Orchid's Rao says learnt a lesson in choppy markets

Kailasam Raghavendra Rao, founder and MD of Chennai-based drugmaker Orchid Chemicals & Pharmaceuticals, has said he repents borrowing money to buy more shares in his company and that he will never do it again. Mr Rao, who incurred a personal loss of Rs 75 crore when his lenders sold off 7.5% stake from his family's holdings on Monday, also denied market talk that the company had suffered forex losses.

But the bigger worry for Mr Rao would now be the vulnerability of the company for a takeover, as its market value at a mere Rs 750 crore is just a third of what it was just two months ago. With only 17% stake, the cash-strapped founders may find it difficult to resist such an eventuality, some market sources said. Ironically, it was this vulnerability that forced Mr Rao to try raising his stake with borrowed money.

Investors were rattled again on Tuesday as Orchid shares lost a further 10.3% to close at Rs 113.95 on BSE. “It has hurt me. And it has hurt so many other stakeholders,” Mr Rao, a first-generation entrepreneur and son of a railway clerk, told ET. “Borrowing to raise stake was an inappropriate thing to do.

It is a big lesson for me.” In March-April 2007, Mr Rao said he borrowed around Rs 85 crore from Indiabulls and Religare Finvest to raise the promoter stake from 17% to 24%. In an improvised system called promoter funding, brokerages lend money to company founders against a pledge of their shares. Indiabulls typically lends Rs 25-33 against shares worth Rs 100. Religare lent Mr Rao half the value.

“There are thresholds specified when the margin calls would come into play if the price falls,” Indiabulls CEO Gagan Banga said. Mr Rao had repaid around Rs 5 crore to these firms, but the market plunge invoked the thresholds last Friday. The two firms asked him to pay up the margins, which Mr Rao could not manage by Monday.

“I was in a village near Bangalore and the suddenness of the whole thing took me by surprise,” he said. When the stock fell further, partly as the beleaguered Bear Stearns sold off a million shares, the brokerages sold off a good portion of the pledged shares and recovered their money. Mr Rao's family lost about Rs 150 per share.

While Mr Rao has cleared his dues to these two firms, he still owes nearly Rs 65 crore to FIs and his current stake is pledged to them. “It is my priority to repay all those loans with my salary, dividend and profit share,” Mr Rao said.

Analysts said the bitter episode has shaken investor confidence on the integrity of the management and the stock is bound to reflect that. “While the company's operations are OK, this thing will set a wrong precedent. People will ask why promoters have dabbled in it,” said Sarabjit Kour Nangra, VP for research at Angel Broking.

Orchid's consolidated revenues for Q3 ended December 2007 rose 40% to Rs 347.38 crore while net profit rose 94% to Rs 49.96 crore. At Tuesday's price, Orchid shares were trading 7.2 times the company's expected 2007-08 earnings.

Analysts have been citing strong earnings visibility over the next two years and new product launches as reasons for their optimism on the stock. Just two weeks ago, LIC bought an additional 2.3% in the company to raise its stake to 7.8%.

Around the same time, Citigroup Global Markets had set a target price of Rs 386 for the stock with a ‘buy' recommendation. Domestic and foreign institutions hold more than 35% in the company while foreign companies hold about 15%.