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Deals with undesirability of debt as a part of corporate capital structure and the consequences with DLF Limted of India as a case study
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Leverage as a Financial Perversion -with a reference to Bhushan Steel
-B.V.Raghunandan
Department of Commerce,St.Aloysius College,
MangaloreSeptember 18, 2014
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
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
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
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
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
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
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
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
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
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
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
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
THANK YOU
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