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Last Updated : Feb 05, 2016 08:49 PM IST | Source: Moneycontrol.com

Why investors need to track share pledging by promoters

Promoters pledge their own stake in the company to raise money. It connotes a lot to smart investors. One should check the promoter pledge among other factors before initiating a trade in a stock.

Vikas Singhania
Trade Smart Online

Pledging of shares can be done by the promoters either for their personal use or for the needs of the company. Funds raised through pledging of shares by the promoter is an off balance sheet item. These the promoter can either use for his personal requirements or invest it in the company as a debt from promoter.

When a promoter pledges his stake; it is generally a last ditch effort. It normally indicates that the promoter is unable to raise money from other sources and has to pledge his own stake to meet the financial requirement of the company. Kingfisher was a case in the point, where the promoters pledged his shares as he was unable to raise funds from any other resources. In a short time after pledging of the shares the company went belly up.

But not every company whose promoters pledge their shares is on the verge of collapse. Banks normally ask some promoters to pledge their shares as margin in case they feel the scenario is deteriorating.

Pledging is not bad

Pledging of shares is not always bad. It is one of the fastest modes of raising money. Promoters use it for short term requirement. Pledging of shares has increasingly become popular among Indian promoters as a source of raising money as well as bankers preferring it as an instrument for securing their loan. Promoters who have pledged their shares have increased from 27 per cent in 2009 to around 46 per cent in 2015, the highest level till date.

Mint recently reported that pledging of shares by promoters of companies listed on the National Stock Exchange rose to the highest level in seven years in the quarter ended 31 December 2015 according to data compiled by capital markets tracker Prime Database.

Promoter share pledging rose 14% in the last quarter of 2015, with the value of pledged shares increasing to Rs.2.03 trillion as on 31 December from Rs.1.78 trillion a year ago. The number of NSE-listed companies where promoter shares have been pledged has gone up from 370 six years ago to 517 as on 31 December 2015.

For an investor the key point to watch is the size of the pledge and the periodicity of various such pledges, in case they have occurred. A sizeable pledge is dangerous in a bad market. As share price of the company goes down, banks or non-banking finance companies (NBFC) who are the main lenders in this market would require the promoter to either pay-up to meet the short fall in margin or pledge more equity. But the bigger threat is the possibility of further selling in case the promoters do not meet up with the margin requirement.

Tree House Education is a recent case, where there was a market buzz that the promoter’s pledged shares were sold in the market that comes to investor’ mind. Sharp fall in share prices when the company was facing liquidity issues were rumoured to be on account of the company’s pledge being revoked. Ultimately the company was sold out to the Zee group.

A text book case of how pledging of shares can be risky was in the case of Great Offshore where the promoter Vijay Kantilal Sheth lost control of the company as he had pledged 99 per cent of his holding and raised Rs 200 crore by giving a margin of Rs 100 crore worth of stocks. Fall in its share price led to selling by the lender and ultimate loss of ownership.

A raid was mounted on Mangalore Chemicals owned by Vijay Mallya who had pledged his entire holding. When the Deepak Fertiliser group saw the vulnerable position of Mallya after the Kingfisher fiasco it mounted a hostile takeover on the company. Mallya had to join hands with the Zuari group in order to save his company.

What should an investor watch out?

Percentage of shares pledge by the promoter points out the desperate situation of the company and exposes it to acquisition risk or share hammering by the bear cartel. For an investor, it is better to look at the process in reverse. It can be a profitable exercise to look at companies where the promoter has removed their pledged shares. One of the first things that a promoter would like to do is free his own shares the moment things are improving. Tracking companies with improving fundamentals and promoter freeing their shares is strong sign for better stock performance.

Recent instance of how Asian Paints share price has moved and stalled with the promoters pledging and releasing their shares is a good exercise to start with. The high of 2014 seen by the market was preceded by a series of companies revoking their pledge. Some of the bigger names included HDIL, IRB Infra, Motherson Sumi, Gateway Distipark and JSW Steel. Remember, markets always reward fundamental strength, revoking of shares pledged is one way of displaying it.
First Published on Feb 5, 2016 10:14 am