I wrote about two companies in January – Deccan chronicles and Zylog systems (read here).

In case of deccan chronicles, the stock had  dropped more than 90% from its peak and a debt default and other allegations were already in the newspapers.

In case of zylog, my impression from reading the annual reports was summarized as follows

1. poor operating performance resulting in cash flow problems (in addition to commoditization of the core business)
2. Cash flow problems resulting in higher debt which was taken to fund the growth
3. higher debt resulting in promoter pledges to get the funds
4. Point 3 causing the stock to drop, resulting in margin calls and forced sale of the pledged stock.
5. The forced sale, causing further steep drop in the stock price

As part of the disclosure, I indicated in the post that I had a very small speculative position in the stock and in the comments section provided the following rationale for it

i am testing a hypothesis that the management will fix cash flow problems and the business is worth more than the current mcap
however it is a speculative position with a large probability of loss. it is also a very tiny, insignificant position

hi anil
i would not call such postions a mistake. i do such things actively – on very tiny amounts

these position have a large learning value which is worth more than the money lost. one could get the same by just watching it, but when you put real money, the experience is very very different. it helps one in avoiding such mistakes in the larger serious position.

A new update

On June 14th, SEBI barred the promoters (read here) from buying or selling any securities in the stock market

The key points in the news article seem to be the following

Sebi had, suo moto, carried out an examination in the scrip of Zylog Systems in view of surveillance alerts regarding variation in price. Sebi during examination of the scrip prima-facie observed that the company provided misleading information to the stock exchanges wherein it stated that its promoters have been buying and increasing their stake while actually the promoters were net sellers and their shareholding declined due to invocation of pledge by financiers. Similar misleading clarification was also given by the promoter of Zylog Systems, Sudarshan, to the media.

Sebi order said that Zylog Systems disclosed incorrect and false information in the quarterly shareholding pattern for the four quarters in the year 2012 to the stock exchanges by overstating the holding of the promoters and understating the quantum of shares pledged by the promoters.

Sebi also observed various instances of non-adherences to accounting standards and listing agreement in the annual report by Zylog Systems.

In addition to the above, the latest results show that the promoters have pledged close to 95% of their holding in the company (up from 75% in the previous quarter)

What next

As I indicated in the earlier post, I created a small tracking position to follow the company and confirm my thesis that the debt/ cash flow problems are temporary and should get solved.

I am not sure if the thesis will turn out to be correct or not, but the SEBI order changes the whole picture. I am fine with poorly performing businesses and will hold the stock for the long term if the management is competent and working on fixing the issues. However, if there are corporate governance issues, then all bets are off.

Although the position was small, a loss always pinches. In this case, I walked into it with open eyes – a case of self torture 🙂


Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

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