Kitex Garments Limited

I see that the Promoters have pledged / encumbered 6 million shares over the past one year as shown in the results – (page 2 of the link – Kitex Q2FY16 rsults). But the shareholding pattern shares filed with the BSE does not show any such pledges / encumbrances (page 5 of the link – SHP 092015)

I do not know which one to believe; but if 6 million shares ~ 24% of their holding, are pledged then it means shares worth Rs 450 crores are pledged (assuming Rs 750 per share). Even at a margin of 50% a sum of Rs 225 crores is probably kept as a line of credit for promoters. We do not know how much of this line has been used.

Over and above this irreconciliable filing, this raises a few questions. One of the promoters of Kitex Garments is Kitex Childrenwear Ltd, which in turn, is apparently fully owned by other Promoters and which is under consideration for a merger with Kitex Garments. So it is possible that Kitex Childrenwear Ltd may use this line to borrow and increase its own valuation creating a fair-value swap ratio that is unfavorable to minority shareholders of Kitex Garments. Imagine I own a listed Company A and an unlisted Company B. Further Company B also owns Company A. Now Company B borrows against the shares of Company A that it owns and uses this capital to increase its valuation (essentially high leverage with low equity to improve valuation metrics) relative to Company A. Consequently when a merger is considered Company B will get a more favorable swap ratio; and upon merger shares held by Company B in Company A is cancelled and I will get more shares in Company A than if Company B had not pledged its shares. In other words I am indirectly using via Company B the value of Company A to enrich myself at the cost of other shareholders of Company A.

What happens if Company B’s borrowings (against Company A shares) default? The lender will simply liquidate the pledgee shares; the shares will tank and the risk will be borne by everyone.

Of course to be sure we do not know how and how much of this pledge is used, but the potential risk to minority shareholders is real.