Saptak Holdings owns 80% of a power generator with its own debt and all of a small trading arm, and owes notes at the holding company. What do the holdco noteholders recover in a liquidation, and how do the consolidated accounts overstate their protection?

The Holdings noteholders recover about 80%. Generation pays its Rs 300 crore of debt first, leaving Rs 200 crore of equity, of which Holdings owns 80%, Rs 160 crore. Add Rs 40 crore from the trading arm and Holdings has Rs 200 crore for Rs 250 crore of notes. The consolidated accounts count all of Generation's value and EBITDA, including the minority's 20%, which suggests a 96% recovery the notes can never reach.

Suppose you lend money to a friend who owns 80% of a restaurant with a partner owning the rest. If the restaurant is sold, its suppliers and bank are paid first, then what is left splits 80 to 20. Your claim is on your friend's 80% of what is left, never on the partner's 20%, however much your friend runs the place. Holdings' noteholders are in your position: they stand behind Generation's own lenders, which is structural subordinationLenders to a parent rank behind the creditors of its subsidiaries, because the parent only owns shares in them., and they share what is left with the minority.

Run it entity by entity. Generation: Rs 500 crore less Rs 300 crore of its own debt leaves Rs 200 crore of equity. Holdings takes 80%, Rs 160 crore; the minority takes Rs 40 crore. Trading arm: Rs 40 crore, all to Holdings. Holdings has Rs 200 crore against Rs 250 crore of notes, a recovery of 80%.

Because Holdings controls Generation, it consolidates 100% of Generation's assets, debt and EBITDA, and shows the minority's 20% as a single line in equity called non-controlling interestThe share of a subsidiary’s equity owned by outside investors. Consolidated accounts include all of the subsidiary and show the outsiders’ share as one line within equity.. A reader who takes group value of Rs 540 crore, subtracts Generation's Rs 300 crore of debt and hands the rest to the notes gets Rs 240 crore, 96%. That reading gives the notes the minority's Rs 40 crore, which they have no claim on.

Leverage gets flattered the same way. Consolidated debt of Rs 550 crore on consolidated EBITDA of Rs 88 crore is 6.25x. Holdings' look-through view counts its 80% of Generation's EBITDA, Rs 64 crore, plus the trading arm's Rs 8 crore, Rs 72 crore, against 80% of Generation's debt plus the notes, Rs 490 crore. That is 6.81x, so the notes are more levered than the group headline suggests.

Very. Holdings owns a thin slice of equity on top of Rs 300 crore of debt, so every Rs 10 crore change in Generation's value moves the notes' recovery by about 3.2 points. At Rs 400 crore, Generation's equity halves to Rs 100 crore, Holdings gets Rs 80 crore plus Rs 40 crore, and the notes recover 48%. Below Rs 300 crore nothing passes up from Generation at all and the notes are left with the trading arm, 16%.

Close with what you would check first: guarantees from Generation to the notes, which would lift them alongside Generation's lenders; any shareholder agreement giving the minority special rights in a sale; and cash moving between the companies, such as loans from Holdings to Generation, which would rank as Generation debt and change the waterfall.