Private investment in public equity - PIPE

Private investment in public equity - PIPE

As the name suggests, PIPE involves private equity participants investing in companies whose shares are publicly traded. Thus, private funds are directly infused into the listed company. Generally, the transaction involves private participants (who are a limited group of investors or Institutional investors) and the listed companies which are looking for funds. Thus, the companies allot the shares directly to the investors.

Why should a listed company look for private equity funds ?

All the companies, at what ever stage of life cycle they may be, require funds. The desired end usage may be for repayment of debt, acquisitions, entry into new markets, improving the operations etc., If the market conditions are promising and the market is in bull phase, these companies will for sure go for follow up public offer. However, if the market is in bear phase, then the companies will not be interested in approaching the public for the funds they require. This is because, the market prices of the shares of the companies may be lower than their intrinsic value. If the company approaches public during these times, the company has to under sell the shares at prices which are very much lower than the intrinsic value. The public also may not be interested in buying the share a the price at which the follow up public offer is announced. These factors drive the listed companies to look for PIPE funding.

Why should a private equity investor / institutional investor invest in a public company ?

As said earlier, during the bear phase / gloomy market conditions the valuations of the listed companies will be generally lower than the intrinsic value and the retail investors will not be in mood to buy the shares in these companies. This results in getting a better acquisition price for the private equity investors. The public companies which are looking for funds will be ready to issue shares at the price which will be mutually acceptable to both the parties.

Moreover, the private equity investors will also conduct the due diligence of the companies which are looking for funds. The out come of the due diligence will have great impact on the price at which the private investors want to acquire the stake. Any issues if identified during the due diligence process will further reduce the price at which the stake will be acquired by the private equity investors. Thus, the private investors will get the stake in the public companies at promising values. The private equity players will also have an easy route for exit as the companies are already listed.

Private equity and Venture capital

Venture capital (VC) and private equity (PE) are two terms which often overlap in practice, so the distinction between these goes un-noticed. The purpose of this post is to lay down how both the terms differ.

Private equity is usually about taking an existing company with existing products and existing cash flows (positive or negative depending on the industry, products, strength of management team, prospective markets etc), then restructuring that company to optimize its financial performance.  When private equity works right, it can save poorly performing companies from cash crunch and turn them into profitable enterprises thereby avoiding them from becoming bankrupt.

A Private equity firm wants the companies in its portfolio to continue to grow, so it may add on other synergistic acquisitions and then sell the company to another firm within a few years. Although enormous growth rates are usually desirable, most PE firms are realistic and don’t expect their portfolio companies to grow by quantum leaps. They aren’t seeking exponential growth but rather good, solid geometric growth.

Venture capital is investing in financially viable start up ideas which are backed up by technical brains behind the ideas. This involves funding the persons generating the ideas so as to enable them turn these ideas into realities which generate cash. Venture capitalists invest small amounts of money in dozens of companies. Funding these ideas involves high risk. Also, the funding is required generally at very early stages of product development.

A Venture capital involves betting the start-up which will rapidly bloom into an enormous company (eBay, Microsoft, Sun, Google, and Apple are all examples of venture funded start-ups). The Venture capitalists expect their investments to increase with exponential growth. At the same time, the venture capitalists also run a great risk of failure of the start ups which were earlier funded by them. [As per the historical data, most of the start-ups shut their shops within 5 years from the commencement of business...!].

Apart from the above basic approach differences between PE and VC, the following areas also does matter:

§    PE firms buy companies across all industries, whereas VCs are focused on technology, bio-tech, and clean-tech and simply said emerging areas [New area is the education industry where the investment by VC is growing in India].

§  PE firms mostly buy 100% of a company in an LBO, whereas VCs generally acquire a minority stake – less than 50% [The balance is held by the founders/promoters].

§  PE firms make large investments in various large companies. VC investments are much smaller (since the investments in start-ups generally don’t require huge outlay as the funding is based on the ideas).

§    VC firms use only equity whereas PE firms use a combination of equity and debt.

§  PE firms buy mature companies with products known in the public and which have potential to grow whereas VCs invest mostly in early-stage – sometimes pre-revenue – companies (funding of financially viable ideas which may take considerable time).

REITs (Real Estate Investment Trust) in India - Tax implications

Tax implications on REITs

Why will any investor invests in any venture ? One of the answer is to get a good return. The term GOOD depends on perception. I see 12% net of tax as a good return over a period of 6-9 months, some see this as 8% net of tax for the same tenure. 

Thus any person, while calculating the return on investment will consider the tax impact on the income generated from the return. If TAX element is not calculated / considered properly, the results screw up the happiness of the investors.

Investors in REITs would like some favorable tax treatment so that this remains an attractive route for them to put money as compared to other options present in the market.

Tax treatment of REITs should be made in an efficient manner so that TAX component will not eat into the return generated thereon and if that is the case this will not be any good avenue for the investors to park their money.

Below are few aspects of taxation of REITs which needs to be addressed by the forth coming budget [which will happen sometime after elections results of 2014 are declared].

Dividends

Dividends received by the investor from companies as well as mutual funds are tax free in their hands. 

Now with REITs entering the league as a separate instrument, the question is whether the taxation of the dividend received from this instrument will be liable for the same treatment as of dividends. If this is not the case then the amount received would have to be taxed in the hands of the investor which would put a burden on them. Further, if this amount is o be included as part of income for computing tax based on slab rates, the investors end up paying too much of tax. This is owing to the nature of REITs, most of the primary investors in REITs will he high net worth individuals who are already in higher tax bracket.

Capital gains benefit

There are favorable provisions related to the investments into equities and equity oriented mutual funds when it comes to capital gains earned on these instruments if the gains there on are of long term in nature [holding period being more than 12 months]. 

In case of the REITs there are no clear guidelines on what would actually be considered as the nature of the instrument and how would this be taxed. 

This has importance because if there is a capital gain that is earned at the end of the day when the investor goes to sell the investment and if the impact here is negative then this could dent the overall returns from the investment. 

Securities transaction tax

The nature of the REITs is such that it will be listed on the stock exchanges wherein it will provide investors with an option to actually trade in them and in which case this trading may invite securities transaction tax. 

In the absence of clarity of tax matters on these issues, there is very little chance that an investor is going to be attracted towards a REITs in the form that has been proposed. The entire effort of earning returns in the investment could be negated by the tax position. 

This tax angle will be key before investors invest in them. Unless there is a beneficial way in which this is actually dealt with it could turn sentiment against REITs which could be difficult to correct at a later stage hence the important thing is to get the details right the first time around.

So, let’s keep our fingers crossed and wait for the Finance Minister [New...!] to come up with some provisions in the budget.

REITs (Real Estate Investment Trust) in India

Background

Market regulator Securities & Exchange Board of India (SEBI) is looking to allow real estate investment trusts (REIT) in India which could open up new funding channels for real estate assets in the country. The regulator has, in its draft note for a seperate regulatory framework under SEBI (REITs) Regulations, 2013 said REITs would be allowed only for large assets.

India’s real estate sector is in deep crisis which is primarily because of delays in completion of projects, demand having slowed down and interest rates remaining high. The move of SEBI towards REITs is aimed at attracting money into the sector which has been experiencing a liquidity crunch since the last 5-7 years.

SEBI initially released guidelines in 2008 which it shelved subsequently, and now it decided to revive the plan.

The main objective of REITs is to mobilize the retail investors wealth into investment in real estate properties by routing the funds through Real Estate Investments Trusts. So, in the near future can consider this as one section of portfolio [Currently we have Equity, Fixed income, MF, Gold, Bullion]....and this again comes with equal exposure of retail sectors income to the riskiness of real estate sector.

REITs sell like stocks on major exchanges and invest directly in completed real estate projects instead of those projects under-construction. In this way, investors can earn regular income through the rent received from the properties.

According to the consultative paper released by Sebi, REITs are a win-win for both real estate developers and investors. "On one hand, REITs provide the investors with an investment avenue, which is comparatively less risky than investing in under-construction properties and provides regular income. On the other hand, REITs provide the sponsor (usually a developer or a private equity fund) avenues of exit thus providing liquidity and enable them to invest in other projects," it said in the paper.

Besides other factors, Sebi also said that REITs bring in transparency and accountability in the real estate sector thus making it a popular choice across the globe. [These are already in place in USA].

Explaining the entire framework, the regulator has pointed that REITs will be set up as trusts and cannot launch any schemes.  Upon being registered with Sebi, REITs may go in for an initial public offer (IPO) of minimum Rs 250 crore. Once listed with a stock exchange, it can go in for follow-on public offers (FPOs), Sebi said.

The markets watchdog is likely to announce formal guidelines for REITs after taking into account the feedback it receives from the public. [The date is open till 31 October 2013 to the Public for submission].

It has said that for coming out with an initial offer, it has been specified that the size of the assets under the REIT shall not be less than Rs 1,000 crore ($160 million) which is expected to ensure that initially only large assets and established players enter the market.

Further, it has called for a minimum initial offer size of Rs 250 crore and minimum public float of 25 per cent to ensure adequate public participation and float in the units. The minimum public holding norms are in line with listing conditions for firms on the stock exchange.

The REIT shall be set up as a trust under the provisions of the Indian Trusts Act, 1882 and it shall not launch any schemes. The REIT shall have parties such as trustee (registered with SEBI), sponsor, manager and principal valuer.

             

The trust will need to get registered with SEBI post which it can raise funds through an initial offer and once listed, may subsequently raise funds through follow-on offers. Listing of units shall be mandatory for all REITs.

The REIT may raise funds from any investors, resident or foreign. However, initially, till the market develops, it is proposed that the units of the REITs may be offered only to HNIs/institutions and therefore, it is proposed that the minimum subscription size shall be Rs 2 lakh and the unit size shall be Rs 1 lakh.

The market regulator had previously released a first draft of guidelines for REITs in 2008 after which the entire REIT framework was withdrawn to make way for real estate mutual fund (REMF), which eventually did not see the light of the day.

What is REIT ?

A REIT or a Real Estate Investment Trust is a body that buys, develops, manages and/or sells real estate assets. REITs allow participants to invest in a professionally-managed portfolio of real estate properties.

Simply-

Allows retail investor to participate in large commercial real estate investments

Offers high liquidity as shares can be traded like any other security at stock exchanges

Pass-through entities – pay dividends with no taxation at company level

Business activities are generally focused on generation of property rental income

Trustee, manager and sponsor

The trustee shall be independent of sponsor and manager and hold the REIT assets in the name of the REIT for the benefit of the investors with a primarily supervisory role.

To ensure that the activities of the REIT are managed professionally, it has been specified that the manager needs to have at least five years of related experience coupled with other requirements such as minimum net worth of Rs 5 crore.

The sponsor shall be obligated to maintain at least 25 per cent holding (pre initial offer) in the REIT. The lock-in-period for the 25% is  3 years and units exceeding 25 per cent mark shall be held for at least one year from the date of listing. The sponsor shall also ensure at least 15 per cent of the outstanding units of the REIT at all times.

Even in those cases where the sponsor sells its units it shall arrange for another person/entity to act as the re-designated sponsor.

The sponsor(s) also need to have at least Rs 20 crore net worth and experience of at least five years in the field.

Refund and delisting

The REIT shall have to return the money if the initial offer fails to garner at least 75 per cent of the target corpus or less than 20 investors participate in the offer. The units of the REIT would need to be listed within 15 days of the closure of the offer.

The trustee shall apply for delisting if the public float falls below the prescribed limit, the number of unit holders other than related parties to the REIT falls below 20, SEBI or the stock exchange requires such delisting for violation of the listing agreement, sponsor/manager requests such delisting which is also approved by unit holders or unit holders themselves apply for such delisting.

Investment conditions and dividend policy

In line with the nature of the REIT to invest primarily in completed revenue generating properties, it has been mandated that at least 90 per cent of the value of the REIT assets shall be in completed revenue generating properties. Revenue or rent generating property shall mean property of which not less than 75 per cent of the area has been rented/leased out.

The remaining 10 per cent of REIT assets can be invested in developmental properties, provided that such investment shall only be in properties which shall be held by the REIT for not less than three years after completion and shall be leased out; listed or unlisted debt of companies; mortgage backed securities; shares of public listed companies which derive at least 75 per cent of their revenues from real estate activity; government securities or money market instruments or cash equivalents.

To ensure regular income to the investors, it has been mandated to distribute at least 90 per cent of the net distributable income after tax of the REIT to the investors.

REITs have been allowed to invest in the properties directly or through special purpose vehicles (SPV), wherein such SPV holds not less than 90 per cent of their assets directly in such properties. However, in such cases, it has been mandated that REIT shall have control over the SPV so that the interest of the investors of the REIT are not jeopardised.

The REIT shall not invest in vacant land or agricultural land or mortgages other than mortgage backed securities. Further, the REIT shall only invest in assets based in India. It shall not invest in units of other REITs.

Investment upto100 per cent of the corpus of the REIT has been permitted in one project subject to the condition that the minimum size of such asset is not less than Rs 1,000 crore.

All related party transactions shall be on an arms-length basis and shall be disclosed to the exchanges and investors periodically. For any related party transactions for acquisitions/sale of properties, valuation reports from two independent valuers shall be obtained and the transaction for purchase/sale of such properties shall be at a price not greater/less than average of the two independent valuations.

Investors' approval is required for all the related party transactions wherein the value is above a threshold as provided in the proposed regulations.

Borrowings, valuation, disclosure norms and investor rights

To avoid excessive leverage, the aggregate consolidated borrowings and deferred payments of the REIT have been capped at 50 per cent of the value of the REIT assets. If the same exceeds 25 per cent, requirement of credit rating from a credit rating agency and approval of majority of investors has been specified.

To ensure that the underlying assets of REIT are valued accurately, requirement of a full valuation, including a physical inspection of the properties, has been specified at least once a year. Further, a six monthly update in the valuation capturing key changes in the last six months has also been specified. Consequently, NAV shall be declared at least twice a year. Provisions have also been specified for valuation in case of any material development.

Detailed disclosures have been specified for the annual and half-yearly valuation reports.

Further, for any purchase of a new property or sale of an existing property, it has been required that a full valuation be undertaken and the value of the transaction shall be not less than 90 per cent or more than 110 per cent of the assessed value of the property for sale/purchase of assets, respectively.

The investors shall have the right to remove the manager, auditor, principal valuer, seek delisting of units, apply to SEBI for change in trustee, etc. An annual meeting of all investors is mandatory to be convened by the trustee wherein matters such as latest annual accounts, valuation reports, performance of the REIT, approval of auditors and their fees, appointment of principal valuer, etc. shall be discussed.

Further, approval of investors has been made mandatory in special cases such as certain related party transactions, any transaction with value exceeding 15 per cent of the REIT assets, borrowing exceeding 25 per cent, change in manager/ sponsor, change in investment strategy, delisting of units, etc.

In order to ensure that a related party does not influence the decision, it has been specified that any person who is a party to any transaction as well as associates of such person(s) shall not participate in voting on the specific issue.

(Part of the content is sourced from few websites).

Open market operations (OMOs) - I

The liquidity conditions in the markets keep fluctuating depending on the demand and supply of currency in the markets. If the demand for Rupee is more than supply, then this shoots up the lending rates. This is because the borrowers want the money for business even at a higher rate. So, when all the borrowers borrow money at a rate higher than the usual, this drives up the cost of products or services which will in turn drive the inflation up.

There may be times when the supply of Rupee is more than the demand. This is a situation where the rupee is available easily and hence the banks will not charge higher rates of interest.

OMOs are the operations conducted by RBI in the open market which involves sale/purchase of Government securities to /from the market with an objective to adjust the rupee liquidity conditions in the market. When there is excess liquidity in the market, RBI resorts to sale of securities which will result in flow of money from the market to RBI (The banks and financial institutions buy these G secs by releasing cash from there system).

Similarly when the liquidity conditions in the market are tight, RBI purchases the G secs from the market which will result in flow of money from RBI into the system (The banks and financial institutions sell the G secs which they are holding and will receive cash from RBI).

Thus, RBI performs open market operations considering the targets for various economic parameters such as interest rates, exchange rates or inflation.

Support & Resistance Levels - Concepts

You'll often hear technical analysts talk on about the ongoing battle between the bulls and the bears, or the struggle between buyers (demand) and sellers (supply). This is revealed by the prices a security seldom moves above (resistance) or below (support) or can simply say as the band in which the said stock is expected to fluctuate during a trading session.

This article of mine is an attempt to explain the basic concepts of Support & Resistance levels and how they are calculated.

What are Support & Resistance levels?

Support and Resistance levels are exactly what their names imply.

Support is the price level through which a stock is not expected to fall. Resistance, on the other hand, is the price level that a stock is expected to surpass. To put this differently, the price level which, historically, a stock has had difficulty falling below. Thus this is a level at which a lot of buyers tend to enter the stock which in turn creates a demand for the stock and pushes the price of the stock up. This is often referred to as support level.

Resistance is a price level which a stock finds it difficult to break through. To put this differently, the price at which a stock or market can trade, but not exceed, for a certain period of time. The stock or market stops rising because sellers will increase more than the number of buyers which in turn will increase the supply in the market and thus pulls the price of the stock down. This is often referred to as resistance level.

Testing the support & resistance levels:

If the price of a stock falls towards a support level it is a test for the stock. The support will either be reconfirmed or wiped out. It will be reconfirmed if a lot of buyers move into the stock, causing it to rise and move upwards from the support level. It will be wiped out if buyers will not enter the stock and the stock falls below the support.

If the price of the stock rises towards the resistance level, it is a test for the stocks resistance. The resistance will either be reconfirmed or breached. It will be reconfirmed if lots ofsellers place sell orders at that level, causing the price of the stock to come down from the resistance level. It will be breached out if sellers will not enter the stock and the stock raises above the resistance.

Role Reversal

Once a resistance or support level is broken, its role is reversed. If the price falls below a support level, that level may become resistance. If the price rises above a resistance level, it may often become support. As the price moves past a level of support or resistance, it is thought that supply and demand has shifted, causing the breached level to reverse its role. For a true reversal to occur, however, it is important that the price make a strong move through either the support or resistance.

In almost every case, a stock will have both a level of support and a level of resistance and will trade in this range as it bounces between these levels.

Importance of support & resistance levels:

These support and resistance levels are seen as important in terms of market psychology and supply and demand. Support and resistance levels are the levels at which a lot of traders are willing to buy the stock (in the case of a support) or sell it (in the case of resistance). When these trend lines are broken, the supply and demand and the psychology behind the stock's movements is thought to have shifted, in which case new levels of support and resistance will likely be established.

Support and resistance analysis is an important part of trends because it can be used to make trading decisions and identify when a trend is reversing. For example, if a trader identifies an important level of resistance that has been tested several times but never broken, he or she may decide to take profits as the security moves toward this point because it is unlikely that it will move past this level.

Support and resistance levels both test and confirm trends and need to be monitored by anyone who uses technical analysis. As long as the price of the share remains between these levels of support and resistance, the trend is likely to continue.

It is important to note, however, that a break beyond a level of support or resistance does not always have to be a reversal. For example, if a price moves above the resistance levels of an upward trending channel, the trend has accelerated, not reversed. This means that the price appreciation is expected to be faster than it was in the channel.

Being aware of these important support and resistance points should affect the way that the trader trades a stock. Traders should avoid placing orders at these major points, as the area around them is usually marked by a lot of volatility. If the trader feels confident about making a trade near a support or resistance level, it is important that he/she follow this simple rule: do not place orders directly at the support or resistance level.

This is because in many cases, the price never actually reaches the whole number, but flirts with it instead.

So if you're bullish on a stock that is moving toward an important support level, do not place the trade at the support level. Instead, place it above the support level, but within a few points. On the other hand, if you are placing stops or short selling, set up your trade price at or below the level of support.

How to calculate support & resistance levels of stocks?

There are many ways to calculate levels of support and resistance (Pivot point method, Moving averages, Fibonacci numbers etc). One of the most common is to use a series of formulas to calculate "pivot points", described herein.  

·         Calculate the pivot point as follows, using the previous day’s high, low, and close:

Pivot or P = (High + Low + Close) / 3

·         Calculate the first support point               : S1 = (P x 2) – H

·         Calculate the second support point           : S2 = P - (High - Low)

·         Calculate the first resistance point           : R1 = (P x 2) – Low

·         Calculate the second resistance point       : R2 = P + (High - Low)

Adjusted Pivots

Many traders adjust their value for P as follows:

P = O + (H + L + C) / 4 (where H, L & C are from the previous day’s stock details) and O is Today's Opening Price.

Pivot points are short-term indicators, and ultimately it is the trader's responsibility to use them wisely, in conjunction with other confirming indicators. However, a set of pivot points must be recalculated each day.

Three principle factors determine the strength of support and resistance levels:

The longer the period of time a price trades in a specific area of support or resistance the greater the significance of the level.

Volume is another way to gauge the importance of a level- the more volume of trading that takes place the more significant the level. The more recent the activity the more significant the level- the reason being that the level is influenced by the positions of traders currently in the market.

Conclusion

Determining future levels of support can drastically improve the returns of a short-term investing strategy because it gives traders an accurate picture of what price levels should prop up the price of a given security in the event of a correction. Conversely, foreseeing a level of resistance can be advantageous because this is a price level that could potentially harm a long position because it signifies an area where investors have a high willingness to sell the security. As mentioned above, there are several different methods to choose when looking to identify support/resistance, but regardless of the method, the interpretation remains the same – it prevents the price of an underlying from moving in a certain direction.

Reverse mortgage

What is Reverse mortgage and how does it operate?

It is a type of mortgage in which an owner of a residential property in Indian can borrow money against the value of his or her home. A reverse mortgage provides stream of income flows which normally senior citizens can tap into for their retirement. Borrower need not have any income nor is his credit record relevant as the loan is being secured by the underlying property.

Under the reverse mortgage, borrower will have various options to receive the loan, either lump-sum, monthly payments or a line of credit. Amount received not considered as income chargeable to tax since the loan advances are disbursement of the principal and not income. No repayment of the mortgage (principal or interest) is required until the borrower dies or the home is sold. The loan amount can either be repaid by the borrower, his/her legal heirs.

All one needs to ensure to avail a reverse mortgage loan is to have an own house with no encumbrances.

Tax breaks for reverse mortgages

The reverse mortgage scheme has been announced in budget 2007 with a view to provide a stream of cash flow to needy senior citizens against mortgage of their residential house. There were areas of confusions which were addressed subsequently in the Finance act, 2008 where in the following two amendments were made effective FY 2007-08 which cleared off all the confusions:

a. Though mortgage of property under transfer of property act is treated as transfer, a new provision has been made under section 47(xvi) of the income tax act to provide that any transfer of capital asset in a transaction under notified reverse mortgage scheme will not be treated as transfer and shall not attract any taxable capital gains.

b. A new provision u/s 10(43) of the income tax act has been introduced to clarify that any amount of loan, received either in lump sum or installments under a notified reverse mortgage scheme shall be treated as exempt from income tax.9/27/13.

Further, the Central Government has also notified ‘Reverse mortgage scheme, 2008’ vide notification No. 93/2008 dated 30-09-2008. As per the notification, the reverse mortgage benefits can be availed by an individual who is 60 years or above as on the date of application for loan to the approved financial institutions. Such an eligible person has to apply for the loan under this scheme in writing to the approved financial institution. Only thing he/she needs to ensure is that the residential house property is located in India and it is free from any encumbrances.

Loan eligibility

The approved financial institution being any scheduled bank of housing finance company may disburse the loan to the reverse mortgagor by any one of the following modes namely.

a. Periodic payments to be decided mutually between the institution and the reverse mortgagor.

b. Lump sum payment in one of more tranches, to the extent that the aggregate of the amount disbursed as lump sum does not exceed fifty percent of the total loan amount sanctioned.

The loan so granted under reverse mortgage shall not be for a period of more than 20 years from the date of signing the agreement by the reverse mortgagor and the approved financial institution. The reverse mortgagor, or his legal heirs or estate, shall be liable for repayment of the principal amount of loan with interest to the approved lending institution at the time of foreclosure of the loan agreement.

Almost all the banks in India have their own sweet reverse mortgage plans!