As always, the FIs (LIC, GIC and UTI) are sincerely wishing that the issue of Escorts halving its equity will somehow solve itself. How else does one explain the postponement of their stand on the issue at the AGM, considering that 21 days' advance notice is given. The issue will apparently be decided on the basis of norms issued for buy-back of shares (if and when issued). However, although the reduction in equity is permitted (Sec 100 -104 Of the Companies Act) in this case it is quite clear that shareholders don't stand to gain and the proposal needs to be rejected.

Consider the facts. Of the total capital employed of Rs 1293.13 crore for 1997-98 (net of revaluation reserve), investment in subsidiaries account for Rs 191.43 crore (14.8 percent of TCE). The subsidiaries are either loss making or make meagre profit and hence funds deployed hardly earn any return. Incidentally, investment in subsidiaries has more than doubled from Rs 92.03 crore in 1995-96. Investment in unquoted equity(including investment in subsidiaries) amount to Rs 262.5 crore or 20.3 percent of TCE and total investments at Rs 381.17 crore account for 29.5 percent of TCE.

Is Escorts a manufacturing company or an NBFC? The balance-sheet structure and P/E it gets, suggests that it is more like an NBFC. For the last two years, gross block has declined and profit on sale of assets account for 35 percent of PBT in 1997-98 (44 percent of PAT) and 49 percent and 66 percent in 1996-97. The scheme of reduction in capital will simply result in reduction in cash outflow by way of dividend.

From the above it is clear that deploying the funds in the business may not generate returns to redeem the preference shares or to pay dividend. The cash inflow by way of dividend for shareholders could be substantially less and the first dividend though cumulative on preference shares is due after five years. Buy-back as and when permitted will involve cash outflow for the company which operationally, it is not in any position to generate.The proposal is a backdoor buy-back with deferred payment.

It is not clear as to where the funds saved will be deployed. However, the track record of the company as well as the fact that the management had to be forced not to subscribe to 1.44 crore additional equity shares instead its share of 0.38 crore shares in Escorts Finance are indicators as to where the funds will flow.

The preference dividend at Rs 10.8/share(12 percent on Rs 90) results in a cash outflow of Rs 35.96 crore. Taking the discount rate at 15 percent, the value of preference share works out to be Rs 34/share. The dividend discounted at the same rate results in value of Rs 35. As a result of equity reduction, the EPS should double and assuming the same P/E of 4, the price ideally should double i.e. should be Rs 154. Even then the risk premium is 42 per cent. The above is the best case scenario. The problem is that discounting factor should at least be 20 percent (cost of equity of HLL) which will sharply increase the risk premium. Itis too costly a price to be paid for a Nanda group company.

Pharma Exports

Lack of provision for allowing exports of new drugs under Drugs and Cosmetic Acts cannot be cited as a reason for imposing a ban of exports for new molecules by the domestic bulk drug industry. Reports of the recent notification has brought exports of new molecules to a standstill, with government authorities including the drug controller of India, themselves waiting for clarifictaions from commerce ministry, law ministry before deciding on appropriate measures.

IDMA believes that past method of no-objection certificate was perfectly legitimate, as the persons who are buying drugs are quite knowledgeable and wouldnot buy drugs that are either substandard or having quality problems. A central government approval in addition to the state and FDA commissioner approval could result in the industry moving towards a system of centralisation of procedures for exports. This would be a step backward in the reforms as today the onlyrequirement is the licensing from the state government and approval from F& D commissioner. Logically we should be moving to a system of automatic approvals to speed up exports. However, additional requirements from central government on case to case basis or on any other basis, would make the system extremely slow.

The effect of these steps on the earnings in the short term for bulk drug pharmaceutical export companies could be very severe. Cipla for instance has 15 percent of its income from exports and has plans to launch new molecules for exports. Sun Pharma has planned for launch of six new molecules. So has Ranbaxy labs and Dr Reddy Labs (DRL). Although Ranbaxy and DRL have approximately 50 percent of income coming from exports, the percentage of new products in this sales turnover is only 3 per cent. But the difference lies in the margins that one gets on exports, which are two to three times the local margins.

In addition, the speed at which a new product is introduced plays a big role indetermining the final market share of the company. After the slow growth rate seen in Asia and Asia pacific region all the major exporters are targeting American market having a market size of $ 20 billion. Even a couple of percentage points in the fast growing market can change the fortunes of the company. But if more bureacatic tangles come in way, it is quite likely for India pharma companies to show half the present growth rates in the future.

EMCEE (with contributions from Urmik Chhaya & Manish Saxena)