Is this diamond forever?

What are the key factors that make fund managers decide on a buy? Read on.

Dipen ShethYeh heera kya sadaa ke liye hai?" This is the question on my mind as I e-mail my fortnightly instalment to MONEY TODAY from a musty hotel room in Vadodara, Gujarat. It pertains to a mid-sized company called Diamond Cables in the business of making power conductors and cables. Back from the brink of financial disaster, Diamond has embarked on a growth plan that boggles the mind, to say the least. But before you take a potshot at investing in Diamond for the long term, let me tell you what I know about it.

Diamond Cables first hit my radar in February 2006 when the company announced its plans for debt restructuring. Driven by rumours of a financial revamp, the Diamond scrip was trading at around Rs 60. I was sceptical because the company had terrible financials—an overleveraged balance sheet and operations on a scale that was insufficient to service the debt burden.

The story starts in late 2005 when Amit Bhatnagar (Diamond’s joint managing director) told his bankers in a fit of frustration that he had decided to wind up the company as it was reeling under a cash crunch. The roots of this crunch went back to the company’s capital expenditure (capex) into alloying and rolling (backward integration in conductor manufacturing) which would give it unparalleled advantage in terms of product quality.

Diamond was always respected for the technical capabilities of Amit’s father, S. N. Bhatnagar, a reputed technocrat in the transmission and distribution (T&D) industry. The business was viable but a delay in releasing working capital funds was making it unsustainable. Not surprisingly, Diamond’s bankers were not budging and were reluctant to take any further risk by lending additional debt.

The company was fast turning sick, which forced the junior Bhatnagar to look for alternate financers. Amit took his company to several “distress situation investors” and initiated a “haircut” to settle with his banks. The discussions dragged on and on while another financial year drew to a close (March 2006). Diamond had to extend its accounting period to September.

In August 2006, after months of tortuous negotiations and iterations, the banks finally agreed to settle the Rs 131 crore of outstanding debt at, hold your breath, Rs 45 crore only! Infusion for the debt settlement came from Clearwater Capital, an international investor that among other things, specialises in distress situations. Clearwater acquired a stake in the company via a warrant issue at Rs 95 per share and fully convertible debentures (also convertible at Rs 95 per share) plus an infusion of Rs 128.5 crore debt into Diamond.

The results of this resuscitation showed immediately on the balance sheet. For the 18-month period ended September 2006, Diamond’s net worth jumped from a negative Rs 2.33 crore in March 2005 to a positive Rs 17 crore. While total debt remained high at Rs 102 crore against the earlier Rs 118 crore, Diamond effectively had only one real lender now: Clearwater.

In the six months after September 2006, operations ramped up. This revitalised the profit and loss account. Bhatnagar decided to close accounts for the six-month period to March 2007 which had posted a 53% rise in sales to over Rs 138 crore. A remarkable increase from Rs 90 crore sales in March 2006. On a comparable basis, the company doubled net profit to over Rs 16 crore.

Sensing that the company was going places, I was planning a visit to Vadodara, where Diamond is based. But in February 2007 (well before I could shake off my laziness), Diamond announced another round of fund raising (Rs 52.5 crore), this time at Rs 150 per share. The intention was to expand into related areas of T&D: high-tension and speciality cables (a high-margin business), T&D feeder projects, hightension and low-tension projects as well as acquisition of companies in the power equipment business.

Clearly, Diamond was aspiring to become a turnkey provider of products and services under one roof. Soon enough, Bhatnagar closed two important deals: the takeover of Western Transformers and more important, the acquisition of a controlling stake in Apex Electricals (a once-respectable name in the transformer business that had fallen on bad times) and its associate companies in the business of distribution transformers, transformer laminations and copper wires.

For a mere Rs 85 crore, Diamond was adding some 10,000 mega voltampere of transformer capacity plus cold-rolled grain oriented (lamination) and copper wire drawing to its business. In another development, the debt of Rs 70 crore on Apex’s books is proposed to be settled at 15% of the original value, while a capex of over Rs 30 crore will be pumped in over a two-year period to refurbish its capacities. The ultimate revenue potential from Apex: a staggering Rs 800-900 crore, up from Diamond’s current run rate of under Rs 400 crore a year. A blended EBIDTA margin of around 15% is more than likely by the end of year as the transformer business is currently supporting 20% and more.

Won’t all this require further dilution on an equity account already used to fund raising? Will the growth in business take its toll on a management already short on bandwidth? Will new managers in key positions deliver? Will working capital finance, once the reason for the company’s tottering finances, prove to be a bottleneck? Will the projects business, which has bid for projects worth more than Rs 1,000 crore manage to deliver on business promise like the products business ? A million questions haunt me even after my recent trip to its headquarters. a day before Diamond’s June 2007 quarterly results announcement. The Bhatnagars are confident they can pull it off, although the numerical (and detailed) answers to my long list are yet to be furnished.

What I like about this management though, is its strategic clarity and ability to deliver on the ground, at least so far. Goodish vibes and oodles of talent were visible across all levels of management. Till the numbers come to me, these are the only indications that this shiny stone is indeed a diamond. But should it be held forever? Stay tuned for more updates. And yes, if you are fishing for a disclaimer or disclosure of any kind, we have bought Diamond Cables.

By Dipen Sheth, Head of Research, Wealth Management Advisory Services