a bankruptcy court yet. And if they do, you should not bet in this company, because if they do, and this company cannot pay them back, then it's chances are your shares will go to zero. That's almost $ given. Look, again, the last example I give you is future retail. Now, future retail is this interesting company because Amazon and Reliance are fighting a battle over it. Reliance has said it's going to buy the assets of Reliance, of future retail.

Deepak Shenoy: It means literally like it's saying, Reliance is not going to buy a single share of Future Retail. It isn't. It's going to say if Future Retails owns pots and pans, those pots and pans will be sold to Reliance for a consideration that allows Future Retail to pay back whatever lenders $ they owed money. So effectively it's a liquidation. It's selling all that it has to be able to pay back its lenders. What happens to the Future Retail's shareholder? He owns a company that owns nothing. Effectively his company is gone. He's getting nothing. This is an effective bankruptcy, except it's not gone through the bankruptcy process. Why hasn't it gone through the bankruptcy process? Because the banks know that if it goes through the bankruptcy process, there will be a resolution plan and stuff like that. And Reliance will probably bid half of what the current company is been bid for and Reliance was also probably pretty clear that listen, if you take this to a bankruptcy, it's going to take me two years. I'm going to bid much lesser plus you will know, you know, you will delay it so long that Future's value of its brand, of its stores, will probably go to zero by the time. So I will not bid so much. I'll bid much lesser. Banks knowing this, want to support this resolution, but you as a shareholder should know that banks have 0% of your interest at heart.

Deepak Shenoy: They have their own interests at heart. They don't care if you go to zero. They want this Reliance purchase to happen so that they can get paid. But if that Reliance purchase happens, you're definitely not getting paid. So there are times when you might bet on a company. There's a tail risk that it might work. There's a tail, oh it's not a tail risk, it's the tail reward. The reward is the tail and I say the tail is because if you have a curve which has a very high probability of success you know and a very small probability of failure, you would generally you know have a curve that kind of says ok on the probability side, the lowest probabilities of failure and the highest probabilities of success. But chances are that there's this black swainish kind of event which increases the risk and the impact of a failure so much because you haven't expected it and the probability of that is actually higher than you think, simply because the world goes through a disaster so many times. Here, you will only get a success in a tailish kind of event. 90% of the time it would be a failure, so you can bet on it like you're betting on a casino chip or a lottery ticket. But do you really want to do that? Because aren't lottery tickets more entertaining to play with?

Shray Chandra: So I know we're not fans of everything he says, but at some level, the, this Warren Buffett saying "Be greedy when others are fearful" may work, but not necessarily when math is against you so, so terribly.

Deepak Shenoy: Yeah, and you know, interestingly, Buffett did invest in a bunch of distressed companies, and some of them were mega failures. For instance, he invested in Salomon Brothers and Salomon Brothers, they were a debt finance company. They invented the junk bond market, which was effectively ways for less than pristine companies to be able to raise debt. And Salomon was in trouble by itself $ in crisis in 90, in the early nineties. And Buffett walked in and said, I will be the white knight or whatever it was, and he was the white knight for approximately two days. And then he figured out this is a bunch of crooks that run this company, and he doesn't want to be involved with a bunch of those bunch of crooks. So, therefore, he said, okay. He did sell it out and $ you know got out at the time, but sometimes [00:50:00] when everyone is fearful about a company, in a bankrupt company, it makes sense for it. So you don't, you want to buy distress elements when there is a reasonably big chance of success? I'll give you an example and how it marks who the distressed debt investor typically does this. So for instance, if you went to a Coffee Day today, it's a company in distress, you might be able to buy it out. And they did this with Hotel Leela. Well, Brookfield, not Oaktree, but Brookfield, this is Hotel Leela. It said, listen, you have all these hotels, you have about 3,000 crores in debt. Nobody is giving you debt at less than 10% a year or 12% is what they were paying.

Deepak Shenoy: So about 360 crores, oh sorry, it was 4,000 crores in debt. So 4,000 crores in debt is at, you pay 400 crores in interest per year. That's 100 crores a quarter. You own, you earn an EBIDTA of only 80 crores a quarter. So obviously you can't even make interest payments. But you know what? If I gave that 4000 crores to you and you were able to pay the banks, now you owe me a 4000 crores and I am a Canadian fund in Canada. We are happy to get even 5% on our capital. So I'm happy to get even that 5%. So if I take this 4000 crore and get 5%, I need only 200 crores, which is 50 crore a quarter. Your 80 crores after you pay me 50 you're still left with 30, which is a profitable business. So why don't I give, buy this company out for 4000 and then use this distressed, this is distress investing. When you buy out the company and you have this cost of capital and all that stuff put in. But to do this with shares and say that Brookfield bhaiyya, please mujhe, give me some money back because Brookfield will be like, Dude, I rescued this company. I'm keeping all of it myself. Why should I give it to you? This is the point. And you know, for I think I don't know if Leela is still listed. Maybe it is, maybe it is not, but it's probably substantially diluted after Brookfield invested in it. That would be a reason to get into distressed investing.

Deepak Shenoy: But to get into a company thinking that in a rescue somebody will be benevolent enough to say, tu chota reatil investor, le tereko 10X de diya. This kind of thinking, I think it's the worst kind of thinking. We should basically tell everybody, you are not out there buying these ₹10, ₹5, ₹2 names and expecting to get rescued. If you don't understand these stocks and don't understand the bankruptcy process, don't even participate in the markets. This is not for you. So when you're in the markets, you don't get sympathy just because you are, you know you're X or Y. So be greedy, the Warren Buffett of "Be greedy when somebody is fearful" it's like be greedy with a lot of money and a lot of intelligence and a lot of time and the ability to convert $ this intelligence and time into positive returns over this thing. It's not like I go to my brokerage, click buy button and then pray for the rest of, that I think doesn't work. And I would say that is the advice I want to leave people with, is that not that this is completely out the door, but it takes a different kind of thinking to think, to do distressed investing. So, therefore, don't buy bankrupt companies. They're probably going to be zero for, you know, for most of it. Once in a while, somebody wins the lottery and that's why a lot of people buy the lottery. But that doesn't mean that you, your investing needs to be a lottery ticket.

Shray Chandra: Well-put. So thank you so much, Deepak. That was super helpful and super insightful. We'll try and avoid lottery tickets investing going forward. Thank you, everyone, for listening. If you've made it this far, please take note of the Discount Code CMPODCAST for a 15% discount on a Capitalmind Premium membership. You can see more of our episodes at capitalmind.in/podcast, and while you're on our site, you can learn more about our do-it-yourself and fully managed Portfolio Management Service at capitalmind.in. Deepak has a book out called Moneywise. It's available on Amazon and Flipkart or at shop.capitalmind.in if you want a signed copy. If you have any feedback, suggestions or topics for our next episode, please do shoot over an email to podcast@capitalmind.in. Thanks for listening.