The ITC Classic Story

THE CLASSIC POST-MORTEM contd...

The credit rating agency, Credit Rating Information Serviced Ltd. (CRISIL) downgraded Classic's rating for its fixed deposit scheme and non-convertible debentures from AA to A+ and from FAA+ to FAA-, respectively in June 1996 and further to A- and FA, respectively in December 1996. An internal CRISIL note revealed some other important issues that had led to Classic's demise. The note stated: “Although the company's asset portfolio remained fairly well-diversified in terms of the client base/industry spread, the high growth rate, and the inherent risk in corporate plant and machinery financing had an adverse impact on the company's asset quality, resulting in difficulty in timely recovery of dues from a number of clients.” The note further criticized Classic's exposure to the corporate asset financing business in general, and to the machinery segment in particular, which was inherently deemed to be risky.

THE MERGER

ITC soon realized that only one of the country's three mega-financial institutions - Industrial Development Bank of India (IDBI), Industrial Finance Corporation of India (IFCI), or ICICI would be in a position to absorb Classic's losses and bad loans. ITC approached IDBI and ICICI and held extensive discussions with both the FIs. Eventually, a deal was struck with ICICI at a swap ratio of 1 ICICI share for 15 shares of Classic^[4] .

In January 1998, shareholders of Classic approved the company's amalgamation with ICICI with 99.93% of the votes in favor of the resolution. Justifying the merger from ICICI's perspective, Kamath said, “Our goal is to move towards universal banking with a spectrum of financial solutions. Any opportunity to move closer to the goal will be capitalized.” However, a section of ICICI shareholders, holding shares of both ICICI and ITC Classic, opposed the merger resolution claiming that the merger ratio was unfair and was ‘leaked'to the market.

They said that the price dropped and adjusted to the merger ratio much before the announcement of the ratio by the company. They also alleged that if the market price of the share was one of the considerations, then the fall in the price of the share just before the merger was a clear indication that the swap ratio was already in the market before the announcement. Voices were also raised against ICICI's decision to retain only those Classic employees whom it found capable after internal evaluations. However, since the dissenting shareholders were in minority, the resolution was successfully tabled.

ITC and its affiliate companies subscribed to a preferential share issue of Rs 350 crore of ICICI as part of the merger proposal. The preferential share capital carried a nominal interest of Re 1 for every Rs 1 crore of share capital issued for a period of 20 years. The infusion of funds in ICICI by ITC was to take care of any future liabilities arising out of the merger. One-fourth of Classic's asset base of Rs 1,000 crore accounted for investments in subsidiaries that operated in the stockbroking and mutual funds business. As ICICI was not interested in them, ITC provided Rs 272 crore to repay secured creditors, and to make up for the losses due to the decline in the investments made by these subsidiaries.

It was decided to prepay Classic's creditors to reduce its interest burden. ITC also assumed the liabilities and obligations in relation to all guarantees and indemnities issued by Classic. ICICI accepted to absorb the Classic personnel as per its requirements and the rest were redeployed by the ITC group.

^[4] The swap ratio was based on four factors - net asset value (NAV), market value of the shares, earning potential and credit for intangible assets. Independent auditors C.C. Chokshi and Company and Bansi S. Mehta and Company carried out the valuation exercise. The NAV of Classic was negative; the market value of the shares did not reflect the true value (the scrip was then trading at Rs 20); and the earnings potential for the next three years was deemed to be zero. Only the intangibles of the company were found to be of some value. The worth of the firm, calculated after deducting the net present value of its assets from that of its liabilities, was found to be negative. This led to the swap ratio being heavily biased in favor of ICICI. Classic loyalists who had seen the scrip quoting as high as Rs 375 in September 1994 were quick to point out that this was an extremely poor valuation. However, the valuation was justified on the basis that it took into account the high level of non-performing assets of Classic.

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