Disclosure: Long Sterling Biotech
In addition to the 4 points mentioned above,
)- Cholamandalam Finance offloaded approximately 1cr shares in Oct/Nov at 10 levels. These were picked up by 5 market operators who, in absence of management comments, are managing the price of Sterling Biotech. The stock has support at 9-10 levels but fails to cross 10.05.
Surprisingly, there is significant delivery offtake (61% for the last few weeks).
)- The company jet has also been reportedly impounded
)- The State Bank of Mysore case is against the promoters ie personal loans. The IDBI case is against the company. Both cases have not progressed into litigation yet.
Sterling Biotech is like a deep OTM call option currently.
)- They are one of the largest manufacturers of gelatin globally (7% global market share). They structurally enjoy a competitive cost advantage as raw material are bovine bones (cheap in India). Gelatin products are used in the pharma industry (most capsules) and the food industry. The business is stable, generating about 6-8% operating margins.
)- They are 33.4% owned by the promoters (the Sandesara group); 55% of these shares are pledged to financial institutions. Recent news in the press re: defaulting a Rs50Cr loan from Andhra bank and impounding of the company jet (unconfirmed).
)- The company issued multiple rounds of FCCBs between 2004 and 2007. The second last tranche of $140mm was redeemed at par and cancelled in 2010. They have $170mm of FCCBs due for repayment on 16 May 2012 issued at a conversion price of Rs200. Given where the stock was in the last 6 months, there was no way this is going to convert into shares.
)- The debt is carried on Sterling Biotech’s balance sheet (Rs3700Cr) and the interest payment is far greater than their operating profits so they are running net losses. The official story was they wanted to increase capacity on their biotech business, reflected in capex over the last 2 years (~$270mm). The money was invested into the SEZ (Rs1700Cr) and the Nigeria oil business (numbers unavailable) via shadow companies. These are on the 2010 annual
report as unsecured loans to group companies
In it’s current form, the company cannot pay the FCCB due in May and is technically bankrupt. The bonds are trading at 50 cents on the dollar (listed in Singapore). With lack of any intention from the management and the plegded shares overhang, the shares have gone in freefall and is a classic operator driven story now (alternating upper and lower circuits for 10% moves) with support at Rs 9 levels.
Why this is interesting:
)- There is economic incentive from the promoters to keep this company afloat ie it is a liquidity issue, not a solvency issue.
)- The money was invested and is locked in Nigeria and the SEZ and the promoters are most likely struggling to get it out. The oil well was supposed to produce 100K barrels per day by now; current output is only a fraction of that estimate.
)- Even if they refuse to bail out the company and we head to default, there are no bankruptcy laws in India ie a bond default will most likely go to court (ala Wockhardt). If it does, PPE as of Dec’11 alone was $918mm so technically the bonds are backed by assets but trading below par to reflect the difficulty of recovering this in India via a bankruptcy proceeding. The book value per share is about Rs98 and the underlying business is stable enough to be sold in whole to a US/EU player. In this situation, the bond holders get paid at par and equity holders get the remaining piece of the pie
Now if they do manage to scrape the money and pay off the bonds, both the stock and the bonds go up - bonds from one cent to the dollar and the stock from 10 to 50 (atleast 0.5x book value of 98).
In addition to all of the above, there are softer issues in play ie the repayment of the 2010 FCCB in full and reduction of pledged shares from 98% to 55%. If the intention of promoters were to default ie. siphon the money out of the company, these actions are contradictory.
This is a high risk trade - close to 90% capital loss vs 400% upside so trade this position like you would buying call options.
