We have today sent the following letter to the Board of Directors:


16 July, 2020

 

The Board of Directors
N.B.I. Industrial Finance Co. Ltd.
21 Strand Road
Kolkata 700 001
India
Attn: B. L. Gaggar, Chairman

 

Dear Members of the Board,

We are writing to you on behalf of Metrica Asia Event Driven Master Fund which holds a stake in N.B.I. Industrial Finance Co. Ltd. (“NBI”) equivalent to 9.5% of the non-promoter shares.

We have been following and investing in NBI for several years, and we highly rate the company’s annual reports and earnings releases which are informative and detailed.

Nonetheless, we have recently found several aspects of the company’s management to be puzzling, and we have been unable to derive satisfactory explanations from the publicly available materials.

As such, we will be seeking your assistance in answering the following questions at the forthcoming Annual General Meeting. We present these questions in advance to give the Board ample time to consider its responses.

 

Question 1

We have been impressed by NBI’s performance since its listing on the National Stock Exchange in 2016, with a positive net profit every year and net assets on a rising trend. However, we note that the company has only paid a dividend once during this period. Please refer to the following for details:
Profit, net assets and dividends

Year ending March Net profit Net assets Dividend paid
2016 3.4 1,072
2017 80.7 1,502 0.1
2018 3.8 1,493
2019 6.1 1,709
2020 13.0 1,617

All figures in ₹ crore (10 million). For fiscal 2018 and earlier, net assets have been adjusted to reflect market value of quoted investments as reported by company.

 

We note that the explanations for not paying a dividend given in the annual reports or announcements of results of years other than 2017 have been as follows:

2016: To further strengthen the financial position of the Company and to conserve resources your Directors have decided not to recommend dividend [sic].

2018: The Board does not recommend any dividend for the year . . . with a view to further strengthen the resources.

2019: The Board does not recommend any dividend for the year . . . with a view to further strengthen the resources.

2020: Please note that the Board has not recommended any dividend for the year … with a view to conserve resources.

Our questions on this topic:

Why do the resources need conserving, given the company’s extremely strong balance sheet and earnings by any objective standard?

When will the company consider the resources as being sufficient to resume dividends? Please commit to a target expressed in terms of financial statement ratios.

 

Question 2

Our second question is with reference to the Union Budget 2020-21 presented by Finance Minister Nirmala Sitharaman, which has abolished Dividend Distribution Tax (DDT) for fiscal 2020-21 onwards.

We note that, in prior years, companies were not taxed on dividends received, but they were subject to DDT on dividends paid out. Netting off was available where dividends were received from subsidiaries, but this did not apply to NBI as none of its investments qualify as subsidiaries (50% ownership required).

We also note that from this fiscal year, companies must pay income tax on all dividends received unless they pay out at least as much in dividends to their own shareholders at least one month before the tax filing date (Section 80M of the Income Tax Act). This applies to all dividends, not just those received from subsidiaries. We summarise our understanding of this topic in the following table:

 

India: dividend tax pre- and post-April 2020

  Dividends received Dividends paid
Before April 2020 (DDT regime) NO TAX DDT payable but deduction for dividends received from subsidiaries (50%+ ownership)
After April 2020 Taxed as income but deduction for dividends paid out at least one month before tax filing date NO TAX

 

We congratulate the company on earning a record level of dividends from its investments in fiscal 2020. We further note that NBI has received dividends in each of the last five years, and has only once paid out even a small fraction of these to its own shareholders. Please refer to the following table for details:

 

NBI: dividends paid and received

All figures in ₹ crore (10 million).

Fiscal year Dividends received Dividends paid Paid / received
2016 3.4 0%
2017 10.1 0.1 1%
2018 5.2 0%
2019 5.5 0%
2020 14.0 0%

 

From fiscal 2020-21, if NBI continues its past pattern of not paying out all of the dividends it receives, it will naturally result in a higher tax bill and consequent destruction of shareholder value.

Given the abolition of Dividend Distribution Tax, will the company commit to paying out all dividends received from its investments from fiscal 2020-21 onwards, given that to do otherwise will incur unnecessary and wasteful taxes?

 

Question 3

We congratulate the company on its history of recording large capital gains from its investments such as Shree Cement.

Our third question is with reference to the Union Budget 2018-19 presented by Arun Jaitley, which introduced capital gains taxes on the sale of listed equity shares held for more than one year, at a rate of 10%. This became effective on 1 April 2018.

We note that since that date, companies such as NBI which directly hold listed equity portfolios have been liable for capital gains taxes on them, which must be recorded as deferred tax liabilities according to Indian Accounting Standards even if there is no current intention to sell the positions.

On top of this, shareholders of companies such as NBI are liable for their own capital gains taxes, whether as retail or institutional investors.

We note that this means that NBI’s shareholders effectively face two layers of capital gains taxes on the listed equity portfolio: once at the company level, and then again at the shareholder level.

By contrast, shareholders in – for example – a mutual fund which held listed equities would face only one layer of taxes.

We note that NBI’s directors have highlighted the company’s commitment to efficiency in the 2019 Annual Report, page 30 (our emphasis):

 

The Company is fully committed to the principles of transparency, integrity and accountability in all spheres of its operations and has been practicing the principles of good corporate governance over the years. In keeping with this commitment, the Company has been upholding fair and ethical business and corporate practices and transparency in its dealings and continuously endeavors to review, strengthen and upgrade its systems and procedures so as to bring in transparency and efficiency in its various business segments.

 

We would like to gain a better understanding of how the maintenance of a corporate structure which results in double taxation for its shareholders is consistent with a commitment to efficiency.

Given the introduction of long-term capital gains tax on equities, how does NBI propose to address the “double-taxation” issue within the context of the company’s commitment to good corporate governance?

 

Question 4

We highly appraise NBI’s selection of high-quality assets for investment, including a substantial stake in one of the most successful cement companies in India (Shree Cement) which accounts for around 95% of the total portfolio by value according to our research.

We also note that, despite this, NBI’s share price is trading at a very large discount to the value of these assets. Please see the following for an illustration:

 

According to our research, this has been the case ever since NBI moved its listing to the National Stock Exchange in 2016, with the typical discount being in the range 73-79%. Please see the following table for details:

 

Average share price discount to net assets

Quoted investments valued at market. Updated as of 10 July, 2020.

Year ending March Net assets per share at start of year (₹) Average share price (₹) Average discount to net assets
2017 4,445 935 79%
2018 6,359 1,743 73%
2019 6,077 1,307 78%
2020 6,958 1,427 79%
2021 6,581 1,486 77%

We note that shareholders who wish to sell their shares must therefore accept an extremely low valuation. In addition, the company is hampered from raising equity finance as it would be grossly value-destructive to do so with the share price at such an extreme discount to book value.

What measures does NBI propose to address the share price’s significant discount to net asset value?

 

Question 5

We congratulate NBI on its long and illustrious history. We note that the company was incorporated in 1936 and is categorised as a Non-Bank Financial Company (NBFC) under the Companies Act, 1956. However, in contrast to many other listed NBFCs, it does not appear to have conducted any real business for a very long time. Despite the company’s name, NBI Industrial Finance does not appear to conduct any “financing” of any “industry”.

We also note that around 95% of the company’s assets are represented by its holding in Shree Cement. And most of the non-Shree Cement investments are also listed stocks that any investor could go out and purchase by him/herself. Yet compared with holding these stocks directly as an individual investor, NBI is highly disadvantaged due to the requirement to pay National Stock Exchange listing fees, auditing fees, annual report preparation fees, dividend taxes (from fiscal 2020), long-term capital gains taxes, employee salaries, directors’ fees, office rent and so on.

We would like to ask the Members of the Board to shed light on the purpose of NBI maintaining its listing on a public stock exchange when almost every investor would be better off buying shares of Shree Cement directly.

What is the purpose of maintaining the company’s listing on the public markets?

 

We thank you for your consideration of the above questions, and look forward to hearing your responses at the General Meeting.

Yours sincerely,

 

 

 

Damian L. Edwards
Chief Investment Officer
Metrica Partners Pte. Ltd.

About Metrica:

Metrica Partners Pte. Ltd. is a Singapore-based investment manager founded in 2016 by Damian L. Edwards and David Mulvenna. Investors in Metrica’s funds include global institutions, family offices, high net worth individuals and its employees. Metrica promotes good corporate governance and works with its portfolio companies to enhance shareholder value. More information is available at https://metricapartners.com.