In this post, I will highlight a common practice how promoters increase their 'net-worth' by creating nothing extra but by just doing certain adjustments, that is, moving some things from here to there. I will elucidate with a fictitious example.
Lets say, House Builders Ltd. is a listed company having a Market Capitalisation of Rs. 500 crores and a shareholding of 50% by its Promoter and the rest 50% by the public. It is engaged in the business of Construction and Real Estate Development. The construction business of House Builders is valued at Rs. 400 crores and real-estate business at Rs. 100 crores.
In order to increase his worth, Mr. Promoter plays a simple game. He creates a company Land Buyer Ltd. with the minimum required Rs. 1 lac share capital and makes it a wholly owned (100%) subsidiary of House Builders Ltd. Take notice that Land Buyer is not doing any business as yet and its Memorandum of Association says that it will be engaged in real estate business. Now, Mr. Promoter, as the Chairman of House Builders, takes approval from shareholders to transfer the Real Estate business of House Builders into its 100% subsidiary Land Buyer Ltd. for a consideration (payment) of Rs. 150 crores (approved by an independent valuer of-course). Shareholders won't have any apprehensions as both the companies belong to them (from a ownership viewpoint) and a fair value is being paid. Now, Land Buyer Ltd. avails a bank loan of Rs. 150 crores to finance the purchase, pays to Home Builders and thus, gets the real estate business.
After 6 months, Mr. promoter applies to list Land buyer Ltd. on the stock exchange and proposes to raise Rs. 500 crores from the public giving them a 50% shareholding in it. Thus, the market cap. of the newly listed company becomes Rs. 1,000 crores. Land Buyer Ltd. then pays off the Rs. 150 crores loan from the just raised Rs. 500 crores and uses the rest Rs. 350 crores in its further growth and corporate purposes.
What happened here? Mr. Promoter and the shareholders of Home Builder did nothing productive. Home Builder Ltd. didn't constructed an extra building or Land Buyer didn't sold an extra plot of land. But shareholders (including Promoter) of Home Builder got richer by Rs. 550 crores !! How?? Do the math !!
They sold their real estate biz. of Rs. 100 crores for Rs. 150 crores: Profit - Rs. 50 crores.
Their shareholding in Land Buyer Ltd. is now worth Rs. 500 crores: Proft - Rs. 500 crores
Net Profit: Rs. 550 crores !! Isn't that a nice game??
the shareholding of house builders in land buyer ltd valued at Rs 500 crore is not a profit i guess!!!!!!
ReplyDeleteits not a profit as an cashflow-in, but it sure increased the 'Net-Worth' of the promoters...isn't it?
ReplyDeleteThe profit obviously comes from the overvaluations. In the first place the bank is ready to give a loan of 150 even though the business was only worth 100. Second time also the public was ready to pay 500 for 50% share. Which means they evaluated a business worth 100 to be at 1000.
ReplyDeleteSo i would say its the foolishness of the people that made him rich. (like the Greater Fools Theory)
I curious more interest in some of them hope you will give more information on this topics in your next articles. rocket mortgage
ReplyDelete