Orient Refractories - Update

Orient Refractories made a announcement to the BSE last evening stating the intent of the existing promoters to sell 43.62% of their stake in the company to M’s Dutch US Holding B.V Netherlands which is a entity wholly owned by RHI AG Austria.

I had written in my previous post about the likelihood of this deal. The hypothesis played out on that variable however one is disappointed by the stated price of the transaction and the open offer price. The deal was stuck at a price of Rs 43 per share. This is clearly far lower than the number I had, benchmarking the superior financial ratios that Orient displayed coupled with the valuations that Vesuvius trades at in the Indian market. The interesting part is the existing promoter Rajgarhia will continue to hold 5% in the company and will be on the board of directors.

The stock should trade in the 38-39 mark factoring relatively higher acceptance ratio as the public shareholding also contains members of the promoter family coupled with large retail holding.

The deal though disappointing cant be complained about since the investment yielded a return of 30% in  3 months.

It would be worth watching this transaction over the life of this deal as the market could provide additional investment opportunities

a)      Use the open offer route to make cheap shares in case the price drifts down as the market’s interest in the deal diminishes.

b)      Post open offer correction would be interesting to see as to where the stock settles down and the likelihood of investment opportunities.

The eternal search for the next situation is on …..

Orient Refractories - The heat is on.

Orient Refractories has a interesting past and a interesting future. It was born by demerging itself from Orient Abrasives which is a part of the Rajgarhia group. Orient Abrasives initiated a scheme of demerger through which for every one share of Orient Abrasives the shareholder received one share of Orient Refractories. The company got listed in March 2012 and had a interesting first few weeks in terms of price movements.

It was a demerger that I had tracked but didn’t see any potential value unlocking by virtue of the demerger transaction. What however piqued my interest was trying to understand the potential driving variable behind the demerger process. The refractories business was a great business with high ROE versus the Abrasives business which had poor financial ratios. The thought that crossed my mind was that the management was looking at selling off one of the businesses though it was tough to ascertain which one.

Fast forwarding in the month of May 12 there was a news article in the economic times talking about German group RHI being interested in buying Orient Refractories, The link is attached here. The stock of course rose on the back of this news and started trading in the 32 – 38 trading band as there were periodic news of this takeover. This made it interesting to dig deep into the company.

Some reading up on RHI and the concall + presentation for the June 12 quarter mentioned the fact that they were looking at a acquisition in India and the same would be closed by the end of the year. Parallely, Orient Refractories also initiated a VRS scheme, expenses for which were booked in the June 12 quarter. With the resultant time delay the market lost interest in the stock and stock drifted down to the 29- 30 levels where the position was built into the counter. 

The month of Oct and Nov saw flurry of activity again as the news of the takeover started surfacing again. Here’s a link to a new story in the Economic times.

Though there were standard denials from the company, what is really interesting is the current investor concall of RHI for Sept 12 - Link. The CFO  in the concall in response to a question explicitly mentions that they are talking to Orient Refractories and of course a few other players :-). Of course the deal horizon has got pushed back. The market in the meantime has pushed up the stock in the 38-40 range.

The market has anchored itself to the price point mentioned in the ET article of Rs 42 for the deal though I would be surprised if the deal was to happen at this price point. Factoring in valuations and precedents on some global deals coupled with control premium my expectation would be that the deal ( if it takes place :-)) should happen in the Rs 55-60 price range.  It would be a interesting next couple of months to check if things are heating up.

Disclaimer

1)      The articles that are posted on this blog either stock specific or otherwise should not be construed as investment advice to buy/ sell stocks. These are sharing of my thoughts for discussions.

2)      As a analyst and investor I may have positions in stocks discussed on the blog and may exit these positions without intimation.

3)      Please do not base your buy/sell decision purely based on the articles in the blog. Do carry out your own diligence before your base your decisions.

Thinking about Thinking

The brain has a amazing ability to contemplate based on the sensory stimuli that it receives which it then matches with the memories that it has stored to arrive at a suitable response to the stimuli. This is common across all species and with us homo sapiens. The human mind however differentiates itself with other species in its ability to contemplate itself contemplating over something. This particular repetitive quality or as we popularly call it second order thinking, is to quote Prof Ramchandran’s talk on Ted the “Holy grail of  Neuroscience”

One of the interesting aspects of second order thinking is its ability to have a slightly more rational approach as it analyses the relatively emotional reaction of the first order thinking.  But to quote Yogi Berra “In theory there is no difference between theory and practise. In practise there is”.

So let me come to a practical experience that I went through last month. I had bought Hero Honda about a year and half back at around Rs 1400 . This was the phase post the break up with its erstwhile partner Honda and the market had turned bearish on the stock with the outlook for the company appearing bleak. I had at that point tried to sit back through the clutter, think through what were the key success variables in the two wheeler business and what value did Hero bring to the table. Though the market was focussing on the technology front, my thoughts led me to believe that the key differentiator ( beyond the brand/ positioning etc) that Hero bought on the table was the distribution strength that it had and the associated mindshare. Having looked at the past instances and examples of Bajaj  & TVS, technology was available off the shelf, maybe costing 400-500 crores which could be acquired and a product portfolio built in 2-3 year horizon. But building distribution especially rural distribution was a challenging task.

Fast forwarding and having collected about Rs 150 ( 70+35+45) of dividend along the way and missed opportunities to sell the stock at 2200 ( I got greedy :-)), I started pondering last month over how the business environment had evolved over the last one year. The company had moved forward on executing the technology gap by acquisition/ tie-ups and has progressed on taping the export markets. Couple of things have happened which made me start looking at a exit. The domestic market had slowed down and Hero was finding it difficult to grow on the large base that it had, coupled with slowdown in the export markets resulting in a relatively delayed launch in the export markets. But most importantly its erstwhile partner Honda has been making progress and gaining marketshare at a pace which to be honest I had not anticipated. 

This is where something interesting happened. As my brain started formulating this line of thought, I began to notice from my comforts of my car that more and more newer bikes and scooters that appeared on the road were largely from Honda and to a certain extent Bajaj. My scanning eyes would rarely notice a Hero bike or scooter.

My second order thinking was telling me that this was clearly availability bias coupled with reinforcement bias playing out where the brain was scanning for data to confirm a decision that was already taking shape in my mind. It knew that Hero’s strength was largely in 100 cc segment and it never had a strong foothold in the urban landscape where the competition was stronger. So logically the second order thinking should have prevented the first order thinking from garnering any fresh data points. But to the surprise of my second order brain, I was still not able to stop looking out of the car window trying to notice the increasing number of Honda vehicles on the road. Though I was rationally able to think that I was being irrational, it didn’t help take away the irrationality.

I did finally sell Hero Motocorp around the 1950 levels and exited the position. Till date my third order thinking is not able to reconcile the inability of the first and the second order thinking to merge together. If all this sounds confusing, well it reflects the confused state of my mind :-).

Rahul Dravid - The role model

To my biased mind Rahul Dravid who announced his retirement today, has been one of the greatest cricketer that this country has produced and unfortunately will get the least credit for his contribution to the game. I had put out a post in 2008 which I felt deserves a repost as a dedication to Dravid. 

Sachin Tendulkar, Rahul Dravid, Rakesh Jhunjhunwala
What does Sachin Tendulkar have to do with Investing? I think a lot and to me forms the basis of how I approach investing.

Sachin Tendulkar is a phenomenonal batsman and a thinking cricketer. He clearly the best batsman this country has produced if the not the world. I think he was born gifted and has a amazing sense of timing and hand eye co-ordination. He showed it, way early in his career and progressed by building on it. He is, as I would say a “natural”.
Every single Indian who picks up a bat aspires to be like Sachin Tendulkar. Mother pray and fathers bray in coaxing their litters into wielding the willow. But for every Tendulkar, there are a million who fall by the wayside and are left selling credit cards and writing blogs :-).

Let me examine another cricketer - Rahul Dravid. I wouldn’t by any stretch of imagination call him a natural. Dravid is the hard working, technically correct cricketer who puts in a lot of effort and displays tenacity. He unfortunately is not gifted with the raw natural talent that Sachin has ( This is true for 99.99% of us ). So he has made that up with sheer hard work and getting down to the basics. I would put Anil Kumble in a similar bracket as Dravid.
Dravid will not be as great as Sachin but he has left his indelible mark on Indian cricket.

The problem is that all of us aspire to be like Sachin when we are as talented as Dravid, if not worse. We walk in believing that we are potential god’s gift to mankind and leave the field with dreams shattered and egos hurt.

The key to success is to realise whether you have the natural talent of Sachin and if not, to change tack and become like the hardworking Dravid. Strategy No 2 clearly has a higher probability of success.

So what does this have to do with stockmarkets?
I think most people behave very similar when it comes to the stockmarkets. We all believe that we are the Sachin Tendulkars of the market with inborn insights and natural stock picking abilities.

There are people who have those abilities and I have met people like that. People who have the right instincts in terms of timing the market or the ability to look at a trading screen and see patterns. I have met people who can look at a balance sheet’s and come up with amazing insights.

Unfortunately these people constitute just 0.01 % of the population that exists in the stockmarkets. The remaining 99.99 % of us are not born with natural instincts. And a significant chunk of this population enters the market believing that they are the next Rakesh Jhunjhunwala’s of the world.

They leave disheartened and disillusioned by the experience and unfortunately some a lot poorer.
The way I look at the markets for myself is to position myself as a Dravid ( Knowing fairly well that I m not a Sachin). Nudging here and there, scoring those singles and twos and hopefully a few fours and sixes along the way.

The key to scoring runs is to retain your wicket or your portfolio to play the next day.

Bipolar Disorder

Bipolar disorder is a condition in which people go back and forth between periods of a very good or irritable mood and depression. The "mood swings" between mania and depression can be very quick. People suffering from bipolar disorder tend to toggle between going out spending all their money and feeling at the top of the world and slip in maniacally depressive state couple of weeks later feeling that the world is coming to an end.

I have a friend who has been suffering from this ailment for the last few months. He is called Mr Market. Mr Market was going through this really depressive phase in the months of Nov and Dec where everything on this planet appeared to be going wrong. Greece was going under, Anna Hazare was fasting, Power sector was in doldrums, government was twiddling their thumbs, corruption was everywhere-  telecom, mining etc.  Of course Mr Market's friend's, Mr Economic Times and Mr CNBC who as opposed to cheering Mr Market up seem to have aided this state of mind by wallowing in the same depressive state. After-all what are friends for if they cant stick together and wallow in misery. 

As the bells tolled to ring in the new year, Mr Market suddenly came out of his depressive room and walked into sunshine. Was it the drinking on the new years eve or just a cocktail of liquidity and dopamine that he injected, Mr Market felt he was on top of the world.

Buy Buy Buy and he wants to buy everything on this planet. The world has changed, the sun is shinning, Greece might be going down but that’s for the Germans to worry, Anna Hazare has been having hearty meals off late, who needs power when we have hope, and the corrupt have existed for 2000 years of human history so whats the big deal etc.

Mr Markets friends Mr Economic Times and Mr CNBC seem to be coaxing him into pulling those credit cards out and go on a binge. I m told Mr Market and his friends were last seen at the Mid & Small Cap Mall buying everything in sight. Microcap market is next on the cards followed by the TIP market. Mr Market’s old friend Mr Brokerage House who has been suffering with Volume Disorder for the last one year has recovered and is gradually joining in helping Mr Market in his buying binge.

Mr Market’s other close friend Mr Merchant Banker is planning to bring his old sweethearts Ms “IPO 1”, Ms “IPO 2”, Ms “IPO 3”, Ms “IPO 4”, Ms “IPO for Suckers” to the party. Ms IPO’s were on a sabbatical for the last year spending time with Mr SEBI on a workout regime getting in shape. Shape or no shape a women become more attractive when u r drunk which holds true for Ms IPO’s.

In all this, though Mr Market is a close friend and I like to spend a lot of time with him, for some reason our mood swings are inversely correlated. I was in such a ecstatic state in December and am beginning to get morose now.

Gets me to wonder whether it is Mr Market or I who suffers from bipolar disorder.

Here’s a few lines from a nice song by the “Carpenters” dedicated to you my friend Mr Market 

Top of the World

Such a feelin's comin' over me 

There is wonder in 'most ev'ry thing I see
Not a cloud in the sky, got the sun in my eyes

And I won't be surprised if it's a dream

Everything I want the world to be

Is now comin' true especially for me

Nesco Ltd

We value investors are a funny breed. I have over the past couple of years experienced that though we might share the same framework and thought process for some explicable reasons the portfolio of value investors rarely seem to match beyond maybe 20 – 30% of stocks. I regularly compare notes with my fellow friends and value investors Rohit Chauhan and Neeraj Marathe ( and a few more ) and funnily I have found that all of us have different stocks that we are comfortable with.

So it was a interesting that during the last week of December it transpired out of conversations/emails that all three of us have been independently looking at a company - Nesco Ltd. So we decided that post the year end break without discussing individual thought processes or our view on the company, we will put out posts on our blogs with our perspective on this investment opportunity. We thought it would be an interesting exercise for us as well as the readers of our blogs to have a post on the same company at the same time. The idea is not to see who is right or who is wrong. All three of us know that even if we reach a consensus, all three of us could be very wrong and even if all of us have different conclusions, all three could be very right! Well thats the best thing about investing, there is no one way of doing things.

You can check out Neeraj Marathe’s post at  http://neerajmarathe.blogspot.com/  and Rohit Chauhan's post at  http://valueinvestorindia.blogspot.com/ 

So here goes my side of the story 

Nesco Ltd was established in 1939 as New Std Engg and operated in the capital goods business. The company had plants in multiple locations in Mumbai which it finally consolidated at a single location in Goregaon on the Western suburbs of Mumbai with a 70 acre plot.

The company started incurring losses in its capital goods business and gradually shifted to the business to Gujarat and converted the Mumbai land bank into a exhibition and convention centre. The size of the land bank coupled with close proximity to the airports and the national highway has enabled it to become one of the premier exhibition centres in the country and has conducted over 500 exhibitions and events at the location. The closest competitor in Mumbai, Nehru Centre is less than 1/15^th the size in terms of exhibition space.

The company has also converted its old plant sheds into IT parks and is in the process of constructing a large IT park ( IT park 3). IT park III will have nearly 8,00,000 sq feet of space and the company has leased  out a significant chunk of this project which is under construction and should be ready for fit outs in the next couple of months. 

The management has been conservative and has repaid the debt on the books and has used the internal accrual route to fund expansion for the IT park that it is setting up. The management has clearly stated plans for IT park IV and IT park V where it intends to use the cash flow generated out of the exhibition business and rental income to fund construction of the remaining IT parks.

Financials

FY 2011

a) Income

1)       Convention Business -  65.62 crores ( up 21% over previous year)

2)       IT Park ( rent Income ) – 51.61 crores

3)       Capital Goods business -  16.82 crores ( Down from 24.8 crores in the previous year)

4)       Income from investments and other income -  10 crores

b) Cash/ Investments on Balance sheet -  168 crores

c) Net Profit -  68 crores

d) Cashflow from operations -  78 crores

HY -  2011 -2012

a) Income

1) Convention Business -  25 crores ( HY 2011 -  21 crores )

2)       IT Park ( rent Income ) – 51.61 crores

3)       Capital Goods business -  15.29 crores (HY 2011 -  6.61 crores )

4)       Income from investments and other income -  3.15 crores (  HY 2011 -  3.63 crores )

b) Cash/ Investments on Balance sheet -  215 crores

c) Net Profit -  25 crores

Dividend policy

The dividend payout ratio has been poor because the management has chosen to reinvest the cashflow in construction of the new IT building. The management intends to maintain the same as it is averse to taking debt and will use internal accrual to fund further construction over the next four to five years. One can’t argue against this thought process of the management considering the high operating margin and ROCE.

Valuation

The company is currently available at a market cap of Rs 800 crores with no debt on books. Against which we have

Cash / Investment on Books -  215 crores

Net Profit – 68 crores ( Last year) 

IT Park III should start contributing from next year and on a conservative estimate of Rs 80 per sq feet should generate an additional Rs 50 crores of revenue in FY12-13. 

So net cash of the company is available at 5-6 times and which would appear low for a company with high ROE and with steady cashflow and huge entry barrier to the business.

Risks

1)       Though cashflows over the next 4- 5 years are slated to be lined up for construction of IT park IV and V, subsequent to which there is lack of clarity on what the management intends to do with the cashflow going forward. The bladder problem of management either earmarking the cash for its capital good business or blowing it up into unrelated diversifications exists.

2)       The historical low dividend payout ratio though can be argued as logically correct at this stage of the business could however turn out to be a constant thought process for the management.

3)       The biggest risk that I perceive is that the entire business model is constructed around a piece of land in a single location in Mumbai. Mumbai is currently the most expensive city in this country with respect to real estate prices. There is a situation of oversupply of commercial property in Mumbai. The company stands exposed to not just a generic correction in real estate prices ( hence associated rent income )  but more importantly derating of the Mumbai real estate market. There is a increasing trend of companies shifting their IT / ITES operations out of Mumbai to other locations like Bangalore/ Pune/ Gurgaon etc. Case in point is that Intelenet which occupies one of the building did shift a significantly large process of over 2000 ppl to Aurangabad. TCS Eserve which occupies one of the other buildings is expanding its operations in Ahmedabad and other Tier II cities. Considering the 4- 5 year window when shareholders could possibly look at actual cashflow, this is a large risk that the business carries.

 My viewpoint

Prima facie the company appears to be cheap with relatively steady cashflows. I intend to look at company from a different angle.

Is Nesco a cash bargain / holding company and hence should be valued accordingly?

Lets examine the management competency variables

1)       The biggest achievement of NESCO is the piece of land at Goregaon which it fortuitously acquired a long time back.

2)       The current business model and cashflows are dependent on this piece of land.

3)       Can we say the management has competency in the real estate business and can take up more projects beyond this piece of land like any other real estate developer. 

4)       Is the same true about the Convention business? Do we think the management has competency to set up x more convention centres across the country and run it?

5)   The only operating business that management is running which is the capital good business has a chequered past track record.

So lets flip the coin and look at NESCO as a holding company / cash bargain opportunity.  We have a plot of land which on a conservative basis can be valued at RS 2000 crores + 200 crores ( Cash on balance sheet) = Rs 2200 crores.

This piece of land through rent and the convention centre generated about  68 crores of net profit last year . (I m keeping the calculations simple at this point of time without valuing the capital goods business separately) 

Effective yield of 3.4%. This yield should go up to about 5 % with the IT building III coming to play.

The market today values

Holding companies -  25% of intrinsic value

Cash bargains  -  40-50% of cash on balance sheet

 ( One can argue on the merits and demerits of these discounts but if one feels otherwise clearly there are better managements who could  be looked at for cash bargains)

 Considering the relatively lower yield being earned as compared to other cash bargains and management risk we can value the company at about 40% holding value.

 Value of the company -  40%* Rs 2200 crores -  880 crores

Current market cap  - Rs 800 crores.

Conclusion

Considering the lack of visibility of cashflow payout to the shareholders over the next 4- 5 years, I would like to look at this opportunity a couple of years down the line as clarity emerges on the management’s thought process and visibility on dividend payout and deployment of future cashflows.

Wordsworth

Like women’s fashion, there are words and phrases which come into our daily lives at light speed and disappear equally fast. Very few stick around to become part of our long term vocabulary. I have experienced this in all facets of life over the years whether in College/Corporate world/ Indian movies or in the investing space.

I of course rue words and phrases which are dear to me disappear gradually from the popular vocabulary. For Ex the word “Zulf” was so intrinsic to Hindi romantic songs but has been gradually replaced by the crude “Baal”.

When I was in management school the word “ Paradigm” had just emerged as the new paradigm of corporate lingo and everything kept moving to newer paradigms. Paradigm though still used fairly extensively has now been replaced by a more easy to pronounce “ Plane”. We all now seem to moving onto different planes and of course try to land on the “Same Page”.

The investing world also has its fair share of words and phrases that come and go like flavours of the month. It was with much amusement that I was recollecting just about 6 – 12 months back one of the most popular pair of words that most TVanchors and pink newspapers were mouthing was “ Coupling” and “ Decoupling”. I am sure most of you have a wry smile about this one.

Readers would recollect we used to be “Coupled” one week and miraculously used to get “Decoupled” the next week and again get coupled the next week. It was like speed dating and I thought it would have been easier to track Liz Taylor’s everchanging marital status than figuring out where our markets were in their love affair with global markets.

I of course am not so sure whether we are currently coupled or decoupled though our correlation or the lack of it with the global markets remain the same.

A new phrase that I m increasingly hearing for the last 6 months and has entered the Tv anchors lingo is “Risk Aversion”. It would be interesting to see how long “ Risk Aversion” lasts or will it also disappear gradually if markets go up.

To end, a nice phrase from the English romantic poet William Wordsworth

The mind that is wise mourns less for what age takes away; than what it leaves behind.

Interesting Accounting - Jyothy Laboratories

I was listening to the current quarter concall of Jyothy Laboratories and came across some interesting accounting.

In the month of May 11, Jyothy Laboratories announced the acquisition of Henkel’s stake in its Indian subsidiary Henkel India, gaining a foothold in the detergent market. Henkel India has been losing money for sometime and Jyothy has initiated action in turning the business around. As part of the exercise Jyothy has borrowed money on its balance sheet and lent that money to Henkel to manage debt on its books.

In the current quarter Jyothy has borrowed over Rs 460 crores ( 4600 Rated Taxable Zero Coupon Non Convertible Debentures  of a face value of Rs 10 lacs) by issuing short term debentures to the bank and lent the same to Henkel India. The debenture has been issued for a period of 91 days and will be redeemable at a premium of Rs 26,801.47 per debenture.

Now comes the interesting part. Jyothy in its current quarters results has booked other income of 14.82 crores. Nearly about 12 crores of it is interest paid by Henkel India to the parent for the money that Jyothy has lent to it. It is a significant amount considering the fact that Jyothy’s PBT for the quarter is Rs 16.93 crores.

But guess what, there is no corresponding interest expense booked in Jyothy’s accounts against the income that they are booking. On the concall the management said that since it is a zero coupon debenture which is being redeemed at a premium, the company is allowed to write of the redemption premium ( which is essentially interest) from the reserve and surplus. So magically they are booking interest income in the profit and loss account and expensing it out in the balance sheet.

Not really Ujjala bright and clean I must admit 

Endowment Bias and our wives – Interesting paradox

I have been besieged with increasing demand from my fans ( Fan club of two people - My pet frog and my pet rock) to start writing on the blog again. So here goes …

I m sure most of you have read about endowment bias on multiple blogs. Prof Bakshi has written on it and so have my friends Rohit and Neeraj commented on it.

Endowment bias or effect is the phenomenon where people start valuing something more after they own it. It is the effect where people would demand a considerable higher price for a product that they own as opposed to what they would be prepared to pay for it before they own it.

A practical example is that people will always expect a higher amount for their home when they are selling as compared to what the prevalent market rate. In case of the house part of the value ascribed comes from the effort put in over the years in converting the house to a home at a emotional level. The buyer of course has no such emotional attachment to the house. A car once purchased, miraculously seems to better features than the neighbours car and so does our television or tablet etc

Endowment bias seeps into our stockpicking when suddenly the company we buy transforms from a ugly duckling into a white swan. It begins to look very precious with great business opportunity, great management, ability to increase marketshare, ability to increase margins etc. This flaw also plays out in our decision to sell the business when we always perceive it to be more valuable than what the market is willing to pay for it.

The paradox of course is that we suddenly don’t find our wives more beautiful or more precious after we marry them ( hopefully my wife is not reading this). I haven’t encountered men (even women) paying glowing tributes to their spouses like saying “ How good a cook my wife is or how beautiful/ intelligent she is or how caring my husband is etc

One way of looking at the paradox is that we really don’t own our wives :-). A lovely song by the Beatles called the “Norwegian Wood” comes to my mind immediately

“I once had a girl, or should I say, she once had me …"

Punjab Alkalis Update

I had earlier written on the opportunity arising out of the possible disinvestment of Punjab Alkalis by the Punjab state government.
The opportunity seems to have taken a ominous turn with an update that I read on the website which states that no bids have been received before the due date. The link is enclosed below
http://www.pbdisinvest.nic.in/html/approver_current_status_PSU.htm
Though I cant make out whether this is a old update when initial interest for the disinvestment was called for or a fresh update for the financial bids. Part of it could originate from the floor price that the government has defined or structure of the deal.
There could be fresh round of bids called with some concession from the government, I would rather err on the side of caution. Considering there is no valuation comfort, it makes sense to exit the situation without having to live thru the risk.

Humour in Results

It is my honest belief that there is a lot of humour all around us if we look at things with a slightly open mind.

As I was browsing through announcements on the BSE site, I came across a interesting announcement made by Gujarat Alkalies and Chemicals ltd regarding their results.

http://www.bseindia.com/xml-data/corpfiling/AttachHis/Gujarat_Alkalies_and_Chemicals_Ltd_140211.pdf

In the Press release Shri Guruprasad Mohapatra, IAS, MD of the company announced that financial ratios have improved significantly at the end of the third quarter as compared to year end March 10

1) Price Earning Ratio - 13.15 times from 5.37 times

2) Current Ratio - 1.68 times to 1.56 times

3) Debt Equity Ratio - 0.13 times to 0.17:1 times

4) Book Value - Rs 193 from Rs 185

Now you would wonder what magic did the management did to improve PE ratio. It is news to me that management’s are now beginning to be judged by how well they can talk to the markets and improve their PE ratios.

Coming down to the magic that the management did to improve this PE ratio. It was a goal that they achieved by reducing the nine months profits of the company from 86 crores to 58 crores. Forget the price just reduce the earnings. I m waiting for the day they bring down the profits to zero and increase the PE ratio to infinity :-).

Midday / Nirma Update

Midday

I had initially written about the midday demerger opportunity and followed it up with a subsequent post when I exited the trade. Links to the post are enclosed below

1) http://investingvalues.blogspot.com/2011/01/take-midday-break.html

2) http://investingvalues.blogspot.com/2011/01/midday-update.html

The stock went Ex on the 20th and the market finally valued the radio business at Rs 8.60 per share on the closing of the day. This was in sync with my estimates of Rs 8-10 per share with 10 bucks on the outside.

Nirma

I had written earlier on the Nirma Delisting opportunity and the structure of the transaction. Link of the post is enclosed below

http://investingvalues.blogspot.com/2011/01/nirma-delisting.html

The reverse bookbuilding closed and the company has garnered enough shares to make the delisting successful at a price of Rs260. The management has till Feb 02nd to announce its acceptance / rejection of this discovered price.

There is a side trade that can be done now that the book has closed. Typically in the event of the management accepting the price, the stock will move towards the Rs 255 mark with the arbitrageurs sealing the gap. At the current price of Rs 248 there is Rs 6-7 bucks on the table in a 10 day period. However in case the management decides otherwise and rejects the offer then the stock could settle 25% lower from here. To quote Buffett/Munger this is the classic “Picking pennies in front of the roadroller” :-) and I for sure don’t have the appetite for it.

Nirma - Delisting

The promoters of Nirma in their announcement on 11th of October stated their intent to take the company private and de-list it form the exchanges. I have in the past invested in multiple delisting opportunities and had also put out a guest post on my friend Rohit blog detailing out the framework that we follow while evaluating a delisting opportunity. The link to that post is here
Using that framework let me quickly run thru the thought process in evaluating this special situation opportunity. In any delisting opportunity and the same framework can broadly be applied across other special opportunities, there are 3 risk points in the transaction


1) Time Risk
2) Price Risk
3) Deal Risk

Let me address each of these risks with respect to the Nirma opportunity.
1) Time Risk - The entry point for the transaction was timed post the shareholder approval. Post which filing is done with the exchanges. By monitoring various milestones in the deal, Time risk was constantly tracked.
2) Deal Risk – The promoters owned 77% stake in the company. For the reverse bookbuilding to succeed the promoters had to garner atleast 13% in the process.
Analysis of the shareholding structure indicated that institutions held about 2.56% shares and 42 individuals owned about 14.97% shares in the company. Clearly the company had to manage these shareholder to ensure that the delisting takes place.
3) Price Risk - This is where the opportunity really opened up. The promoters in their communication indicated Rs 235 as the fair prices for the delisting process. This effectively set the floor for the delisting.

Transaction Details
As stated earlier the floor price on the transaction was effectively set at Rs 235 as the promoters had indicated that they were comfortable with this price. I entered the trade around the last week of November in the price range of Rs 222 - 225. Surprisingly inspite of the Rs 235 floor set, the market was effectively paying me option money to take up this position.

The reverse bookbuilding started on the 17th of Jan and is on till the 20th which is tomorrow. I exited the position today in the range of Rs 245-247 on the exchanges. The trade gave me a return of 10% on capital in a span of 2 months.

There could be more return on the table as the book appears to be closing in the 250 -260 range but I m comfortable taking my money home without having to live thru the risk.

Midday - Update

I had posted yesterday on the small position that I had created in Midday at Rs 38.2 as part of the merger process. I promptly exited the position today at Rs 40.2. A gain of about 5% in 15 days. Might not sound too exciting for most ppl but I like trades like this. If I can do just 5 -6 trades like this in a year on assigned capital, i would be more than happy. Attaching the payoff matrix. Will continue to track the situation to see how it finally progresses.

Take a Midday break

One of the resolutions that I made this year was to be regular on the blog both in terms of posting as well as responding to queries. It has of course taken me 17 days in the new year to move on this resolution. It is not really the best of starts but the intent is to be more regular this year in terms of posting on the various special situation transactions that I look at and also in terms of long term value picks.

I have been tracking a special situation case covering the acquisition of Midday’s print business by Jagran Prakash.

Midday as a company can be broken up into 2 pieces the relatively valuable print business with a good franchise and the cash guzzling radio business.

Structure of the deal

Under the scheme of arrangement Jagran Prakash will acquire the print business on a slump sale basis. As part of the arrangement the Midday shareholder will get compensation with shares issued by Jagran Prakash. The ratio proposed under the scheme of arrangement is 2 shares of Jagran Prakash for every 7 shares of Midday.

The residual Midday will consist of the radio business which did a topline of about 30 crores and a loss of 15 crores last year. Clearly this business is in its investment phase of building up the franchise in terms of radio property.

I have been tracking the deal for sometime and have been registering the price of the residual shares of Midday at every milestone in the life of the transaction. Considering the nature of the radio business and the timelines involved, I had refrained from building a position the stock and the intent was to do it very close to the actual record date.

I took up a small position on the 3^rd of Jan at Rs 38.2 once the announcement had got made for the board meeting for deciding the record date.  The reason for the small position was more a combination of having a learning process coupled with not too much comfort in terms of underlying valuations for the radio business. I would value the radio business on the outside at Rs 10 per share.

Punjab Alkalis - Divestment

I’ve had a long break from the blog. Part work pressure part inactivity to do with the current market activity level. Posting on a spl situation opportunity.

Punjab Alkalis - Divestment

CMP - Rs 42

Punjab Alkali is a PSU owned by the Punjab government. The government has initiated a divestment process by which they intend to sell their stake in the company. The government had called for bids for their stake and Aug 16th was the last date for submitting bids. On completion of the process the divestment will trigger a open offer.

News report from the Business Standard - August 16th

Fourteen companies, including Jai Prakash Associates, Nirma, Grasim Industries today submitted bids for buying stake in the Punjab government-owned Punjab Alkalies & Chemicals (PACL).

"We have received 14 bids from the companies for the disinvestment of PACL," Punjab Directorate of Disinvestment Director V.K. Singh told reporters here today.

Other companies which submitted their bids were Surya Pharmaceuticals, KUDOs Resources, Amtek Auto, Nectar Lifesciences, Goyal MG Gases, DCM Shriram Credit & Investment, KLJ Resources, Panoli Intermediates (India), Lords Chloro Alkali, Jay Polychem (India) and Bhushan Power & Steel

Some serious players like Grasim, Nirma and a bunch of players who I have no clue what they are upto.

Opportunity

The company has a 90000 TPA caustic soda plant and the associated chlorine & hydrogen plant. It is a loss making unit currently

Valuations

Market Cap - 86 crores

Debt - 83 crores

Total EV - 169 cores

Replacement cost of this plant

On a conservative estimate setting up a 90000 TPA capacity would cost Rs 350 crores including power plant. Since Punjab Alkalis doesn’t have a power plant and which was the key reason for its losses, we can pare down the replacement cost to around Rs 250 crores.

Factor in additional cost for VRS and transactional costs we can expect conservatively bidding should be around the Rs 225 crores EV minus Debt 83 crores = Equity value of Rs 142 crores as opposed to current market cap of Rs 86 crores resulting in a spread of about 65%.

Risk

Like all divestment programs, there is always the risk of delay. To a certain extent the delay has already taken place. Of the 14 bidders, 12 qualified the technical round to put in the financial bids. The Divestment dept in the Punjab government has put the bids of the remaining 2 bidders to the ministerial committee. Post the ministerial committee meeting the approval for the remaining bidders will come thru and the financial bids called in.

Disclosure: I could have a position in the stock and I recommend readers to do their own analysis before investing in the stock.

Genetically Irrational

Cant blame us for being irrational. Its in the genes afterall. Nice video on TED

Zenotech Labs - Bitter Pill

I had earlier posted on Zenotech Labs laying down the original premise of the trade in a post here.

http://investingvalues.blogspot.com/2009/11/curious-case-of-zenotech-labs.html

After much delay the supreme court judgement came and the court ruled in the favour of Daichhi and the minority shareholders lost the case. The open offer will now happen at Rs 113.6. The stock promptly corrected to the Rs 100 mark where I exited my position taking a loss of about 10-12% on the trade.

A bitter pill to swallow but the downside was factored in the trade in case the judgement came in favour Daiichi.

The stock has subsequently moved down to the Rs 94 level and at some point of time will start becoming attractive considering the high acceptance ratio on the open offer.

Positioning for Luck

In my previous post on Abbott Labs, I had written how part of the returns that the stock delivered for me was good stock picking and part of it was pure luck.

Can u position yourself to get lucky? How do u ensure that u get hit by good luck more often than bad luck.

I want to put across a example from my life in terms of how one can be positioned for luck. On finishing my 12th Std/ HSC/ Jr college, I took up admission into a engineering college in the stream of production engineering. A friend of mine from the same batch took up admission in a stream of medicine called “ Occupational therapy”.

In my batch of 80 students, there were 3 girls and 77 boys. In his batch of 50 students there were 2 boys and 48 girls. I m sure you will appreciate who amongst the two was positioned for luck :-). So even if I was a cute guy with a great sense of humour and extremely sensitive ( I cant claim I m any of the above), the stakes were just loaded against me to be able to woo a charming lady. My friend of course was in such a envious position that he would really have to shoot himself in the foot to get it all wrong.

There is of course always the probability that I managed to woo one of those three girls and my friend managed to get it all wrong but I would assign a very low probability to it.

He was just positioned to be lucky.

When we come to stock picking, unlike choosing u r graduation stream we have the option of choosing what stocks to buy and what to avoid. We can work our way to get lucky more often than been unlucky. Spot more white swans coming our way as opposed to encountering black swans.

Lets look at IT companies right now. Both Infosys and TCS are great companies with great business models. But at 26 PE with the world economy slowing down, currency turbulence, political pressures etc we are positioning ourselves to get unlucky on this one. These companies could still deliver great numbers and growth but at these valuations there is a high probability that we could get unlucky on these stocks. I cannot at this point visualise what possible events could happen which could make me lucky in these stocks.

I bought Clariant chemicals in my portfolio a couple of months around the Rs 430-440 mark. The stock came on my radar after I heard a global announcement about a plant shutdown in thane which would release some prime property ( about 36 acres) and unlock value. On the operating level the company has been delivering great numbers and improving performance on all fronts. I bought the stock around the 8-9 PE mark.

Beyond this Clariant has about 120 acres of land more at another plant in Kolshet Thane. It has maintained a very high dividend payout ratio over the years. The parent is in a bad shape and is rumoured to be up for sale. A possible sale will trigger a open offer in India.

Of the above variables only the operating performance and the land sale are known variables. All other variables are events that I could possibly get lucky with. They might not necessarily happen but when I bought the stock at 8-9 PE, I was positioned more to get lucky as opposed to get unlucky.

There is of course the other way of doing this

It was to get your parents to name you “Lucky” which would have resulted in you being lucky for the rest of your life :-).

Abbott Labs

I had originally put out a post on Abbott labs about 2 year back when I added it in my portfolio. The link is enclosed below.

http://investingvalues.blogspot.com/2008/05/stock-idea-abbott-india.html

I had bought it around the Rs 540 mark when the markets were around the 16500 range. The stock ended today at 1134 with the index at 17,400 levels. Along the way I sold about 50% of my holding around the 735 mark and continued to hold the rest.

So on a like to like comparison Abbott has delivered me over 110% return as compared to the Index which delivered about 4% in the same period. ( I haven’t factored in the dividends that came thru and the share buyback that took place).

Thought process

1) My original premise on Abbott was the fact that it was a great business with high ROE and throwing out surplus cash every year. Though there are other pharma companies with a similar structure, what I liked about Abbott was the fact that the parent globally had a philosophy of returning cash back to shareholders in the form of dividend or share buybacks which made it more attractive as a holding.

2) I also along the way anticipated that the parent which was generating surplus cash would direct that surplus cash into acquisitions with a greater focus on emerging markets. Abbott acquired Solvay and followed up with its current acquisition of Piramal Healthcare making it the largest pharma company in the country.
The market has of course carried out a round of PE re-rating and assigned it a PE in sync with large MNC pharma companies from the tier 2 pharma company PE that it was getting.

Doesn’t all of the above make me sound like a great analyst?

I want to bring here the interesting concept of “Hindsight Bias”. To quote Wikipedia “Hindsight bias is the inclination to see events that have occurred as more predictable than they in fact were before they took place”. Simply put we believe that we predicted or were prepared for event that have happened in the past. Invariably most people will recognise hindsight bias when something goes wrong. For Ex Most people will tell you that they knew that the sub prime crisis was waiting to happen.

The real challenge of hindsight bias to recognise it when something goes right for you. For ex In Abbott’s case my hypothesis was based on point 1 of the thought process that I have listed above.

Point 2 of how I predicted that they would be acquiring companies in India and become the largest pharma company in the country is complete hogwash and a attempt at making me look very intelligent and insightful.

So the return that the stock generated from about Rs 540 to about Rs 725 was my stock picking skills but the return from there onwards to 1100 bucks is pure luck :-). But then I m not complaining.

I though however believe in a concept which I call “ Positioning for luck”. Will write a separate post on that.