Corporate Governance takes a back seat ft. JSPL

Yet again, JSPL decides to take its shareholders for a ride! That's why it’s making headlines and pressing on us to question - "Is Corporate Governance even a thing?”

It isn’t the management, per se, that runs a corporation. In fact, corporations are much beyond their board of directors. You’ve all kinds of stakeholders, as in employees, shareholders, lenders, customers, government, community, and every other type of agency you can think of. And for once, imagine running your business without any of them? One word - impossible.

Naturally, if these stakeholders sniff something cooking in the business, it’d send wrong messages across the spectrum, and before you know it, you’d have pitched yourself against the world! It’s like you rub their back, they rub yours. And if you scratch it, the worse is ahead!

Hmm, then what blows the whistle?

Corporate Governance

Corporate Governance is, simply, a set of rules, practices and processes by which a firm is directed and controlled. The objective is to align as nearly as possible the interest of all stakeholders. This encompasses everything that ensures trust, transparency and accountability. From internal controls to performance measurement to corporate disclosure, it’s all about ‘being proper and prosper’.

Companies like HDFC, Infosys and Cipla, etc., have earned quite a name for good corporate governance - ‘Leadership category’. On the flip side, there are entities for whom it isn’t exactly their strong suit. A case in point is JSPL.

JSPL is in the limelight once again for flaws in the execution of corporate governance practices. And if you aren’t aware, we’ll take you through the interesting story. So, wait for what?

When JSPL belittled Corporate Governance...

Jindal Steel and Power Limited (JSPL) owns a 96.42% stake in its subsidiary Jindal Power Limited (JPL).

JSPL’s board has approved the sale of JPL to Worldone Private Limited. Ordinarily, this deal would seem to be ‘at arm’s length’, and there won’t be anything iffy as such.

But the thing is Worldone (the purchasing entity) is owned by Naveen Jindal, who also happens to own JSPL (the selling entity)! Meaning, the owner’s company is selling its subsidiary to a private company owned by the owner himself! Just saying ¯\_(ツ)_/¯

Well, this is what we call a ‘related-party transaction’ in market parlance. In these kinds of transactions, it’s only natural for stakeholders to get a bit more skeptical and pay attention to what’s going around. By the same token, JSPL has garnered quite a number of raised eyebrows for this deal (you'll soon realize why).

You see, as long as the deal is in accordance with legal and moral principles, none will question you. But if you play down transparency and governance, you’re bound to invite trouble!

So, how did JSPL exploit this deal, you ask? Well, in every way possible…

Valuation of JPL - ‘a deal at a steal’

The deal valued JPL at Rs 3,015 Crore.

As one would expect, JSPL said that the selection was a ‘clean process’, and Worldone had submitted the highest bid for purchasing JPL. But that doesn’t seem to be the case!

According to shareholder advisory firm Ingovern, the enterprise value (after considering equity, debt and cash) of JPL is in the range of Rs 10,000 - 12,000 Crore! Edelweiss Securities’ estimates are even higher.

But the deal price (Rs 3015 Crore) is nowhere close to that! At about one-fourth of its enterprise value, it seems Worldone is getting JPL at a deep discount. And because Mr. Jindal owns Worldone, it’s only natural to ask - “how clean was the selection process really?”

That’s not all; even if you consider transaction comps (an analysis tool based on recent similar transactions), you’ll still notice that the valuation is far below Adani Power’s and NTPC’s values! Make of it what you will.

Why sell JPL?

We bet if you’re used to reading between the lines, this must have intrigued you - Why sell the entire stake in JPL?

You’d be prompted to think that there’s some issue plaguing JPL - maybe it isn’t turning a profit or is sitting on a huge pile of debts or anything worse for that matter. But NO!!!

As a report speaks, JPL is turning into a Cash Cow for JSPL & was all set to generate Rs 2,000 Crore of profits, which is, in fact, more than double that of last year’s profits! Even the management of JSPL seems to be confident of the growth prospects of JPL. Speaking on its good debt profile, rating agency ICRA’s April report on JSPL notes that - “the company’s power business under JPL remains self-sustainable.”

Then, why sell it in the first place?

Well, the management of JSPL has reasons. They say it’d reduce their consolidated debt, increase cash flows, enhance focus on core steel division, and improve their carbon footprint & thus better ESG (Environmental, Social, and Governance) ratings.

However, factoring in the good growth prospects of JPL and terms of the deal, the likes of Edelweiss Securities feel that the divestment is a dud. Even speaking of the bit on ESG metrics, isn’t it worth questioning - “how rational is it to trade shareholder’s interest for environmental protection?” Well, we leave this matter for you to ponder.

Oh wait, there’s more…

The one with ICDs

ICDs or Inter-Corporate Deposits are the deposits between a parent company and a subsidiary company, where the entity with excess cash transfers it to the entity in need. Simple as that.

JPL had transferred about Rs 4,400 Crore to JSPL as ICDs. Meaning, now JSPL owes this amount to JPL.

And the terms of the deal state that once JPL is sold, these ICDs shall be converted into an ‘Unsecured Loan’ (with an interest rate of 9.5%). And there emerges the pain point.

Just think - once JPL is sold, it will no longer be a subsidiary of JSPL. Meaning, JSPL would be like any other company for it. Then, why would it convert the advance given to JSPL into an ‘Unsecured Loan’? Could it not have asked for some collateral as well? Because what if JSPL defaults? You don’t have that ‘parent-child’ relation now to bear those losses yourself, right? Who knows, perhaps only the board can answer.

What’s more…

JSPL holds some preference shares in JPL. Though named as otherwise, preference shares, by nature, are primarily like debt. And JSPL is entitled to get 5% interest on these preference shares.

But a meager 5%? Seriously! The Government of India, being a risk-free entity, borrows at 6% (through G-secs, etc). And JPL is at near risky junk status (ICRA’s credit rating ‘BBB’), then why would JSPL agree to a mere 5% return on preference shares?! This doesn’t make quite economic sense!

Had these preference shares been categorized as debt, this wouldn’t have been possible, as Section 186 of the Companies Act (2013) makes it mandatory for the lender to charge interest at a rate higher than that of government-issued security of similar tenure. Just because these aren’t termed as ‘debt’, there’s leeway. But given the nature of preference shares, perhaps this rule should be applicable here as well. What say?

Anyway, this also means JSPL receives 5% interest from JPL and pays 9.5% to it. From the surface, it’s like the additional 4.5% interest margin moving from JSPL to JPL to Worldone to [umm... never mind]. Smell something?

And if you account for all of this - from the value and terms of the deal to the objective of selling to this bit about ICDs, you’ll realize that, ultimately, the minority shareholders are at the receiving end of all outcomes. If JSPL has to take a haircut due to any reason, it impacts the money available for them. Which kind of explains why a media-induced dissent among shareholders has now taken off, thus, making JSPL re-evaluate its decision. Oops.

And it remains to be seen how events unfold.

The bottom line

Now, this isn’t the first time JSPL is into such a mess. In July 2020, a similar kind of deal was structured where Jindal Shadeed Iron and Steel LLC, again a subsidiary of JSPL, despite having its financials intact, was sold to Templar Investment Ltd, an entity owned by JSPL’s promoter group. Back in 2012, JSPL ran into controversies for its opaque remuneration policy, and also for being a beneficiary of the Coalgate scam.

However, the thing is, you may sneak away once or twice, but not always. Hopefully, this time, JSPL comes full circle and leaves a lesson for other corporates to learn.

Believe it or not, (Corporate) Governance makes the world go round.

Anyway, what’s your takeaway from this story? We’d love to read you in the comments below.