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Tuesday, February 15, 2011

Lessons from Jain Irrigation proposed NBFC foray-Information overload, unsustainable value addition

When Jain Irrigation informed the stock exchanges on 28th Jan,2011 of its plans to set up a NBFC to "integrate rural financing and sale of Company's products to the farmers", the response was muted. This item, hidden in a host of other resolutions, was missed out by the financial press/markets. But when the realization sank in, panic selling crashed the price from Rs 225/share to less than Rs 175 on Feb 3rd, 2011. After 'experts' on a popular financial site(www.moneycontrol.com) opined that this strategy was 'synergistic' with  the current one, order returned and the share price has bounced back to 200+. This episode has quite a few lessons for investors
  1. Learn from parallels across industries:-Educomp(India's premier education company) had an issue with mounting receivables from Government and other schools which had installed its 'Smart Class' infrastructure heavy solutions. These mounting debtors and capex heavy nature of business depressed the ROE/ROCE margins. Finally in 2009, Educomp decided to spinoff its receivables and infrastructure business to a SPV, which would pay Educomp upfront. What distinguishes this from Enron is that Educomp has negligible equity stake in that SPV and has persuaded banks/financial institutions to purchase the securitized debtors via the SPV route-without recourse. If we carefully notice, even Jain Irrigation had a problem of debtors, because the Govt would delay subsidy payments(Jain Irrigation's business model revolves around farmer's purchase being subsidized by Govt, which directly pays the manufacturer). So it now wants the farmer to take debt from its own NBFC(leaving the latter to bear the payment delay).
  2. Information Overload:- In a low promoter held stock(and fairly liquid one at that), you would expect such vital information to disseminate quickly. But it took 2 working days for the impact to sink through. If this is the scenario with a 1 page press release, I shudder the imagine the consequences when IFRS comes to India with its voluminous disclosures. Like how Enron did, companies may get away with blatantly confessing sins in their financial filings, with analysts being non the wiser. 
  3. Irrational response:- Then panic was unjustified because shareholders could have voted with their ballots instead of stampeding out of the stock-unlike a typical Indian company with 50%+ promoter holding, shareholder activism may actually work here.
  4. Unsustainable plans:- Strategy 101 classes harp on entering a venture if there is a strategic moat. In this case, there is little evidence to suggest that Jain Irrigation has a retail distribution strength. And then the stringent RBI licensing norms for NBFCs could come in their way, unless they tie up with a bank/financial player. Which begs the question-why have a NBFC instead of an alliance?
  5. Irrational valuation concerns:- A reason raised on some forums was that the company is entering a low margin NBFC business which detracts from the high margin 'Micro Irrigation Systems'. Fine- so use Sum of the Parts approach to value it-why punish the entire P/E ratio for that
I suspect this issue will fester longer and make the stock more volatile. Investors in this counter are advised to read up on this issue and take a long term view.

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