Investment Advisory Service

Wednesday, 19 December 2012

Wipro - Demerger Update

Wipro is moving quite quickly on the demerger scheme. The merchant bankers deserve a compliment for the same. The High court of Karnataka has directed a meeting of the shareholders to approve the scheme. The meeting will be held on December 28, 2012.

The information statement can be checked here and the scheme of arrangement here.

Court Convened Meeting on Dec 28, 2012
18 Dec 2012 11:05
Wipro Ltd has informed BSE that, by an order made on the November 26, 2012, the Hon'ble High Court of Karnataka at Bangalore, has directed that a meeting of the Shareholders of Wipro Ltd ("the Applicant / Demerged Company") will be held on December 28, 2012, at 04:00 P.M. for the purpose of considering and, if thought fit, approving, with or without modification the Scheme of Arrangement between Wipro Ltd (Demerged Company), Azim Premji Custodial Services Private Limited (Resulting Company) and Wipro Trademarks Holding Limited (Trademark Company).

Monday, 17 December 2012

Wipro Limited- Scheme of Demerger

The Demerger Scheme

Wipro Limited has announced the plan to demerge its non-IT business into a separate company ; Wipro Enterprises Limited. The non-IT business consists of :

A)  Consumer Care, Lighting and Furniture Business
B)  Infrastructure Business (Hydraulics and Water)
C)  Medical Diagnostic and Service Business

The new company will be an unlisted entity and the shareholders have been provided with 3 options to choose from in lieu of the non-IT business which will get hived off.

  1. Receive 1 equity share of Wipro Enterprises for every 5 equity shares of Wipro Limited
  2. Receive one 7% Redeemable Preference share (Face Value Rs 50) in Wipro Enterprises for every 5 equity shares held in Wipro Limited. The preference share shall have a maturity of 12 months and shall be redeemed at a value of Rs 235.20
  3. Exchange the shares of Wipro Enterprises with shares of Wipro Limited (pure IT company post the scheme of arrangement) held by the promoter. 1 share of Wipro Limited can be opted for every 1.65 shares of Wipro Enterprises.
NRI shareholders can either choose for option 1 or option 3. However, the ADR holders will compulsorily be given option 3.

The demerger will make Wipro Limited a pure IT company and will also assist Wipro Limited in increasing the public float for the purpose of meeting the minimum public shareholding requirements. The promoter owns 78.31% stake in the company as of Sep 30,2012. Since ADR holders hold 1.73% stake in the company as on Sep 30, 2012 ; the stake of the promoter will definitely come down by this much and more from the action of Resident Indian and NRI shareholders who opt for option 3.

SEBI has approved the proposal to reduce the promoters’ holding by way of the demerger and subsequent exchange of shares in order to comply with the minimum public shareholding norms.

In March 2012, in an attempt to bring down the promoters’ shareholding in the company; Azim Premji Trust had done an “offer for sale” and offered to sell 3.5 crs which was around 1.5% of the outstanding equity. The issue remained partially subscribed and the trust was able to sell only 1.78 cr shares which was 51% of the quantity offered. The sale happened at a price of 421 while the current price is 375.

How good and large is the non-IT Business ?
For the year ended March 31,2012 Wipro Limited had a consolidated top line of  about 37,000 crs. The IT Business contributed about 32,000 crs which was 86% of the turnover. The non-IT business contributed 14% or roughly 5,000 crs which looks small when compared to the IT revenues but is large enough in its own right.

In consumer care space, Wipro has brands like Santoor soap, Chandrika soap, Aramusk, Yardley, Safe wash etc. In indoor lighting, Wipro shares No 1 position with Philips; in commercial lighting Wipro is No 3 and in the furniture business, it is No 2 after Godrej. Wipro Infrastructure Engineering is world’s largest independent hydraulics cylinder manufacturer in the world with a 70% market share in India.

The management has been very active in growing the consumer care business inorganically. In the last few years, host of acquisitions have been done like Glucovita (2003), Chandrika (2004), North West Switches (2006), Unza Holdings (2007) and Yardley in 2009. The latest one being the acquisition of LD Waxsons (2012).

Of the non-IT business, the consumer care and lighting business is the largest piece which generated a turnover of around 3300 crs and generated ROCE of 18-20% in FY 12. In the current half year, this division has notched sales of about 2000 crs. Annualising the revenues to 4000 crs and going by the peer valuations, this piece could easily sell for 2-3 times its revenues if it were to list separately. Thus the consumer care division can be valued between 8000-12000 crs.

Other businesses like infrastructure and medical diagnostic businesses are relatively small and currently earn far lower margins and ROCE than the consumer care business. In the current half year, this division has notched sales of about 750 crs. The annualised revenues would be about 1500 crs. Difficult to value this piece in light of the poor margins right now. However, just to put a range of values to it, if it were to sell between 0.5-1 times revenues, this piece could be valued between 750-1500 crs.

The management of Wipro has indicated in the latest concall that the non-IT business would have debt of 200 crs and cash of around 1500 crs. So net cash of 1300 crs is going to come along with the non-IT business.

The sum of the parts for the 2 pieces plus the cash thus ranges between 10000 crs-14800 crs. Wipro Limited has 246 cr shares outstanding. Since for  every 5 shares of Wipro Limited, 1 share of Wipro Enterprises would be issued; Wipro Enterprises would have 49.2 cr shares. Thus, according to my workings, the per share intrinsic value of the non-IT piece of Wipro Limited ranges between 203 and 300 bucks. The average of the 2 figures is around 250.

Is the demerger fair to the shareholders ?

Point 1. The shareholders of Wipro have not been given an option to remain invested in the non-IT business. The option to retain shares of Wipro Enterprises is a dead option with no sight of listing. -1 to Scheme.

Point 2. But are the shareholders of Wipro actually invested in Wipro for the non-IT part ? People might come up with all sorts of arguments but the fact is that with 86% of the turnover and 95% of the profits coming from the IT division, the weight of evidence is heavily tilted in favour that for the current shareholders, Wipro is an IT company. Period.

Point 3. What is the scheme offering in lieu of the non-IT business ? Option 1 is a dead option and Option 3 is in the realm of speculation because Wipro shares price is a moving target and we don’t know what price one would get for the Wipro Limited (pure IT company) shares when they are sold. Option 2 of taking the preference share is a more concrete benchmark to find out what the shareholders are receiving for the non-IT business. The present value of the preference share at 10% discount is Rs 217 which is close to my average intrinsic value working of 250 of the non-IT piece. Thus, in my view the shareholders are being offered a fair price for the non-IT business. +1 to the Scheme.

Point 4. The promoters had tried to reduce their shareholding through an offer for sale but it didn’t succeed. With the deadline for complying with the public listing norms approaching, the promoters had the option to either opt for delisting or to try again and sell shares through offer for sale. Reverse book building for a 92,000 cr market cap company is not a joke and the promoters might not have the liquidity of 20,000 crs plus required to buy out the minority shareholders. Offer for sale might have proved disastrous as the stock price might have slided massively thus hurting the very shareholders of Wipro. +1 to the Scheme.

Overall to me it seems that the promoters have been pragmatic and have hit 2 birds with a single stone by offering this demerger and the exchange of shares scheme. In spirit of the Wipro’s concept of “Applying Thought” ; a lot of thought seems to have gone behind this demerger scheme too.

What option should the current shareholders of Wipro Limited choose ?

If a current shareholder of Wipro has a much better understanding of the non-IT business and has a much higher intrinsic value figure in his mind, he should definitely choose Option #1 of retaining the shares of Wipro Enterprises. But be prepared for a long ride with no dividends and no quotes on the stock for very many years. I am quite confident that the money is in safe hands and the consumer care business of Wipro would grow handsomely from here but the waiting period might easily stretch into a decade. This option is for people who have a mentality of an art collector. People who can buy a Picasso and sit patiently for decades.

If a shareholder is of the kinds who wishes to update his portfolio on a regular basis and likes the regular stream of dividends, he has to choose from Option #2 or Option #3. With Option 2, one can take his money and if interested buy other consumer care businesses listed in the market. If somebody is interested in only the technology part, he can simply opt for Option #3.

I am currently not a shareholder of Wipro Limited and any shareholder of Wipro reading this post should make his own judgement about the option he wishes to choose.

Is there any opportunity to make money in this deal ?

There is nothing I could think of as of now. But it’s a large company; with an impending demerger; stock is in F&O and the promoter is ethical. It would be interesting to watch and a possibility of making money might come at some later point of time.


Saturday, 1 December 2012

The Ugly Indian

TN Ninan of the Business Standard has written a very crisp and thought provoking column concerning the case of Male Airport and similar contracts which were entered in the past and had Governments, Indian or foreign, as one of the parties to the contract. 

These contracts seem to put the Governments in positions where by if the revenue projections of a particular project are not met (which is almost always the case),
the successive compensations by the Governments follow the case of mating rabbits and the payments end up getting spiralled in a Fibonacci sequence.

What choices do the Governments have apart from either scrapping the contracts altogether or to renegotiate them ?

The issue closely resonates with concerns raised by Neeraj Marathe in his blog about Noida Toll Bridge.

Friday, 19 October 2012

J B Chemicals- Corporate Disclosures

Aaron Levenstein said “ Statistics are like a bikini. What they reveal is interesting, but what they conceal is vital.”
Reading the following announcement provides an uncanny familiarity to the above quote.

Scripcode : 506943    Company : JB Chemicals


With reference to the earlier announcement dated May 24, 2011 informing the Exchange about the Company’s sale of Russia-CIS OTC business undertaking to Cilag GmbH International, Switzerland, (‘Cilag'), a subsidiary of Johnson & Johnson, and announcement dated July 14, 2011 informing the exchange about the closure of the said transaction and the receipt part from the consideration, the balance being kept in the agreed Escrow Account, JB Chemicals & Pharmaceuticals Ltd has now informed BSE that the company and its subsidiaries have received claims by the Johnson & Johnson group entities which corresponds to the amount held in the Escrow account.

The Company and its board of directors consider this action untenable, do not accept the claims and are seeking appropriate legal advice in relation to the same.

The Company shall spare no efforts to protect the interest of all its stakeholders.

Please check the announcement here as well.

In the JB Chemicals- Johnson & Johnson deal, the release of the money kept in the escrow account has been challenged by the buyer; Johnson & Johnson. That’s informative but the announcement is silent on the amount of money kept in the escrow account. And how much claim has the company received from Johnson and Johnson ? Silence again. The announcement is plain English language and has no element of God’s language “Mathematics” in it which is what the shareholders would be very interested in. That leads me to a slightly modified quote of Levenstein that what the announcement has revealed is interesting but what it had concealed is vital.

JB Chemicals had sold its Russian OTC business to a subsidiary of Johnson and Johnson in July 2011. The total sale consideration was 738 crs plus $35 mil to be paid for the inventory and receivables of the said division. Despite being an important part of the transaction, the amount kept in the escrow account was never voluntarily revealed in the public domain and it was only on checking with the company that a figure of 175 crs was mentioned as being kept in the escrow account.

It is very important for the companies to leave opacity behind and lay bare the facts as transparently as possible; obviously without jeopardising the business interests. The lesson for the investors is to be very cautious of the money kept in the escrow account. In the recent times, many a deals like Gwalior Chemicals (now Gee Cee Ventures) had money in the escrow account which never reached the treasury and pockets of the shareholders.

Contrast the above announcement of JB Chemicals with that of announcements made by Ashiana Housing Limited here and here.

On both the occasions, negative developments surfaced with respect to the business of the company. Not only did the company promptly informed the stock exchanges, it also informed the shareholders about the monetary impact and the total amount invested in the projects impacted by the negative developments. That speaks highly about the quality of the corporate disclosures.

To be fair to the promoters of JB Chemicals, let me state that there is no act of dishonesty which I came across in my research on the company. There has been no incident of corporate misgovernance either. But it is imperative that the companies raise the bar of corporate disclosures a bit higher with every passing day. Shareholders would highly appreciate the effort without keeping any part of their love in the escrow account.

Saturday, 14 July 2012

Imran and Vijay

Have a look at the above gold auction cum invitation notice posted in the Business Standard today by ICICI Bank. One Mohd Imran of Najibabad (Uttar Pradesh) had pledged gold ornaments and availed a loan against it. Failing to repay the loan, the bank has taken the step of auctioning the collateral. Nothing wrong on part of the bank. But look at the triviality of things. The gross weight of the pledged gold ornaments is 15.5 gms which going by the last closing price of gold (Rs 29,600 per 10 gm)is Rs 45,880. Let's keep aside the arguments about the net weight of gold in the gold ornaments or the price of gold when Imran would have availed the loan. Intuitively, either of the above or both combined would surely lower the value of the collateral. But let's stick to the figure of 45,880. Going by the gold loan scheme, the loan provided is around 75-80% of the market value of the collateral. Thus, the loan which Imran would have taken couldn’t have been more than Rs 35,000.

I am sure ICICI Bank would be spending much more than 35,000 in the costs related to the auction process; which includes advertising in the newspapers. Thus the Net Present Value of this auction process is negative and hence any sensible banker would simply write off the loan. But any such write off by the bank would lead to an avalanche of moral hazard and there would be scores of Imrans and Ankurs who would willingly default on the loans knowing well that the bank wouldn’t even bother them in the event of non-repayment.

Compare Imran with one Vijay Mallaya. This man has defaulted on 7500 crs of loan (21 lakh times the loan availed by Imran) taken from the banks to give wings to his idiosyncrasy called Kingfisher Airlines. Nothing much came out of the airline except that the Kingfisher bird would have lost its reputation in the bird kingdom on being associated with the airline. By now, the bird would have even applied for a name change through an affidavit filed in the birds’ court.

The banks and the financial institutions find them completely helpless in extracting even one single rupee out of the collateral. Though the banks have started talking about the sale of the planes and the Kingfisher villa; I am ready to bet that the bankers wouldn’t be able to even attend the pool parties at Kingfisher villa ; forget about auctioning the villa. Why is it that time and again, financial institutions are helpless and hopeless in recovering their dues from the large borrowers ? The single biggest factor to my mind is nexus between politicians and large businessmen. Both of them like Siamese twins are joined at the hip. Businessman help the politicians during the elections to buy out votes and post the elections to buy out legislators and members of Parliament. Once in power, politicians control the banks and the bankers. And the two ends meet when the businessman is able to lay his hands on the money in the bank and refuses to pay up. And then this vicious cycle goes on.

This problem can be solved if we have iron handed legislature (very unlikely) and iron handed judiciary (very likely) which forces the defaulters to pay up.

There is one example which is noteworthy. QVT Financial is an international hedge fund which invested in the FCCBs of some Indian companies. Companies which ran out of money and luck; couldn’t convert these FCCBs and opted for restructuring of these FCCBs. Wockhardt being the early mover in the recent debt restructuring mela proposed to settle the FCCBs at a 75% discount to their redemption value. Finding it unpalatable, QVT approached the Bombay High Court for a winding up petition against Wockhardt. Wockhardt tried a bit to sob but the learned judges wouldn’t take any of it and ordered the winding up of the company in the event FCCBs remain unpaid. A tight rap on the knuckles can bring a lot of rouge elements in line. Since then Wockhardt has coughed up money and the FCCBs have been settled. QVT has now turned the heat on Zenith Computers and KSL Limited (promoted by Tayal group. Ex promoter of Bank of Rajasthan). Taking a cue from the Wockhardt case, a lot of companies like Hotel Leela, Subex Limited, 3i Infotech etc have redeemed the FCCBs or settled with the FCCB holders at mutually agreeable terms.

QVT example shows that no new laws are required to tackle this menace. What we want is a bunch of tough lenders and a tougher judiciary.

Post Script : I am not sure if Business Standard reaches Najibabad, a small town 170 kms from Delhi. If that is true, Imran wouldn't be able to read the ICICI Bank notice.

Thursday, 10 May 2012

Delhi Diary

Where would one normally find bouncers ? Usually discotheques. 

But the place I went to recently had a different setting. It neither had neon lights nor did it looked like a disco. However, more than the numberof ordinary people in the room, there were bouncers or should I say pehelwans. I read the banner carefully and verified with the gentleman sitting next to me. It was indeed the venue of the AGM of R Systems International Limited.

It baffled me that why does a company need bouncers ? Sure we have heard and seen shareholders baying for each other's blood for a box of Haldiram's sweets. But never did any company had to employ bouncers to solve such crises. The crisis in R Systems is much graver than that. This company is facing a hostile take over bid from one, Mr Bhavook Tripathi. I had earlier written about it here and here.

In the agenda items of the AGM, the management had proposed a special resolution which envisaged alterations in the articles of association of the company. The proposed amendments were that nobody except the promoter group can take any decision regarding merger, liquidation of any asset, providing any loan to any other entity, special dividend , removal of executive directors etc. Basically all the ingredients of making the company unattractive for any hostile takeover bidder. But the defeat of this special resolution was a forgone conclusion as Mr Tripathi holds 32% stake in the company and the special resolution would have been vetoed out. Sensibly, the company decided to withdraw the special resolution before the AGM to save face.

Meanwhile SEBI has not processed the open offer made by Bhavook Tripathi and even the committee of independent directors of R Systems has not come out with the recommendations on the open offer.

Though on the face of it the promoters of R Systems own 49% in the company and it is difficult to dislodge them but the discomfort in the behaviour of the company and the promoters seems to tell a different story.

Even Ravana (original character, not Abhishek Bachchan) used to think he is invincible till his younger brother Vibhashana revealed the secret of of his death to Rama. Who knows what secret about R Systems does Bhavook Tripathi has up his sleeve ?

Disclaimer : This does not constitute investment advice and I don't have any position in this stock on the date of posting this entry.

Monday, 7 May 2012

Picking pennies in front of a steam roller ?

At any given point of time, I like to keep around 10-15% of my portfolio in special situations which are not linked to the gyrations of the market. There are triple benefits which I see in process : the tendency to immediately use all of the cash to buy equities is perturbed, the regret of seeing severe draw downs of portfolio in case of a severe market crash is also lesser and thirdly and most importantly I get excitement, happiness and pure joy of spotting an arbitrage and working it out. (There are other workouts like Sudoku and Rubik's cube but I don't find them exciting as I am unable to solve them and also there is no money to be made)

Over the last few years, my thinking has evolved over working on a limited number of special sits and not spreading too thin on a number of them. The criterion which helps me select is that the opportunity should provide at least an annual IRR of 15%, it should have very low correlation to the market, it should have minimal risk and it should be good enough to put a minimum of 3% of my portfolio. If any of these criteria is unmet, I give the idea a pass and wait for the next one to pop on my screen. One source of such ideas is the BSE announcements. I religiously read all the BSE announcements and if I miss it someday, my calendar reminds of those dates which appear as a backlog.

One interesting announcement came on April 26th, 2012 about the NCDs (Non Convertible Debentures) of Jyoti Structures Limited. Jyoti Structures,  a company into the business of telecom infrastructure had come out with a rights issue of 1.02 cr NCDs in Feb 2011. The NCDs had a face value of Rs 120 and carried a coupon rate of 7% to be paid quarterly from the date of allotment till the date of redemption which was 15 months from the date of allotment. Accordingly the date of redemption is May 14, 2012. Between Feb 2011 and now, the NCDs traded in the range of 100-110 bucks thus implying an IRR of more than 20% at different periods of time but the financial position of the company didn't excite me much. The risk of interest not being paid and the possibility of a default on redemption made me stay away from the issue.

On April 26th, the company announced the record date (May 6th, later revised to May 10th, 2012) for the redemption of debentures along with the final payment of interest. The interest along with the redemption amount total up to Rs 122.10 per NCD. The total amount required for payment is 124 crs. One look at the Sep 2011 balance sheet shows that the company had around 580 crs of loan (most of it working capital) and around 1000 crs of net current assets. Apart from it, the company has around 70 crs of investments. Overall, it should not be difficult for the company to raise additional working capital loan of 124 crs against the current assets and redeem the debentures. Additionally, the company has kept up with all the quarterly interest payments on the debentures. It seems that the company is both able and willing to redeem the debentures.

The market price of Jyoti Structures N1 is 120.50. The redemption date is May 14, 2012. Buying an NCD now at 120.50 will yield 122.10 with an average holding period of about 7 days. That's an absolute return of little over 1%.

I see little risk of the payment not being made as the record date has already been announced. But there is never a sure thing. So I am keeping this limited to 4% of the portfolio.

Do you spot a steam roller in sight while I am busy picking up pennies?

Disclaimer : This is not an investment advice. My opinions and views are more or less always biased. If I see some steam roller in any of my ideas, I will surely run away and blog about it later, if at all.

Sunday, 11 March 2012

Guess this one ?

Small quiz to the readers. Name and connect these gentlemen.
Clue : Answer to do with investing

Saturday, 18 February 2012

Hotel Leela checks into CDR !

Tucked away in the hundreds of announcements made everyday on the National Stock Exchange was this small announcement made on February 10, 2012.

One of the super brands in the Indian hospitality industry with premium luxury properties has fallen onto bad times and has sought the help of bankers to get out of this mess. What caused this mess in the first place ? The ingredients of this recipe remain the same as always : overoptimistic promoters, audacious and ruthless expansion fuelled by EXCESSIVE LEVERAGE.

As of September 2011, Leela had 4,295 crs of debt on the balance sheet. The quarterly interest cost has soared to 111 crs which translates into an annual interest outgo of around 444 crs. This excludes any interest that the company might be capitalising on the properties under construction. How does the interest outgo compare with the earnings of the company ? In FY11, the company earned total revenues of 525 crs and operating earnings (EBITDA) of 154 crs. Thus, the interest outgo itself is 3 times the annual operating earnings of the company and just a shade higher than the total revenues. Fair point that some of the properties will start contributing now and the earnings will increase but still the overall picture is pretty ugly.

To tide over the crisis, the company has plans to sell some commercial properties and vacant land in Chennai and elsewhere. Recently the company sold the property at Kovalam ( The Leela, Kovalam) for 500 crs. Still,  a lot more needs to be done to repair the balance sheet.

To the already precipitous situation of the company, add the information that ITC Limited is sitting pretty with 13.39% position in Hotel Leelaventures and has hoards of cash to swoop in more shares from the market if needed. The recent take over code comes in handy to raise the stake up to 26% without making an open offer.

The promoters of Leela know that the situation is precarious and with lower stock price , the job of the predatory activist investor becomes easier. Keeping this in mind, they have been buying from the open market and have increased their stake from 54.6% in Dec 2011 to 56.57% in Dec 2012.

The CDR process might be a double edged sword for Leela. Though on one hand, it will provide relief on the interest payment and moratorium on the repayment of debt but on the other hand, conversion of bank debt into equity (standard clause in a CDR process)  might humongously increase the number of shares outstanding. The debt is huge and even if a slice of debt is converted to equity, it will lead to a huge dilution and subsequently the dominant shareholding of the promoters would be compromised.

Let's check that with an illustration. Right now, the company has 38.78 cr shares outstanding and the promoters own roughly 22 cr shares (56.5%).  Assuming that only 1000 crs of debt (out of 4,295 crs)  is converted into equity at the current price of Rs 38. This will lead to an issuance of additional 26.3 cr shares. Thus the total number of shares would become 65.03 crs while the promoters will continue to hold only 22 cr shares which would be only 33% of the outstanding equity. This lower holding might make the promoters vulnerable and put the company in play.

Overall a very interesting combination of a marquee company in a debt trap, premium properties with high liquidation values and  a predator lurking in the shadows.

Leela will need a whole lot of kind and generous bankers to check out of this mess ! Amen.

Tuesday, 17 January 2012

Tata Capital NCDs - Update

A few days back, I blogged about Tata Capital NCDs here.

The NCD-Option III closed today at Rs 1110 thus substantiating the belief that markets are efficient though sometimes with a time lag.

And time lag can vary from a few days to a few years.

Thursday, 12 January 2012

R Systems- Update 1

As per the recent amendments in the Takeover Code, a committee of independent directors need to give their recommendations to the shareholders on the open offer. Complying with that, R Systems has constituted a committee. It will be interesting to see what recommendations they come out with !

Here is the BSE announcement :

R Systems International Ltd has informed BSE that pursuant to the provisions of (Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 the Board of Directors of R Systems International Limited (the Company) has constituted, by passing necessary resolutions through circulation, a Committee of Independent Directors, namely Mr. Raj Kumar Gogia, Mr. Suresh Paruthi and Mr. Gurbax Singh Bhasin to give reasoned recommendations on the Open Offer given by Mr. Bhavook Tripathi for acquiring 26% shares of the Company in terms of Public Announcement dated December 15, 2011 and Detailed Public Statement dated December 22, 2011.

Meanwhile the promoters have been continuously buying shares from the open market.

Monday, 9 January 2012

Tata Capital NCDs- Why this inefficiency ?

On January 7, 2012 Tata Capital Limited NCD - Option 3 (Non Convertible Debenture) traded at an average price of Rs 1134 on the BSE. This debenture was issued in March 2009, had a face value of Rs 1000 and carried an annual coupon of 12%. At a price of 1134, the IRR for this debenture worked out to be 10.2%

Tata Capital Limited had come out with this NCD issue in February 2009.  The debentures were offering a coupon between 11-12% p.a depending on the payment option chosen by the investors. The original issue size was Rs 500 cr with an option to retain an oversubscription up to Rs 1000 crs. With equity markets in bad shape and a nice yield of 12% , this bond to be issued by the house of Tatas created a buzz in the market and the issue was oversubscribed and received Rs 2300 crs.

One important clause of the debentures which a lot of investors miss to read and the financial advisers fail to stress is the availability of the put and the call option. Under this option, after some scheduled time period as mentioned in the document, the issuer has the right to call the debentures and the investor has the right to sell (put) his debentures and take his money back. And both these situations would ideally happen in a case where the market interest rates fluctuated either in the interest of the issuer or in the interest of the debenture holder.

In Tata Capital NCD, the document stated that the put / call option could be exercised after a period of 3 years (in one series it was 3.5 years) from the date of the issue. This announcement made by the company on Saturday mentions that the company has decided to exercise the call option and the directors of the company have approved of the variation in the terms of the NCD. The coupon rate has been reduced across different series. For Option III discussed in the opening paragraph, the coupon has been reduced from 12% per annum to 10.50 % for the rest of the maturity period which is 2 years and 2 months from now.That is a sharp reduction and I concluded that market participants will factor this new development . I quickly calculated that for the IRR to remain at 10.2%, the price of the debenture should come down to Rs 1108 which is 26 bucks lower than the Saturday's closing price of 1134.

To my surprise, this announcement had no bearing today on the price of the Tata Capital NCD and the Option III NCD is still trading at Rs 1134. At this price, the IRR with the reduced coupon rate is 8.81% which is lower than the bank deposit rate for an FD of the same maturity. (Axis Bank is offering 9.3% interest for an FD with a maturity term of 2 years and 2 months). Any rational investor should ideally withdraw his money from this NCD and put it in a bank fixed deposit.

I always thought that bond market participants are more nimble compared to the participants in the equity markets.

What explains this inefficiency? The announcement is out there on the exchanges and there is no information asymmetry. The debenture size of 1500 crs is large and unlikely to escape the attention. Taxation can't explain the inefficiency. These debentures are taxable at the same rate as bank FDs.

Is there anything I am missing here ?

Thursday, 5 January 2012

UTV Software Communications- Move to go private

There is a lot of action happening in the Indian entertainment space ranging from higher DTH penetration, movie production, the entertainment distribution business, realty shows, radio and not to forget the hugely successful  IPL (at least for BCCI and the viewers). With an eye on roughly 240 cr eyeballs in India, the increasing disposable incomes and increasing share of entertainment of the consumer's wallet, Walt Disney Company acquired close to 50% stake in UTV Software Communications in 2008 at around Rs 860 per share

In July of 2011, the company followed up with a delisting offer to acquire the stake held by the public shareholders. There are 4.07 cr shares outstanding and Walt Disney owns 50% of it. Ronnie Screwvala and affiliates own another 20% stake and they are classified as Indian promoters. As per the delisting guidelines, the process to be followed is a reverse book building process where the public shareholders are allowed to tender their shares at a price of their choice above a minimum "floor price".

The first milestone in the delisting exercise was the postal ballot process. The delisting guidelines state that in the postal ballot , the number of share-votes casted by the public shareholders in favour of the delisting should be at least twice the number of share-votes casted by the public shareholders against the delisting process. Note that for the postal ballot to be successful, the promoter votes are counted separately and the public shareholder votes are counted separately. That's a fair clause to prevent the public shareholders from getting bulldozed by the votes of the promoters if both were clubbed together. The postal ballot was passed successfully in this case and the first milestone was reached.

Further milestones were the regulatory approvals required from the BSE, NSE, Foreign Investment Promotion Board, Cabinet Committee on Economic Affairs and the RBI. With some delay, all the approvals have come through. Getting the regulatory approvals is an important milestone as the uncertainty surrounding the deal gets cleared and also the time period of the deal gets fixed. There should not be any further delays from here.

As per the public announcement , the reverse book building will start on Jan 16th 2011 and will end on January 20th, 2011. The shareholders can tender their shares at any price higher than or equal to the floor price of 835. The acquirer "Walt Disney" has provided an indicative price of Rs 1000 per share that it would be willing to shell out. This price is only an indicative price and neither does it prohibit the public shareholders to tender their shares at a price higher than Rs 1000 nor does it prohibit Walt Disney to accept the discovered price in the reverse book building if it is more than Rs 1000 per share.

What is required for this delisting to be successful ?
  1. Quantitatively, the acquirer should be able to reach 90% post the reverse book building. If the number of the shares do not hit that mark, the delisting exercise would fail irrespective of the price discovered. Since acquirers already have 70% stake, they require another 20% to reach the mark of 90%. That means out of 1.22 cr shares with the public, at least 81.3 lakh shares need to be tendered in the book building which is 2 out of every 3 shares with the public. Looking at the shareholding pattern of Dec 22 (available in the public announcement), around 91 lakh shares are held by FIIs and Corporate Bodies and the rest 31 lakh shares are held by individuals. This is an important number to focus as the FIIs and Corporate Bodies are investors who  are aware and understand the dynamics of delisting and can be expected to exercise their votes. If most of them exercise in favour of delisting, the required  numbers can come through. Secondly, the shareholding of FIIs and Corporate Bodies is concentrated and not diffused as in the case of individual shareholders. I would give a 90% chance that the required number of shares would come in the delisting. 
  2. Secondly, the acquirer should accept the discovered price. With an indicative price of Rs 1000, there is already an anchor. Usually it has been observed in the past delistings, that the shareholders want "a little more" than the indicative price and the acquirer also keeps some headroom between the actual price that he really wants to pay and the indicative price. Also, with FIIs and other corporate bodies, it is likely that they will not tender their shares at absurd prices which will drive Walt Disney away. A 10% premium can be expected over and above the indicative price.                                                      
What are the risks to this transaction ? The greatest or gravest risk I would say is the downside risk to the stock price in case the delisting fails for either of the reasons described above. The fundamentals of UTV don't support the price of Rs 1000 and if the delisting fails (10% chance), the stock can easily nosedive to Rs 700 before one can exit.
Also, the employees of UTV have been continuously selling stock in the market. But that might have to do with taxation issues and derisking of their portfolios as a large part of their networth might be in the UTV stock.
There is a :
90% chance of book getting built and exit price being 1100 and ;
10% of chance of book not getting built and exit price being 700;
making the weighted average price being 1060;
while the current price is 990;
providing an expected absolute return of close to 7% in a span of 15 days.

I have invested money in this situation with a clear understanding of not participating in the book building. Tendering the shares in the delisting would be akin to "burning the bridge" while it makes sense to "preserve optionality" in this case. For a better understanding, read Prof. Sanjay Bakshi's posts: Link 1 and Link 2 .

These special situations are not very juicy but are very stimulating to work on. They help to keep abreast with the latest regulations and also help to forcefully keep a slice of portfolio in such cash equivalents which can be very useful in case of a severe market decline.