Case 089Working capital and cash flowCore
A group reports Rs 800 crore of consolidated cash and Rs 1,500 crore of parent debt. The cash sits in a joint venture, a regulated subsidiary, an overseas unit and the parent. How much is really available, and what is true net debt?
1The situation
Aranyak Group, an invented conglomerate, reports consolidated cash of Rs 800 crore and net debt of Rs 700 crore against Rs 1,500 crore of bonds issued by the parent. Consolidated EBITDA is Rs 400 crore, so the group presents net leverage of 1.75x.
The cash is spread out. Rs 300 crore sits in a 51% joint venture whose agreement requires the partner's consent for any dividend or loan to the shareholders. Rs 200 crore sits in a regulated subsidiary that must hold at least Rs 150 crore under its licence. Rs 100 crore sits in an overseas subsidiary and would bear 15% tax if brought home. Rs 200 crore is at the parent. The bonds mature in two years, and a credit analyst asks you what cash the parent could actually use to repay them.
2Your task
How much of the Rs 800 crore can the parent use, what is true net debt and leverage, and what would you ask management?
Quick check
Of the Rs 800 crore, how much could the parent send to its bondholders tomorrow without anyone else's permission?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
About Rs 335 crore is usable, so true net debt is about Rs 1,165 crore and leverage 2.9x EBITDA, not the 1.75x reported. The parent's Rs 200 crore is free; the regulated subsidiary can release Rs 50 crore; the overseas cash yields Rs 85 crore after tax. The joint venture's Rs 300 crore needs the partner's consent, and even then only 51% of it belongs to Aranyak. With the partner's consent to a dividend, usable cash rises to about Rs 488 crore. The bondholders face a Rs 1,500 crore maturity with a third of the headline cash behind it.
Step 1Why is consolidated cash not the parent's cash?
A family that adds up every member's bank balance has a number, but the parents cannot spend the daughter's salary, the money in the son's locked savings scheme, or the uncle's share of the family shop. Consolidation adds up cash the group controls; it does not say which legal entity holds it or what stands between that entity and the parent. Aranyak's bonds are a claim on the parent, so the question is what the parent can lay hands on. Each location has its own obstacle: a shareholders' agreementThe contract between the owners of a joint venture that sets out who must agree before the company pays dividends, borrows or lends. at the joint venture, a licence condition at the regulated subsidiary, and a tax charge on the overseas cash.
Step 2How do you work through each pocket?
Take them in order of how hard they are to reach. Parent cash is free; regulated cash is free only above the licence minimum; overseas cash is free after the tax on bringing it home; joint venture cash is not free at all until the partner says so. The regulated subsidiary holds Rs 200 crore against a Rs 150 crore minimum, so Rs 50 crore can come up as a dividend. The overseas Rs 100 crore loses 15% to tax, leaving Rs 85 crore, and the actual rate depends on the treaty and the current rules in both countries, which you should confirm rather than assume. The joint venture is the trap: the agreement needs consent, and 49% of any dividend goes to the partner, so the most Aranyak could ever see is Rs 153 crore.
| 200 | cash held at the parent, Rs crore |
| 200 - 150 | regulated subsidiary cash above its licence minimum |
| 100 x (1 - 0.15) | overseas cash after the tax on repatriation |
| 0 | the joint venture's cash, unavailable without partner consent |
| Where the cash sits | Reported, Rs crore | Usable by the parent | What stands in the way |
|---|---|---|---|
| Parent company | 200 | 200 | Free |
| Regulated subsidiary | 200 | 50 | Must keep Rs 150 crore |
| Overseas subsidiary | 100 | 85 | 15% tax on bringing it home |
| 51% joint venture | 300 | 0 | Partner must consent; 49% is not Aranyak's |
| Total | 800 | 335 | Rs 465 crore trapped or lost to tax |
Step 3What does this do to the credit view?
Net leverage moves from 1.75x to about 2.9x on the same EBITDA, and part of that EBITDA has the same problem, because the joint venture's earnings are consolidated too while its cash is not reachable. There is also a running cost: Rs 465 crore earning perhaps 6% in deposits while the parent pays 9% on bonds is a negative carry of about Rs 14 crore a year. Ask management four things: whether the joint venture partner has ever consented to a dividend and on what terms; whether the regulated subsidiary's minimum is a floor or a ratio that moves with its business; what the overseas unit needs the cash for; and how the parent plans to meet the Rs 1,500 crore maturity, since refinancing rather than repayment is now the realistic route. A rating analyst would treat the joint venture cash as restricted and give the parent credit only for the Rs 335 crore.
Where candidates lose it
The common loss is netting all the cash against all the debt because the consolidated balance sheet does. The bonds are the parent's; the cash is mostly somebody else's to release, and the interviewer wants to hear the word parent before the word net.
The second loss is counting 51% of the joint venture's cash as usable because Aranyak owns 51%. Ownership gives Aranyak a share of a dividend if one is declared; the agreement decides whether one can be declared at all.
What the interviewer asks next
- The joint venture partner offers consent to a dividend in exchange for a higher share of future profits. How would you value that trade?
- Aranyak proposes an intercompany loan from the regulated subsidiary to the parent. What would the regulator and the bondholders say?
- How should the group present net debt in its investor materials so that this does not look like concealment?
- If the overseas tax on repatriation rose to 25%, would it change what you recommend?
Company names and figures are illustrative.