“Everybody has a plan …..”

“Everybody has a plan till they get punched in the face”. This brilliant quote can be credited to the famous American philosopher “Mike Tyson” :-) . ( His detractors might point out his fetish for ears but didn’t Vincent Van Gogh also cut off his ears).

It’s a extremely impactful statement with implications for any participant in the stock markets. We plan for all kinds of scenarios that the market throws at us. For ex Looking at the market right now we could plan that if the market corrects by 20% we could deploy additional capital into the markets. Simple statement of intent or plan factoring in a possible scenario.

It becomes easy to implement this plan if the market gradually drifts down a percent or two every week and winds up going down 20% over a six month period. It’s a series of small punches that the markets throws at you which tires you out but keeps you in play to deploy the action plan that you had thought thru.

The challenge is when you get punched in your face by the markets when they correct 20% in a week or fortnight. At that moment the mind freezes and all the best laid plans of men and mice go waste. Fear and self doubt seeps in and the reptilian brain takes over.

The R-complex as it is called overrides the more rational functions of the brain and results in primitive behaviour where the survival instinct takes over. We of course see that in the rush to the exit door that happens with market participants.

Can we work our way thru this and retain our rationality? I think the first step is being able to recognise when our mind starts moving into this state.
The awareness of it might helps us deal with a few punches thrown between our eyes.

Paradox of Choice - Prof Barry Schwartz

Prof Barry Schwartz's Talk on the "Paradox of Choice" at the TED conference. It has very interesting implications beyond the fact of why we still savour the limited choices that Doordarshan used to offer as opposed to the plethora of channels now which seem to have nothing to offer.

As the markets offer us more and more instruments and asset classes like equities, debuntures, options, gold, copper, art, interest rate futures, forex futures etc, we start spreading ourselves thin not willing to limit or restrict our choices to particular asset classes.

The curious case of Zenotech Labs

This saga should give Ekta kapoor a complex for the twists and turns and the never ending nature of its existence.

Circa Oct 2007
Ranbaxy enters into a definitive agreement to increase its stake in Zenotech to 45% by purchasing of shares from promoters and preferential offer.

Jan 2008
Ranbaxy completes open offer and acquires 2.2% shares through the open offer at a price of Rs 160 per share. Ranbaxy’ stake goes upto 46.79%.

June 2008
Daiichi buy’s out Ranbaxy from the Singh brothers and hence becomes owner of the 46% owned by ranbaxy in Zenotech which results in triggering of the open offer due to the indirect acquisition.

Jan 2009
Daiichi makes a open offer to acquire 20% from the public shareholders at a price of Rs 113. 62 per share.
The promoter Dr Jayaram Chigurupati claims that Daiichi had in a meeting promised to pay Rs 160 to the shareholders.

The battle begins

Dr Chigurupati and retail shareholders file cases in the court and with SEBI to ensure that the open offer happens at Rs 160.

Feb 2009
SEBI dismisses the case and Daiichi prepares to rollout the open offer at Rs 113. Dr Chigurupati and the retail shareholders take the case to SAT.

Oct 09
SAT rules in favour of the retail shareholder and directs Daiichi to do the open offer at Rs 160.

Nov 09
Case is also filed in SAT to ensure that Daiichi pays interest for the delay
Daiichi takes the case to supreme court and agrees in Supreme court to pay interest in case it loses the case.

The supreme court has decided that Dec 02 2009 will be the final date of hearing and the judgement should follow.

There are of course multiple cases being fought between Daiichi/ Ranbaxy and Dr Chigurupati in the CLB also.

Where do we stand now

Current shareholding
Dr Chigurupati & associates - 25.76%
Ranbaxy - 46.85%
Public shareholders - 27.39

Precedence suggests that Supreme Court tends to go with SAT order though precedence is no guarantee.

1) Supreme Court rules in favour of retail shareholders
Open Offer Price - Rs 160 + Rs 10 ( approx interest) = Rs 170

2) Supreme Court rules in favour of Daiichi
Open offer prices - Rs 113.

CMP - Rs 115

I had bought stock in the Rs 108-112 levels. The way I see it is the downside is restricted to around 8-10 bucks where as the upside could be around Rs 140-150 on the stock, with the information that SAT ruled in favour of the retail shareholders.

The most important thing is that this long drawn saga will come to an end with clear defined timelines.

To take a quote that I like from “ The curious case of Benjamin Button”
“Life can only be understood looking backward. It must be lived forward.”

Predictably Irrational - Prof Dan Ariely

I am currently reading Prof Dan Ariely's book "Predictably Irrational". Enclosing one of his videos which gives a flavour of the kind of work he has been doing in the area of behavioural finance. The book is a interesting read. This video is from a presentation he made at the TED conference.

Areva T & D - Impending Corporate Action

Areva T& D is the Indian subsidiary of the French nuclear power major Areva. The Indian listed subsidiary is focussed on the Power T & D business.

In the month of June 09 the parent announced its intent to globally sell its T& D business and invited bids for the same. The company which is listed, has its majority stake owned by the French government.

The stock in India reacted on this news positively in the month of June but like all other corporate events the markets tend to forget.

I have been tracking the deal for sometime and finally the company made a press release that 3 bidders have submitted their final bids and the bids are getting assessed.

1) Alstom / Schneider
2) General Electric
3) Toshiba / INCJ

I have enclosed the link to this press announcement.

http://www.areva.com/servlet/cp_td_09_11_2009-c-PressRelease-cid-1257776944025-en.html

The French government has always maintained in its announcement that the deal will be closed by the end of this year. Reuters had also given out a release though quoting unnamed sources that the announcement date of the winner will be Nov 15th.

Either ways the deal is in its last stage and I would assign a very low probability of the deal not materialising considering the intent of the French government and 3 shortlisted bidders.

Announcement of the winner will immediate trigger the open offer clause as per SEBI’s takeover code. The risk in the transaction is that Areva T & D ivery expensively priced on all valuation parameters and the stock could correct in the interim period.
CMP – 280.75

Innovative Foods - Money for Nothing

I came across this corporate announcement on Innovative Foods.
http://bseindia.com/qresann/news.asp?newsid={4038BCAC-2189-44EE-AD2C-807B2263BE72}&param1=1

Innovative Foods is a Chennai based company which was a BIFR case. Based on the BIFR proceedings the promoters were asked to bring additional capital which resulted in their stake increasing to 93%. According to the BIFR order the promoters has to give a exit option to the remaining shareholders of the company and the company arrived at the exit price of Rs 34.5 to paid to all public shareholder who tender their shares. I have enclosed the link to the offer document.

http://bseindia.com/xml-data/corpfiling/announcement/Innovative_Foods_Ltd_091109.pdf

The offer is open till Nov 19th.
The stock was trading around the 32.15 mark after the announcement date and currently trades around 33.65.

So u can technically buy the stock in the market at this prices and tender at Rs 34.5 and be assured that 100% of you shares will be accepted and money paid to you.

So whats the catch?
Not enough trading volumes and high impact cost so u can deploy very small amounts of capital.

But it is a case of “ Money for Nothing”.

Gwalior Chemicals – Shareholders Gain, Arbitrageur lose

I’ve had a small break from the blog due to work pressure. Along the way a lot of water has flown under the bridge both on the Gwalior Chemicals front and a lot of other special situations opportunities have come on my radar.

The board of Gwalior Chemicals made the following announcement after the board meeting
In the first phase the Company proposes to buy back maximum of 40,50,000 shares at Rs. 120 per share through a tender offer route in this financial year. The aggregate amount Rs. 48.60 crores is the maximum permissible buy-back in this financial year ended March 31, 2010 as per Section 77A of the Companies Act 1956.

The market of course didn’t like it and the stock promptly went down to Rs 90 and has been hovering around there.

Lets examine what it the management is trying to achieve I spoke to the company secretary and asked him on the thought process. According to him the company intends to deploy Rs 100 crores as stated in the original press release to buyback shares in 2 phases

1) Phase 1 - This is the announcement that we read above.

2) Phase 2 - Will be done in the next financial year and I would assume somewhere around the Sept – Nov 10 kind of time frame.

So this brings out the logical chain of questions some of which I have received as comments

1) Why the share buyback in 2 phases?
This is because under Section 77 A of the Companies act a company can in a financial year buyback only 25% of the paid up capita+ free reserves of the company. This acts as a upper limit to the amount that can be deployed towards the buyback process hence a 2 stage buyback.

2) Why no dividend?
The management’s view is that share buyback is value accretive to the shareholders of the company and is clearly more tax friendly to the long term shareholders of the company. Factoring in either indexation or without it long term capital gains is lower than the dividend distribution tax that the company would have been borne out of the amount. I cant argue against it.

3) Will the promoters participate in the buyback?
The promoters will be participating in the buyback. The promoters would have to participate in the buyback bcos under the SEBI Takeover code, they cant increase their stake beyond 5% in a given year. Any increase beyond that will force them to make a open offer.

4) What will be the acceptance ratio?
The acceptance ratio is about 1/6th of the shares tendered as the buyback is of 40 lac shares on a equity base of 2.4 crores shares. Assuming about 10% brain dead shareholders who don’t tender we can at best assume a acceptance ratio of 1/5th or 20% of the shares tendered. This is presuming that the promoters will tender in full. The promoters could tender partially and use this as a route to increase their stake by 5% which will further improve acceptance ratio.

I have just worked out a sheet below listing down how the event can play out and the associated returns. I have assigned multiple scenarios giving different haircut to the terminal value that market will assign to the stock based on holding company discount. There is however a potential upside as according to the company secretary the company is looking at potential acquisitions. This will reduce the terminal value discount if the market factors it as a operating company.

So am I happy or unhappy?
I think the arbitrageur has lost in this transaction at the expense of the long term shareholder. I cant fault the management for its actions though I might lose money in the interim.

So what should I be doing?
I entered the transaction wearing a special situation arbitrageur hat and today have the option to wear the long term shareholder hat. I have always been advised by my fellow special situation arbitrageurs with whom I compare notes to never change my hats.

If u entered with a spl sit hat and that went wrong then exit the trade and not to change boats in mid seas. I think I will go with that though somewhere still not convinced that the trade has really gone wrong.

Kalindee Rail - Kabhi Haa Kabhi Naa

I saw a innocuous piece of corporate announcement on the BSE with respect to Kalindee Rail.

Kalindee Rail Nirman (Engineers) Ltd has informed BSE that the Board of Directors of the Company at its meeting held on October 26, 2009, inter alia, has approved refund of Warrant Application money received from Promoters / Prospective Allottees.

The warrants were issued after getting a go ahead from shareholders in a special EGM held on Sept 08 2009. Just after a month on Oct 15th a announcement is made about a board meeting detailing out refunding of the warrant application money to the promoters.

I didn’t know one can get refund of warrant application money. I love this call option where u get u r option premium back if you choose to.

Gwalior Chemicals - Udpate

I had earlier posted an update about the Gwalior Chemcials opportunity

http://investingvalues.blogspot.com/2009/10/gwalior-chemicals-update.html

The dates are finally out for the board meeting to discuss the dividend and /or share buyback. The board meeting is slated for Oct 30th and the agenda is as listed on the BSE site

Gwalior Chemical Industries Ltd has informed BSE that a meeting of the Board of Directors of the Company will be held on October 30, 2009, inter alia, to consider the following:

1. To take the decision on distribution of dividend payout and /or share buyback.

2. To consider and take on record the financial results for the quarter ended September, 2009.

3. To change the registered office of the Company within the local limits of the city.

We should hear the final act on this special situation.

Flurry of activity - Altered Annual Averages

Last week was a flurry of activity for me in terms of the transactions done in the market. I think I managed to alter my annual averages. I tend to rarely trade so it is invariably 1 or 2 transactions a month on which I would disturb my broker.

Solvay Pharma
I had written earlier on Solvay Pharma after the global announcement by Abbott Labs to takeover the Pharma division of Solvay Pharma globally.
http://investingvalues.blogspot.com/2009/10/kahi-pe-nighaein-kahi-pe-nishaana.html

I had entered the stock with the thought of seeing where the market prices the stock post the announcement. The stock has finally settled around the 900-920 mark and I exited the stock with a nominal loss. Will now wait and monitor to look at opportunities where the market could potentially misprice the stock. Afterall there is atleast 6-9 months before the open offer could get announced.

Abbott Labs
I had originally posted on Abbott Labs here.
I had also written about the Solvay acquisition seems to have unintended consequence to the Abbott stock. I exited 50% of my holding in Abbott around the 735 mark. The stock has given me a 36% return versus the Bse sensex which has delivered about 3% return in the same time frame. I haven't factored a additional 3% dividend return and the share buyback that happened along the way.

Suashish Diamonds

I entered and exited Suashish Diamonds on last Friday. One of the few day trades that I would have done. Will write a separate post on this interesting case.

Gwalior Chemicals Update

I had earlier posted on Gwalior Chemicals at this discussing about the opportunity.

http://investingvalues.blogspot.com/2009/06/gwalior-chemicals-special-situation.html

The deal has been consummated with shareholder and regulatory approvals coming through. Except for a amount of 75-100 crores the company has received the balance amount. This amount is currently lying in a escrow account which will be released to the company on achieving some of the deliverables stated in the deal. I at this stage don’t see to much hiccups on this count.

Management had announced a board meeting on the 23rd Sept to discuss the dividend/ share buyback. However the board of directors had to make a unscheduled trip to the US hence the same has got postponed. I last spoke to Sanjeev Pathak the company secretary yesterday and the directors were still not back. According to him the board meeting should ideally happen before the 15th of October.

Kahi pe Nighaein kahi pe Nishaana - Solvay pharma & Abbott Labs

Solvay Pharma
Last Monday I came across the news article of Abbott Laboratories globally taking over the Pharma division of Solvay. Solvay in India has a listed pharma subsidiary called Solvay Pharma.

Since Monday was a holiday on account of Dussera, I expected the market to not react to the news very fast and digest it completely. The stock had closed the previous trading day at Rs 818. The stock open at 860 and gradually made its way up till and by afternoon I think CNBC had picked up the news and the stock finally closed at 949. I managed to pick stock from 861 to 940 with a average price of Rs 920. Couldn’t move fast in the morning as I got stuck in a meeting but there was clearly a window of opportunity in the morning.

From the way the deal is structured globally there is a open offer that needs to happen according to me from Abbott.

Solvay India released their press release the next day on the deal

http://www1.bseindia.com/xml-data/corpfiling/announcement/Solvay_Pharma_India_Ltd_300909.pdf

Quoting a line from the press release

“ This transaction is expected to closed in the first quarter of 2010, pending the approval by the relevant competition authorities”.

First quarter 2010 sounds so far away that the market lost interest promptly pushed the stock price down and it closed at 909. On Thursday the stock closed at 919 after trading as low as 863 thru the day. Lets see how this plays out.

Now let me come to the more important reason for this post. The law of unintended consequence came into play.

Abbott labs.

I had earlier in my post in May 2008 recommended Abbott at a price of Rs 540 and the Sensex was at 16525. The link is enclosed here. The rationale was a impending buyback at that point at Rs 630. More importantly the parent and the Indian subsidiary had a track record of buybacks and the business throws out steady cash.

The company did a 5% buyback at Rs 630 and announced a Rs 14 per share dividend along the way.

So how did Abbott India react to the news

25/09 – 577 ( Before the news)
29/09 – 679 ( On Tuesday – up 17.5 %)
30/09 – 731
01/10 - 692

The stock is up 20% since the day of announcement. Frankly I don’t see what role Abbott India will have in this acquisition expect for a possible merger at a later date. I am not complaining :-).

Like the title of this post Kahi pe Nighaein kahi pe Nishaana ( Aim somewhere and hit something else)

kahee pe nigaahe, kahee pe nishaanaa

jeene do jaalim banaao naa deewaanaa

Movie - CID ( 1956 )
Singer - Shamshad begum
Music - Op Nayyar
Here’s the Youtube link to it.
http://www.youtube.com/watch?v=m0M669No30c

Long hiatus

Back after a long hiatus to writing the blog. Part dictated by work part by a vacation in Kerala. I have been there before but it always amazes me the diversity in beauty that India has from the rain shadowed vast expanse of Leh to the thick tropical kind of greenery of Kerala.

Update

IL& FS Investmart
I had written earlier on IL&FS Investmart covering the original hypothesis and the follow up action on the idea.

1) http://investingvalues.blogspot.com/2008/11/dabur-pharma-il-investmart-two-to-tango.html - Nov 2008

2) http://investingvalues.blogspot.com/2009/06/dabur-pharma-il-investmart-update.html - June 2008

3) http://investingvalues.blogspot.com/2009/06/il-investmart-bingo.html - June 2008

I finally exited the stock in the Rs 270 range where it has been hovering for sometime. Along the way the company has now become HSBC Investdirect. The delisting process is on track with shareholder approval been received for the same.

I decided to exit as opposed to wait till the final delisting event as my belief is that there is maybe a further 10% on the table. Looking at deploying the money in other opportunities or sit on cash.

From my original investment at Rs 84, the stock has delivered a absolute return of 221% over a 10 month period. If only I could find one like this every 6 months :-)

Where do we go now?

I remember a interesting exchange that Taleb had written in one of his books either the “ Black Swan” or “ Fooled by randomness”, I cant recollect which one.

In one of the customary morning meetings that are part of all securities firms one of the traders asked him what would he assign a higher probability to the markets going up or down next week. Taleb’s view was that he would assign a higher probability of the markets going up.

The trader asked him his follow up question on what Taleb’s position was. He replied he was going short on the market which of course perplexed the trader.

It is a interesting exchange. The trader of course missed the point that what is important is not just about the probability of the market moving in a particular direction but how much can the market move in a particular direction.

So there could be a 70% probability of the market moving up 10% and a 30% probability of the market moving down 40%. The payoff in the probability matrix of the market moving down is much higher.

Why did this thought cross my mind? The current market seems to be poised at a interesting juncture. Though the momentum seems to indicate a higher probability of it moving up, the quantum of downside if it plays out will be much higher.

Where do we go
Where do we go now
Where do we go
Sweet child o' mine - Guns & Roses

Profit Growth versus EPS growth

Sales up 15%. Profit up 20%.

I am sure you have seen a lot of advertisements over the last few days which look fairly similar. So where is the gap in this storyline? Does all this profit growth necessarily translate into EPS growth? The answer is no and that’s where we miss the wood for the trees.

There is a lot of equity dilution that is happening out there in the marketplace. All these QIP’s / GDR’s that the markets are applauding, ultimately lead to equity dilution. A lot of FCCB’s are getting repriced post negotiations to current market prices which are leading to substantially larger equity dilutions.

Preferential allotments are happening to promoter groups at substantially lower prices because of depressed stock prices over the last six months. And of course there is always Esops which expand the equity base.

The devil as they say is always in the details and in this case the EPS numbers.

May the force be wth you - Part 2 ( Industry Strikes Back)

I have at numerous instances in life encounter people who argue with me that education is not a necessary condition for success. The classic example that they quote is of Dirubhai Ambani. Look at what he achieved as a school dropout. Didn’t Bill Gates also drop out of college to start Microsoft in a garage?

It is important to understand what a outlier event is or survivor bias is. I think it is critical for every individual to understand some basic statistics. The principle of normal distribution and basic probability.

To believe that Dirubhai Ambani who is essentially a outlier event beyond the six sigma levels reflects the mean is a folly. The average graduate would do better than a average under-graduate and taking it forward a average post grad would do better than an average graduate.

So what does this have to do with investing and my previous post on Porter’s model for industry analysis.

It for me answers why it is important to understand a industry structure.

There are industries where the dice is loaded against the participants in the industry. Ex Airlines where it is rare to find profitable companies. There are industries like commodity companies which follow cycles and it is difficult for a individual company to break out of cycle.

Does this mean that all participants in these industries are doomed? The answer is no. However the dice is loaded against the company. There could be a great airlines company which could be extremely profitable but would essentially reflect the outlier and not the mean of the industry.

So while analysing a company it is important to understand the industry structure under which operates so as to get a fair picture of what are the forces acting against or for the company.

As Buffett says “"When a manager for a reputation for brilliance tackles a business with a reputation for poor fundamental economics, then its the reputation of the business that remains unchanged”.

May the force be with you

I remember Obi Wan Kenobi telling Luke Skywalker in Star Wars “ May the force be with you” and “ Use the Force Luke”.

It brings back memories of a era gone by and reminds me also of something that I read a long time back Michael Porters “ 5 Forces Model”. To be honest there is a certain amount of cynicism that one displays during one’s MBA days for stuff that one would call “ management gyan”.

But like the way I appreciate Asterix comics or Calvin & Hobbes differently from the way I enjoyed them maybe 10 years back, Porter’s 5 forces model provides a nice framework to analyse a industry.

Buffett talks about the moat principle where the business should have adequate competitive advantage. I believe Porters “5 Forces Model” meshes in nicely with what Buffet said and provides a starting framework for evaluating a company.

The Five Forces
The threat of substitute products
The existence of close substitute reduces the leverage that a company has to raise prices as it lead to customers switching to substitutes. Also there could be substitutes which could make the current product irrelevant. Technology products are a classic example of this.

The threat of the entry of new competition
Low entry barriers into a business will ensure that the arbitrage of supernormal profits will get wiped out as more and more competition enters the business.

The intensity of competitive rivalry
Higher competitive rivalry could lead to the race to the bottom in terms of pricing and profitability. Airlines industries is a classic example.

The bargaining power of customers
Classic example would be concentrated set of buyers. Or the risk of buyers backward integrating or switching to substitute products.

The bargaining power of suppliers
Again concentrated set of suppliers could easily squeeze margins and ensure that the business cannot earn supernormal profits.

Porters 5 Forces model is a good starting off point in evaluating the moat around the company. Of course there are other variables that can be added to the process.

Which brings us to the question “ Why do we need to evaluate a industry structure in analysing a company”? That is for the next post.

Till then “ May Porters 5 Forces be with you”.

Addition to the Blog

I have added a new series of links in the blog which covers links to blogs / websites of professors / academicians.

My areas of interests is in the domain of economics, capital markets and behavioural finance. I would be most happy if readers of the blog have suggestions in terms of academicians in these domains, links to whom I could add to the blog .

Piramal Life Sciences or Slot machines

I was reading the balance sheet of Piramal Life Sciences that a friend of mine handed over for me to evaluate.

Piramal Life sciences is the demerged arm of Piramal healthcare which is a research driven drug discovery company. It was formally the R&D unit at Nicholas Piramal. It focussed on four therapeutic areas cancer, diabetes, inflammation and infectious disease.

The balance sheet was a interesting read. The company has zero or negligible sales and is burning cash/ posting net loss of about Rs 25 crores a quarter. It posted a net loss of Rs 110 cores for FY 09 and has accumulated losses of about Rs 202 crores.

This is against a equity and reserve base of about Rs 183.6 cores effectively wiping out the balance sheet. Most of their molecules are still in Stage 1 and 2 of clinical trials.

They have been funding themselves thru short term ICD loans from the parent company and the auditor has even made a remark about using short term funding for long term asset.

Drug Discovery - Risky business
Drug discovery is a risky business with very high upfront capital commitment and low success rate. The payoff’s could be extremely high for a blockbuster molecule but it is tough to assign probabilities. The demerger model is essentially to derisk the parent company from vagaries of drug discovery.

Which brings us to the reason for this post …..

How does a retail investor believe that he can understand the risk return payoff of the drug discovery business when the parent pharma company itself is not sure on this?

I can understand venture funds investing in a business like this bcos that’s there capability set but a retail investor getting into a stock like this is beyond me.

I would rather go with a slot machine even though I know the odds are against me but atleast I understand the odds. The stock incidentally is quoting at Rs 55 giving it a market cap of about 125 crores.

Nilekani farewell at Infosys

I was reading about the news article covering Nandan Nilekani's farewell at Infosys after 28 years as he moves into the government.

Came across CEO Kris Gopalakrishnan's quote which I liked and sharing it
" I have known u for longer than I have not known you". :-)

Dr Reddys Laboratries

When I was enroute to office today I started reading Dr Reddys balance sheet in the car. It had a interesting piece of data that I thought of sharing.

Dr Anji Reddy the chairman writes and I quote

“ If any shareholder had purchased 100 shares during your company’s IPO in Aug 1986, plus the 60% rights issue in Aug 1989, and held on these till date, the person would be owning a total of 5760 shares at a face value of Rs 5 per share. Against a outlay of Rs 2500 ( Rs 1000 in the IPO and Rs 1500 to purchase 60 shares of the rights issue at Rs 25 per share), that investor would have earned a total of Rs 1.95 lacs of divided, including current years proposed dividend.

On 31st March your company’s share on BSE was being quoted at Rs 488.65. Thus, the value of the investors portfolio would have been Rs 28.15 lakhs”.

Now that’s a 1000 bagger in 23 years. A fixed income instrument assuming doubling every 6 years would have been grown 16 times in that period.

If only I had spent less time and money chasing girls in my teens :-). Now I know where Warren Buffett got it right by starting early.

Disclaimer: I am not recommending the Dr Reddy’s stock and I own all of 10 shares, kept just to get the balance sheet :-).

Gwalior Chemicals - Update

I already written about the Gwalior Chemcials deal with Lanxess and the investment opportunity. As part of the process the company has sent across the notice for the postal ballot. I am enclosing a link to the same.

http://www.bseindia.com/xml-data/corpfiling/announcement/Gwalior_Chemical_Industries_Ltd_240609.pdf

The management has reiterated its decision to distribute Rs 100 crores to the shareholders in this communciation.

To wait or not to wait

In one of my previous post Reverend put across a query to me and i quote

“Your views on Mphasis as a potential delisting candidate? An article I came across suggests that HP has no listed subsidiaries in the 170 countries it operates and makes a case for delisting. They have cited Digital (a subsidiary of Compaq) which they delisted. Happened in 2001 or so.. Your insights please?”.

It’s a interesting question and I understand the thought process that goes behind this opportunity. I have also in the past and continue to analyse similar companies.

Lets examine the structure of evaluating such a opportunity.

Mphasis was acquired by EDS which subsequently got acquired by HP globally. HP globally doesn’t have listed subsidiaries and at some point of time would probably go in for a delisting exercise for Mphasis.

The logic is fair and there is strong likelihood of this happening. The important question is when? Next month, Next year or 5 years down the line.

This is a huge uncertainty that one has to live with. Mphasis currently quotes at about 393. In the intermittent period till the delisting happens what level could the stock go down to. This is absolutely critical which leads us to the next stage.

Would I buy Mphasis without factoring in a delisting opportunity? Am I comfortable with financials, performance, industry outlook etc of Mphasis? Is there a margin of safety in the stock without the delisting?

If the answer to these questions is yes? Then it makes sense to look at the opportunity. If intrinsically one is comfortable to hold Mphasis then a possible delisting is a added bonus.

Else one needs to factor in the possible downside in the stock, the likely timeline for a corporate action and the opportunity cost with respect to the general market.

I hold a stock where there is similar logic waiting to play out. Will write on it in my subsequent posts.

On a side note Reverend, I wouldn’t see a straight delisiting exercise in Mphasis. EDS currently holds about 60%. If they were to do this I would expect them to do it 2 stages. Phase 1 do a open offer and increase their stake to either 75% or 90% based on the listing requirements and then in Phase 2 actually go thru the delisting process.

Remembered a old Rafi and Asha song on this ….
ham intezaar karenge
ham intezaar karenge tera qayaamat tak
khudaa kare ke qayaamat ho, aur tu aaye
ham intezaar karenge …

TCS - Management Stockholding

I saw some interesting piece of information in yesterdays ET in the insider trading disclosure on TCS. The top management of TCS got alloted the following number of shares by virtue of the 1:1 bonus issue. The actual holding is double of this.

Mr Ratan Tata - 761628
Phiroz Vandrewala - 50304
N Chandrashekaran - 44264
S Ramadorai - 99560
S Mahalingam - 80840
Mrs Lalitha - 60

Came as a surprise to me that Ratan Tata owns stock in TCS in a individual capacity.

Book Review - Market Panic

I just finished reading the book “ Market Panic” by Stephen Vines. I would say more like browsed through it. The book is ok read slightly repetitive but did have a few good things.

I liked the author’s structure on the various stages of a stockmarket cycle leading to the final panic exit that most markets demonstrate at the end of the cycle.

Listing down how the author has described the various stages of the cycle

Stage I
The cycle starts with some kind of external shock the system that creates important opportunities for atleast one sector of the economy. It could be a event like a war or new inventions like the railways or more recently the rise of the internet

Stage 2
This boom then gets enlarged largely fuelled by expansion of bank credit expanding money supply ( Greenspan being a case in point).

Stage 3
With greater liquidity in the system euphoria takes over and as “Adam Smith” put overtrading. This results in greater trading volumes and higher level of speculation and leverage that builds into the system

Stage 4
As the author quotes “There is nothing so disturbing to one’s well being and judgement to see a friend get rich”. So everyone one wants to get rich. People who haven’t thought of entering the stockmarkets suddenly start investing in the markets.

Stage 5
The real danger signals starts when the stockmarket news moves from the inner pages of non financial newspapers to the front pages. I quote the author “Illustrating this point was the alarming appearance of mutual funds as a “Playboy” cover story. When stocks replace scantily clad young ladies who are well endowed on the cover, logic has clearly taken a holiday’.

Stage 6
Not only does the stockmarkets get inundated with inexperienced participants but their very presence increases demand leading to the temptation and opportunity for many new equity issues designed to capitalise on the window of opportunity for selling all manner of assets at an inflated price. This also leads creation of new derivative products allegedly aimed at sophisticated investors increasing leverage in the system and building pressure. This starts process where lenders start calling in additional margin with central bankers stepping in to deflate the bubble.

Stage 7
As the bubble grows the markets starts losing all sense of connect with the underlying assets.

Stage 8
At this stage a number of scams and dubious investments start coming out. This is interesting as a symptom if not the cause of stockmarket panics.

Stage 9
At this stage the savvy investors sense the top and start exiting from the market. Newer players are unsure and tend to stay put resulting in brakes on the rapid upward price movement. As the “greater fool” becomes difficult to find there is increasing movement from assets into cash resulting in depressing prices leading to unwinding of leveraged positions.

Stage 10
Now the market is in full retreat and there is competition to get out or the rush thru the door. This is typically led/ followed by the dramatic failure of a bank or other institutions or a particular scam.

Stage 11
This is final stage where the very assets which were darlings of the market become the object of revulsion and there is a market wide panic that builds up invariably leading to the regulator putting on cap in terms of limits or acting as a lender of last resort to bring stability and confidence to the markets

I have personally seen about three cycles and I can say that this is a fair template of how the markets move. Of course to add to it I always hear the magical four words “ This time its different” :-).

IL&FS Investmart - Bingo :-)

I had earlier posted here on a special situation transaction covering IL&FS Investsmart and Dabur Pharma. I had just few days back put in a update on the status of this special situation transaction.

IL&FS Investsmart today came out with a announcement that its promoters HSBC are seeking to go in for a delisting :-) Whoopie. The link is enclosed here.

Atleast one leg of the transaction paid off and will hopefully deliver some good bottomline. Lets see how the market reacts to the news tomorrow. I expect the delisting to happen anywhere in the Rs 200 to Rs 250 band. The original price of the transaction was around Rs 84. Will come back with more updates on this as and when the transaction moves forward.

Gwalior Chemicals - Economic Times Update

I had posted earlier thru the week on a special situations case arising in the Gwalior Chemicals stock. The economic times today put out a article on similar lines and I am enclosing the link here to the article.

I am reassured that I haven’t got the numbers wrong or have missed something in my analysis because the economic times argument and numbers are in sync with what I put out in my post.

It of course is now upto the market how they want to value cash especially one which is coming tax free in the hand as opposed to letting it lie in the bush.

Dabur Pharma & IL&FS Investmart Update

I had in the month of November written a post on a potential arbitrage opportunity covering Dabur Pharma and IL& FS Investmart.

A lot of water has since flown below the bridge and due to the fact that I have been irregular on the blog I didn’t put out a update on the opportunity.

The basic premise was the fact that post their respective open offers the promoter holding on both these companies had crossed the 90% mark. The bet was that either the promoters would have to sell their residual stake and bring it below 90% or delist the company. In case a delisting was to take place then the promoters would have to offer the last open offer price to the remaining shareholders.

I m listing down what was the potential payoff matrix at that time.
Dabur Pharma

Current Price – 38.5

Exit Price - 76.5

Delisting Return - 98%

Potential Downside - 20%

IL&FS Investmart

Current Price – 84

Exit Price - 200

Delisting Return - 138%

Potential Downside - 20%

Possible scenarios

1) Both get delisted - Returns - 118% ( Too good to be true :-)) – Probabaility – 25%

2) Dabur delisted, ILFS stays listed - Return 39% - Probability – 25%

3) ILFS delisted, Dabur stays listed - Return 59% - Probability – 25%

4) Both stay listed - Return (-20%) Probability - 25%

Potential Payoff - ( 0.25*118% + 0.25*39% + 0.25*59% + .25*(-20%) )= 49%

Now the update on this arbitrage bet.

Flawed understanding
My understanding of the process was flawed in terms of what happened when promoter holding goes beyond 90%. I spoke to a investment banker who is in the capital markets domain and this is the download that I got.

Delisting happens once the public shareholding fall below the minimum level as defined in the listing agreement. This need not necessarily be 10% but could be higher at 25% also. Once the public shareholding falls below the minimum level then as per the delisting laws the exchanges will give the company one year to comply with the listing norms. The promoter in the meantime has to either dilute or make a reverse bookbuilding offer for delisting. The price that is thrown up through this is the price at which delisting will take place.

Dabur Pharma Update

Fresenius Kabi which chose to acquire Dabur Pharma chose to dilute its holding by making a preferential allotment to Atlas – Vermoegensverwaltungs at a price of Rs 44.95.

This enabled them to bring down their holding to the 90% mark and continue with listing Dabur Pharma which has now been renamed as Fresinius Kabi Oncology Ltd.

The original premise of the arbitrage didn’t play out in this case. However the current stock price of Dabur Pharma is Rs 50. A return of about 30% over the investment price of Rs 38.5.

IL&FS Investmart Update
In case of IL&FS there has been no update with HSBC not making a move either in diluting stake or a delisting offer.
However the last few days the stock has been gradually moving up on the circuit. Maybe the market is smelling some corporate action playing out. The stock is currently at the Rs 140 mark generating a return of about 66% on the invested price. Waiting to see how this arbitrage plays out.

Gwalior Chemicals - Special Situation

Gwalior Chemicals announced on the 8th of June that it was selling its chemical business to Lanxess. The total enterprise value of the deal is Rs 536 crores with Lanxess taking over debt of Rs 156 crores. The equity value accruing to the company would be Rs 380 crores. The company would be still left with a plant at Ankhleshwar.

The management has gone on record saying that they intend to return 100 crores out of Rs 380 crores to the shareholders either thru a one time dividend or share buyback.

The current equity capital of the company is Rs 24.67 crores.

So we are saying that the shareholder will accrue a sale value of Rs 154 per share out of which the company intends to return approximately Rs 40 per share either in the form of dividend or share buyback.

The current stock price of the company is Rs 92. A classic Graham opportunity. Either the market hasn’t figured this out or there is something that I m missing here. Looks like a very attractive deal.

Infosys - Stable friend

I have laid my hands on the current years Infosys balance sheet. As always it a joy to read for both the quantity and quality of disclosures.

Consolidated income has gone upto Rs 21693 crores a jump of 29.96% over the previous year. Net profit has grown to Rs 6828 crores from Rs 4941 crores a jump of 38%. The company continues to improve performance on all cost varaibales as a % of sales with operating profit at 34.08% . Sundry Debtor cycle has been bought down and stands at 16.7 % of revenues as opposed to 19.8% of sales last year.

EPS increased by 31.1% to Rs 99.76 per share from Rs 76.2 per share. Return on capital employed has improved from 41.38% to 42.9%.

Infosys continues to be a high margin high ROCE business with impeccable management track record. I see a few challenging years ahead but Infosys has the management and the organisational competency to ride thru this challenging phase.

A few other observations.

Cost of Capital
I had written last year about Infosys’s computation of cost of capital and the management decision to look at a minimum return of twice the cost of capital on average capital employed and thrice the cost of capital on average invested capital. The current cost of capital for Infosys is 12.18%. it has come down from 13.32% last year as Infosys has factored in 7% as return on risk free capital as opposed to 8% last year for computing cost of capital.

Dividend policy
The company has stated and is maintaining a dividend payout ratio of 30% of net profits which they has listed down as a strategy last year.

Cash on the balance sheet :-(
Cash and cash equivalents on the balance sheet have increased to nearly Rs 10000 crores which is invested in fixed deposits. This has been my only sore point with Infosys. I don’t get the logic on maintaining such high cash levels which is depressing ROCE.

Infosys management has always maintained that they would not be keen in looking at aggressive acquisitions to grow. It would invariably be niche acquisitions to fill skillset or geographical gaps. The business remains immensely profitable and throws out substantial amounts of cash every year. Infosys had also restructured its biggest cost variable - employee cost in the last downturn to incorporate a significant chunk of variable component in it to factor in significant downturns.
With so much buffer available in place I really don’t see the logic of maintaining such high cash levels. Ideally I would want the management to constantly buyback shares so as to reduce the equity base and improve EPS and ROCE.

I don’t even mind a lower dividend payout ratio and a higher share buyback program bcos share buyback is more tax friendly.

I continue to hold some Infosys shares and plan to retain them but not planning to add more as of now.

Out of body experience

Wikipedia defines an “Out-of-body experience” (OBE or sometimes OOBE), is an experience that typically involves a sensation of floating outside of one's body and, in some cases, perceiving one's physical body from a place outside one's body.

The ability to stand away from oneself and watch ourselves and our behaviour in a particular situation.

I want to take extend this concept to a “Out of market” experience. Can we take ourselves out of the market and observe our own thoughts and behaviour at every stage of the market ?

A few months back everybody and their grandmothers were talking about a market which having jumped off the cliff was very likely to continue falling. To quote Munger “ The light at the end of the tunnel appears to be of the incoming train”.

I remember a few participants in the market talking about a bear market rally and I specifically remember Shankar Sharma doing it. His thought was that though we are in secular bear market there could be swift bear market rallies which could take the market up by nearly 50%. I was at that point wondering how do market participants behave in a bear market rally?. Wouldn’t the belief/ knowledge that it is a bear market rally curb the rally or does one tend to alter outlook when one reaches the situation?

This brings me back to my original thought of “ Out of market” experience. Can I at this stage take myself out of the exuberance that I experience right now seeing my stock go up 20% everyday and ponder?

Ponder on whether is the worst over or are we amidst a sharp bear market rally and the jump from the cliff has landed us with Alice in Wonderland.

For ppl who have had the privilege to watch Darby, Tigger & Pooh along with their children( I do with my daughter) it’s the time to move that finger to their heads and “Think Think Think”.

Bull Market Blogger

I am at a risk of being labelled as the “bull market blogger” who appears when the markets perk up and disappears as the down cycle starts :-).

I have been fairly irregular on the blog over the last few months primarily due to the fact that I had to make a choice between saving my business and saving my blog :-). Clearing business won over the blog.

Plan to write more often and provide a update on the past ideas that I had listed in the blog.

Aditya Birla Chemicals ( Bihar Caustic) - Q3 results

Sensex - 8197
Price - 31.15

I had originally posted on Aditya Birla Chem here followed by updates on the Q1 and Q2 results.

The company’s Q3 results are back on track post slight downturn in Q2 because of the boiler blast which affected production. Sales has grown sequentially from Rs 46 crores in Q2 to Rs 49.8 crores in Q3. More importantly Net profit has grown from Rs 6.4 crores to Rs 12 crores where the Q2 profitability was affected due to one time expense on repair and maintenance. Quarterly EPS moved up from 2.78 to 5.14.

Cumulative EPS for first nine months 13.6 and annualise EPS works out to be Rs 18.33. The stock currently is trading at nearly 1/3rd its book value and a P/E ratio of 1.71 times.

The company also got rechristened to Aditya Birla Chemicals from Bihar Caustic. I continue to hold the stock and add at opportunities

Odds & Ends

On one of my previous post regarding Alex from Moneyvidya posed a question to me and I quote him

“Are margins of safety not based on intrinsic values which can only be estimated from the fundamentals. Do you know of a way to create or measure a margin of safety for an investment which protects you from the possibility that all your knowledge of the fundamental properties of the security are incorrect?”

I think one of the most important things in investing or in all aspects of our lives is to understand the concept of probability and the potential payoff arising out a probable event.

When we buy a lottery ticket lets assume the following structure
Scenario 1

Price of ticket – Rs 1
No of participant - 100
Potential payoff = Rs 100 – Rs 10 ( Lottery provider’s fees) – Rs 20 ( Government taxes)= Rs 70

So for a probability of 1 in a 100 we have a potential payoff of 70 times.

The net payoff of this transaction is 1*(70) + 99*(-1) = -29

Most lotteries/ casinos are structured in such a manner where the participants lose money.

Scenario 2
Now let us assume that the lottery provider waived of his fees and the government its taxes and some benevolent donor added a extra Rs 25 to the kitty. Lets examine the structure now

Price of ticket – Rs 1
No of participant - 100
Donor contribution Rs 25
Potential payoff = Rs 100 + Rs 25 = Rs 125

So for a probability of 1 in a 100 we have a potential payoff of 125 times.
The net payoff of this transaction is 1*(125) + 99*(-1) = +26 times

In scenario 2 the odds are structured in our favour and hence a margin of safety is built in the trade. This need not necessarily mean that you will win the lottery but the odds are stacked in your favour.

Lets take this forward to stocks. When I evaluate stocks my starting point is management. What is the margin of safety in terms of management?. When I see a promoters personal yacht being put on the companies books it doesn’t necessarily mean the promoter will take the company down like Satyam but for me the odds are against me on this variable. There is a higher probability that the promoter will siphon out a bigger chunk on a latter date or indulge in corporate actions that is detrimental to shareholders.

I remember in one of my chats discussing real estate with one of my fellow bloggers and he telling me how can u expect ethical promoters in a business which is intrinsically unethical in India. It was a wonderful insight. So whether there is a problem today or not the odds are extremely high of encountering a black swan event in a real estate stock because of promoter action.

Will it happen? Not necessarily but the odds are stacked against you. To compensate for this is the margin of safety high enough on the financials in terms of intrinsic value to price and on a net off basis factoring both this variables is the odds in your favour.

Let us say that one has a portfolio of 10 stocks with positive payoffs on each stock. Lets look at the following structure

Number of stocks - 10
Probability of + returns on each stock - 60%
Probability of – returns on each stock - 40%
Can I eliminate a potential black swan event in a individual stock? The answer is no. To answer Alex’s question, we might encounter a black swan event in a single stock which cannot be eliminated but by building a margin of safety in each stock position one will on a overall portfolio basis achieve positive returns.

Déjà vu

This story is about a organisation which was structured to look at potential mispricing in the bond markets in terms of spreads between 2 instruments and look at those spreads reaching the long term average. The organisation worked its models around bonds, mortgages, equities and derivatives across myraid asset classes. The organisation spearheaded extensive use of quant and modeling in bond trading.

The organisation worked on magnifying its return by taking enormous amount of leverage 30:1. In a 5 year tenure it delivered a return of over 40% per annum. However its enormous leverage in the derivatives market of over $1 trillion wend bad in a month when markets across the world collapsed with a correlation of 1 throwing all the models out of the window. So we reached the stage where the organisation was on the verge of bankruptcy and threatened to take the entire financial system down with them. The huge counterparty risk coupled with fear threatened to freeze markets across the globe.

The bankers of course rushed to the big daddy FED who promptly worked out a bailout package to save the organisation and the markets. And we all lived happily ever after or did we?

I m sure most of us will look at this and the names that will come to our mind are Lehman Bros, AIG, Citi etc

Well this was about a hedge fund called Long Terms Capital Management which went down under in 1998 before the bailout.

The fund was started by John Meriwether ex head of bond trading for Salomon Brothers where he was forced to resign after his top bond trader admitted to falsifying bids in the US treasury auction. J M managed to rope in Nobel price winners Robert Merton and Myron Scholes of the famous Black Scholes model as partners and the funds partners were positioned as a intellectual breed apart. I just finished the book When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein. Interesting read.

There is a strong sense of déjà vu that creeps in as you see the same cycle repeating itself bringing financial markets to a crisis and I can lay a bet that we will see it play out again. “We learn from history that we don’t learn from history” - I had earlier written a blog on this.

PS: Here’s the amazing follow up to the storyline - John Meriwether post the LTCM fiasco went on along with his colleagues to start JWM partners which floated a Relative Value Opportunity Fund where the fund document stated that it would keep its leverage down to 15:1.

The funds posted gains for several years, but in the first quarter of 2008 posted losses, of 31% in the flagship Relative Value Opportunity bond fund.

JM quotes “While we are clearly disappointed by our recent performance, we remain optimistic about the current opportunity set,".
"While we do not welcome the increased volatility in our returns, we believe that increased market volatility is one of the primary preconditions for creating interesting relative value situations," he added
And this was first quarter last year. Bond spreads kept widening significantly post that. History repeats.

The Satyam Saga - Key learnings

Lot has been written on the Satyam Saga and I had earlier posted on it when the Maytas deal was announced by Raju. The intention of this post is not to run threadbare on the scam as there is enough information in the public domain on this. I intend to focus on two key learnings for me from the scam

Lies, Damned Lies and Management.
This event has reinforced by belief that the starting point of any stock selection process is to understand the management and its track record. The ethical values that the management has displayed both in terms of their business dealings as well as dealings with the shareholders.

Its amazing how if a friend, relative, neighbour of ours asks us to become a partner and invest money in a business opportunity, our first instinctive reaction is to check whether we trust the person. The next step is to check whether the business opportunity is attractive. But when we buy stock which is effectively becoming a partner we seem to overlook this variable.

In my experience a detailed running thru the balance sheet more often than not gives you a flavour of the management and how they value the various stakeholders.

Management quality could become a go-no go criteria or should atleast form a significant weightage in the stock selection process.


Black & White Swans
I had earlier written about how I factor in Black Swans in my investment strategy. The Satyam event is a classic Black Swan event that nobody saw coming. This has reinforced by belief in my previous hypothesis that it is critical to build a portfolio factoring in a adequate “ Margin of Safety” to ride out the black swans that one might encounter in the investment journey.

Also being able to accept Black Swans ( negative surprises ) and acknowledge White swans ( positive surprises) helps in building a temperament which doesn’t get unduly ruffled by the vagaries of the market.