Apologies if already posted.Art of borrowing
Apart from KF airlines saga, also contains how a ponzi scheme is setup.
Picture yourself as a smart alec from one of India’s many fast-growing states—Andhra, Gujarat, and now even Bihar—who happens to run a small family business and is an old pal of the local Mantriji. With suitable inputs from his ministry’s babu, Mantriji floats a scheme to put up a large power generation project, say, worth a hefty Rs 2,000 crore.
You summon a huddle of the large extended undivided family, and count your blessings, cash piles and bank accounts. Let’s say you have only Rs 100 crore. That elder who you think has been going senile scoffs and mumbles something to the effect of boys these days wanting to set up projects 20 times larger than the collective family wealth. You sigh deeply and buy him a ticket to Haridwar, Kashi, Chitrakoot or wherever. From here on, he can run the family charitable trust and generate goodwill.
The Rs 2,000 crore power project is of national importance, being of strategic value to the country’s growth, so the government has sanctioned a 12 per cent ‘guaranteed return’. This bait is to be used to get banks in. At high leverage. This implies that instead of the prudent 2:1 debt-to-equity ratio, you can stretch it to 3:1. In simple English, that means for every rupee that you put in, the bank will give you a loan of Rs 3. If you put in Rs 500 crore, banks will release Rs 1,500 crore.
Now, in a company with Rs 500 crore of equity capital, promoters need to have only a little more than Rs 250 crore worth of shares to have a controlling stake of just over 50 per cent. The rest can be dispersed among a million investors. But then, that doesn’t solve your problem. All you have is Rs 100 crore. You are Rs 150 crore short. What do you do?
You appoint a Merchant Banker—guys in suits who help you raise money from capital markets. They make you incorporate a new company with Rs 100 crore in capital, its 100 million shares (of Rs 10 face value each) owned entirely by you and your family. After that, riding on the wonderful project you have bagged, they help you launch an Initial Public Offer (IPO).
You offer the public another 100 million shares at Rs 40 each, a premium of Rs 30. So what if the project has not even acquired land, leave alone plant and machinery, forget generating even a single megawatt of power? The Merchant Banker’s PR division plants helpful stories in the press extolling the virtues of the project and its promoters. Helpful stockbrokers circulate stories of the grey market premium that the yet-to-be-sold shares command. Your IPO is ‘oversubscribed’ thanks to the Standard Tricks Department of the Merchant Banker, and the shares debut on the stockmarket at Rs 50, trading at Rs 10 more than the issue price of Rs 40. The net worth of your company is now Rs 500 crore: Rs 200 crore paid-up capital (half of it yours) and Rs 300 crore in the share premium account. And you still own half the business.
To meet their lending targets (and keep Mantriji happy), the banks promptly sanction Rs 1,500 crore in loans. Mantriji, a coalition partner in the state government by virtue of his three seats in the Assembly, provides support to the Chief Minister, whose party survives on a one-vote majority. Of your 50 per cent ownership, he has been given a secret 10 per cent stake. Of course, he does not own it directly but through two other local businessmen—one, a former property dealer, now a real estate company, and the other, a former tent-tamboo trader, now also a real estate company.
With Rs 2,000 crore in your kitty, you now set off to distant shores to buy power equipment. Your travels take you to Old Europe, to the not-so-old US, and finally to New China, where you settle on state-of-the-art technology for Rs 1,000 crore. Next, your travels take you to Dubai, Singapore and finally Mauritius. Here, your Merchant Bank helps you set up a company that buys this equipment for Rs 1,000 crore from your Chinese suppliers, and then sells it, in turn, to your Indian market-listed power company for Rs 1,500 crore. Thus, your Rs 100 crore investment has already generated Rs 500 crore for you in a tax haven. Satisfied, you return to India with the peace of an ascetic and spirit of a man who has travelled the world to see India succeed.
With the balance Rs 500 crore, you acquire land in a formerly ‘no-go area’ at throwaway prices from naïve tribals who are easily pleased with a third-rate hospital and worse school you set up for their upliftment (thus acquiring a do-gooder’s public image). In two years, the project is up and running. To guarantee 12 per cent returns on the Rs 2,000 crore project, the government buys electricity from you at a price that generates Rs 240 crore. You pay your banks Rs 150 crore in interest, and earn profits of Rs 90 crore on capital of Rs 200 crore. That is an earning-per-share of Rs 4.5, enough to keep your share price in a range of Rs 50-75 and your IPO investors happy.
The Rs 500 crore you ‘earned’ in Mauritius, though, has shrunk to Rs 250 crore because you had to pay off the Merchant Banker, Mantriji, his babu, the press, and a few jholawalas and sundry accomplices. But you are now the proud owner of a Rs 2,000 crore company in India, and have a neat Rs 250 crore in dollars overseas. You can now set up another infrastructure project. This time, your money enters the country as FDI from your Mauritius company.
Oh, we forgot to mention the ‘Business- man of the Year’ award that a business TV channel will give you this year. And the Bharat Sammaan to be awarded by a Hindi TV channel. It’s only a small dent in your overseas bank account. You deserve every bit of it, of course, for having brought so much investment into the country, setting up critical infra projects, putting up schools and hospitals. And those dumb Americans call such path-breaking projects Ponzi schemes!