M&M Financial Rights Issue: Desperate Move or Smart Maneuver?

The news of Right Issue by Mahindra & Mahindra Financial Services (“MMFS”) at INR 50 per share (1:1) in-order to raise INR 3,500 Crore hit the investors like a thunderbolt yesterday (18th July 2020). The issue price was at steep 76% discount on CMP of INR 208 for the company. This left many investors believe (including us) that the step was a desperate attempt by the company to raise funds on immediate basis to provision for huge losses from Q2 Fiscal 2021 onwards.

However, a closer look at the details of the transactions will make you realize that this isn’t a particularly desperate attempt by the company nor is the transaction very dilutive to the existing investors (considering current situation)

Let us consider a scenario for an investor holding 200 shares of the company holding shares at Current Market Price of INR 208

Scenario for an Investor Post-Issue

The holding price post-issue would drop to INR 129 for the investor and effective P/E on Fiscal 2020 basis will increase from 11.9X to 14.8X post-money, which is a 25% increase. Therefore, ideally there should a 25% correction in prices which will lead to post-money valuation (on P/E basis) being equal to pre-money valuation.

It is unlikely there will be such a steep drop in price on immediate basis as many investors would be would wait for the allotment through right issue. However, a high single digit correction certainly is a possibility. Also, the capital raise will improve the company’s capital adequacy situation to tide against the provisions and eventual losses due to Covid-19 Pandemic.

Now consider a scenario where company would have done 1:4 rights issue at INR 175 per share, a discount of 16% from Current Market Price. The fund-raise by the company would have been less by around 16% as compared to fund-raise under current structure. Though the dilution would have been slightly lower (at around 21%), the investors may not have been too keen to invest given the Covid-19 situation and possible headwinds in business at INR 175 per share.

Also, even 1:1 issue at higher value say INR 100 per share would have made many institutional investors jittery regarding the capital requirements of the fund apart from the downward rating due to a steeper value correction.

Investors would now have to either increase their stakes or quit the table

For an existing investor of M&M Financial Services, it would be almost criminal not to subscribe to the rights issue. If an investor chooses not to subscribe, his/her equity stake will be diluted by 50% leading to steep value erosion. Therefore, an existing investor SHOULD absolutely subscribe to this issue or sell before the record date.

To conclude, we believe the move will lead to volatility on the downside on Monday (20th July) and there may be a strong correction, which will likely get bought into by long-term investors gradually owing to interest in Rights Entitlement. This is a good step by the management which works in the interest of all stakeholders of the company for the long-run!