Retail attraction towards IBC stocks and the ABC of a bad bet

When bull markets are in progress, it is easy to believe in happy endings and pots of gold at the end of the rainbow. Retail investors betting big on IBC (Insolvency and Bankruptcy Code) stocks, or companies just emerging from bankruptcy resolution, appear to be carried away by prospects of big gains from beaten-down levels.

But for every occasional IBC stock that turns a multi-bagger, there are dozens that decimate wealth through equity write-downs, delisting or trading suspensions.

Moths to the flame

Take the case of Dewan Housing Finance, which was referred to IBC in November 2019 and after a protracted bidding war, saw the Piramal group emerge the winning bidder in mid-January 2021. The resolution plan, approved by NCLT envisaged writing down the value of the company’s equity shares to zero.

This isn’t surprising given that financial firms seldom have hard assets dominating their balance sheet and derive their value mainly from their loan books.

Even as the bidding was on and reports of forensic investigations into DHFL’s loans regularly made the headlines, retail investors accumulated the stock ending up with 42 per cent of equity by March 31, 2021 from 21.55 per cent in March 2019.

Meanwhile, savvy institutions pruned stakes from 22.4 per cent to just 5.4 per cent. The stock which shot up to ₹43 levels in December 2020 still changed hands at ₹16-17 levels when it was suspended by the exchanges on June 14, 2021. When DHFL stopped trading, the retail holding in it was worth ₹200 crore.

Jet Airways, which ran aground in April 2019 after massive quarterly losses and debt defaults, didn’t have too many unencumbered assets to show when it went into the IBC process. After a long hunt for suitors, the airline saw Jalan-Kalrock combine propose a resolution plan where the airline company would be listed, but equity shares held by the promoter and financial institutions will be fully extinguished, while public shareholders will receive just 1 share for every 100 shares they currently own. But the prospect of this write-down hasn’t deterred retail investors from accumulating the stock. At last count, they held a 18.36 per cent stake valued at ₹190 crore, compared to 11.4 per cent in March 2019. The Jet stock, which is below ₹100 now, has seen short-term spikes that took it to ₹165 in January 2021.

A common thread running across many IBC stocks is a rising retail shareholding even as institutional investors bail out. In November 2020, Uttam Value Steels was delisted from exchanges as per the resolution plan of US-based hedge fund CarVal Investors. The retail shareholding was 20.6 per cent in September 2020, up from 13.4 per cent a year ago while institutional holdings were minimal.

Weak understanding?

Newbie investors don’t seem to understand that stock prices essentially reflect a share in the profits generated by a company. A share holds little value when a company is chronically loss-making, has negative net worth or has more liabilities than assets.

“In an insolvency situation, shareholders’ rights take a back seat. Shareholders hold risk capital which is subordinate to the debt taken by the corporate debtor,” says Anoop Rawat, Partner, Shardul Amarchand Mangaldas & Co.

Yes, there is flexibility provided to a resolution applicant to restructure the equity capital of a company. Still, banks have had to take a haircut of up to 80 per cent in many IBC cases.

“If the creditors are not receiving their entire claim amount, it is unlikely that equity holders will get any value,” explains Aashit Shah, Partner, J Sagar Associates. He adds that in listed companies, equity holders can receive the liquidation value, but there too, interests of creditors always rank higher.

Regulatory action

Recently, stock exchanges mandated listed companies undergoing insolvency process to inform them within 30 minutes of an NCLT approving their debt resolution plan, to curb insider and speculative trading in such stocks. Is this enough or more needs to be done? Can the exchanges blacklist such stocks? Corporate governance experts feel that the onus is on investors (retail or otherwise) to do basic research on companies they invest in or trade in.

“One cannot blame the regulator for the stupidity of investors. The regulator and exchanges can ask brokerage firms to flash a warning when an investor trades in a stock that is in IBC,” says Shriram Subramanian, Founder and MD, InGovern Research Services.

Given the high probability of losses, some even feel authorities should consider halting trading when firms undergo a resolution process. But there is a flip side. “Trading provides an opportunity for those who want to sell and get out of the stock. If there are buyers of shares who are buying in hoping of a favourable resolution then that is the buyers’ risk,” reasons Subramanian.

“You cannot give a clean-chit to retail investors. There is avarice at play at least for some. Why would they go after shares of junk or financially sick companies? For each Ruchi Soya that has jumped 5,000 per cent in 5 years, there are scores of others that haven’t. The same high conviction is lacking from retail in the top-quality companies that are proven wealth generators,” remarked a veteran fund manager.

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