Great Eastern Shipping -- Promoters cast anchor as takeover storm brews

Recommendations:

GE Shipping: Hold and evaluate buyback

GESCO Corp: Hold and exit through open offer

S. Vaidya Nathan

GE Shipping is all set to shore up the control of the promoter group, perhaps imperiling the scarce resources needed for growth in its core business.

GE Shipping does not have large surplus cash flows for the group to put a sizeable buyback without hurting growth. In this backdrop, a buyback programme, while rewarding exiting shareholders, may prove detrimental to long-term non-promoter investors.

GREAT Eastern Shipping Company is now in the limelight for reasons not necessarily linked to its fundamentals. Actions regarding a sister concern has brought GE Shipping to the fore in recent days, and pushed up its stock price. The focus is not so much on what could be in the interest of shareholders as on what would happen to ownership pattern of the company's equity.

Following a threat to their control over GESCO Corporation (the company in which some of GE Shipping's real-estate was vested in 1999 as part of a restructuring exercise), the promoters quickly announced possible courses of action to shore up their stake. The buyback of shares, open-market purchases of shares and a counter bid for a sister concern are on the cards.

The Delhi-based, hitherto largely low profile, Renaissance group announced an open offer to acquire up to 45 per cent of the equity of GESCO Corp (Rs 28.76 crore) at Rs 23 per share. Those behind the Renaissance bid indicated they might raise the price and this appears a likely outcome as the promoters have indicated a counter bid.

The promoter group, the Sheths, has a 13 per cent stake in GESCO Corp and 14 per cent in GE Shipping. It is this low stake that has now led to more action in the market for corporate control. The indications provided by the promoter group has pushed up the stock prices of both companies. The GE Shipping stock, which has been languishing at Rs 20-25, has been up almost 42 per cent in the last 15 trading days.

A clearer picture may emerge after the board meeting on October 31, to consider the buyback programme and the earnings announcement for the July-September quarter. While the earnings announcement may reveal a good picture on account of the improved overall industry fundamentals, the possibility of a buyback programme merits a closer look. How well is the company placed to carry out the exercise in a manner adding value to long-term shareholders?

Contours of the buyback

Any buyback programme by GE Shipping may well have one foremost purpose at this juncture -- to shore up the equity of the promoters. In this context, the following factors would assume importance:

*After the restructuring of the property development and shipping businesses, GE Shipping's equity was reduced by 10 per cent to Rs 258.84 crore. Even at the reduced level, the equity is fairly sizeable. This would mean that a buyback has to be significantly large to make a difference to the promoters' stake and also offer value to the shareholders.

*Assuming the promoters stake at the reported 14 per cent, only a buyback of around 30 per cent of the shares would raise it to the 20 per cent-mark.

*The other facet has to be the pricing of the buyback offer. The stock now trades around Rs 34. With the prospect of the promoter group carrying out open-market purchases to shore up stakes, the stock may well rule firm at these levels. Thus, only a substantial premium may induce shareholders to participate in a significant manner in the buyback programme.

*A 10 per cent buyback programme at Rs 40-45 per share would require a cash outflow of around Rs 110-135 crore. But this would have a marginal impact on the stock's valuation. It would also raise the promoters' stake by just 1.50 percentage points. A 20 per cent buyback would require double this outlay. If the prices are fixed at a higher level, then the bill would go up.

*What may work in the company's favour is that GE Shipping can phase out the exercise as control over the flagship company does not appear to be under immediate threat. But is the buyback necessary?

Yes and no...

Strangely, the buyback may enthuse the market and the shareholders as the stock has been a poor performer in the last five years. Since this is a fairly long period by any yardstick, the buyback may provide shareholders an exit at a better price than in the last few years.

Though the shipping industry went through a difficult period, the combination of industry fundamentals and periodic restructuring exercises have further dampened the stock's valuation.

In this context too, a buyback may well be a welcome denouement. But the other side of this story is that the buyback may be expensive from the point of view of the shareholders who stick with the company. And this set of shareholders will likely constitute a sizeable number. For instance, even after a 20 per cent buyback (which may well be the cap in terms of offer size), non-promoter shareholders would hold close to 80 per cent of the equity.

For this group of shareholders, a buyback programme at this stage (driven primarily by the need to cut the non-promoter equity base) may actually prove detrimental over the medium- to long-term. The reasons lie in the fundamentals of the company.

Growth imperative

``During 1999-2000, the company incurred a capital expenditure of Rs 242 crore, financed 33 per cent out of equity and 67 per cent out of debt. The company took delivery of three bulk carriers, one product tanker, a tug supply vessel and three harbour tugs,'' a comment in a management discussion and analysis.

In 1999-2000, the company reported post-tax earnings of Rs 110.45 crore and cash profits of Rs 291.62 crore. The company closed the year with cash/cash-equivalents of Rs 117 crore. While this may suggest that the company is sitting on a pile of cash, the reality is different.

Indeed, the company may manage to bankroll a 10-20 per cent buyback. The improvement in the industry fundamentals over the last nine months could also help in this context. But it could cut into the fleet expansion and diversification programme (with a thrust on LNG carriers) and raise the gearing levels.

There could be strain on this count on the revenue and earnings growth over the medium-to-long-term. More so since internal accruals (or equity by way of issuance of fresh equity shares) have to be a part of the financing of any fleet acquisition.

This factor could weigh on the stock valuation once the control-driven thrust is completed. And if the whole exercise is viewed as one where company funds are used indirectly to shore up the promoters' equity, that may negatively influence the stock valuation. But the prospect of the company being a candidate in the market for corporate control may limit the downside from the Rs 20-25 price range.

The GESCO Corp story

The ownership of GESCO Corp -- the company in which some of GE Shipping's real-estate has been vested, and which is to be the focus of the property development business -- is under immediate threat. With the promoters holding around 13 per cent and the Renaissance group around 10 per cent, a battle over the property-rich company is brewing up.

A substantial price revision from the present Rs 23 is on the cards. Here the open offer may unlock value for the shareholders as otherwise the stock may have languished. In fact, the property worth about Rs 90 crore and a market cap less than half of that were the trigger for the hostile bid.

Having been in property development for close to a decade with mixed success, the promoters of GE Shipping may not let go easily. For non-promoter shareholders, given the risks associated with property-oriented businesses (with the prime one made private a la Piramal Holdings), the battle over GESCO may provide a good exit opportunity.

The exit may be the better way out though the eventual price too may be lower when compared to the underlying value and prospects. This is because under normal circumstances and given the inherent risks associated with such a business, such stocks may not be highly valued. So, it may be best to exit while the battle for control is on.