Friday, March 14, 2014

Noida Toll Bridge - The Alternate View

There is a lot that an investor can learn from this fine looking gentleman. Harvey 'Two Face' Dent is one of Batman's most interesting villains. Its not that he has a split personality, but his personality gets changed completely due to some events. The point is, he represents both sides of the coin. And that's what an investor should always try to look at, in my opinion.
I too try to do the same with every company i invest in (or reject). The bull case as well as the bear case should be thoroughly investigated, without any bias or preconceived notion. I agree its something difficult to do, but once you leave your ego aside, its is surely not at all impossible.


I had written about Noida Toll Bridge quite some time ago. By and large, investors have been quite negative on it due to a variety of reasons, one of which I had also written about. Also, since the price has not moved since years, it is perceived to be a value-trap. Well, so far, it has been just that, but interesting things are now happening. Looking at the other side of the story would be an excellent idea.
I would recommend that one should go through this extremely detailed report to get a proper background on the company, its agreement with NOIDA authorities and the unique aspects of the agreement, difficulties it faced in earlier times etc. The report will give excellent background to anyone who wants to understand the company better (and also reduce my writing efforts. Yesss, i am lazy!)

A fascinating set of numbers..

Over the past few years, everything other than the stock price has improved!!
Of course, this has happened due to inherent risks attached to the business as well as lack of clarity on several key aspects of the agreement and its proposed changes. The stock price just kept drifting down.


So has anything changed which will cause the stock price to not drift down? Or better still, to go up?!

Let us invert the entire thought process.

The standard investment arguments made in favour of the company include;
  • Large shortfall in recovery of more than Rs.2400 cr, which will result in the bridge staying with the company for a substantial long period of time.
  • Possibility of a one-time settlement to settle this shortfall.
  • Huge margin of safety due to development rights to 99 acres of land, whose value is much more than the current enterprise value of NTBC.
  • Good growth in traffic, plus increase in toll rate, leading to substantially high cashflow for the company.
While all these seem quite yummy, there is absolutely no guarantee that anything of these may really happen. So let us completely drop them all!!

Let us make some really depressed (and depressing) assumptions..
  • The company will get no extension for operating the bridge. The bridge will only last with the company till 2028, post which it will be handed over to the Government.
  • The company will get zero compensation for the shortfall (to which it is entitled to, as per the agreement).
  • The company will not any development rights to the land (to which it is entitled to, as per the agreement).
  • There will be zero growth in traffic and zero growth in toll henceforth, till 2028!!
  • The company will have to spend Rs.5 cr on maintenance of the bridge every 5 years
I totally agree that these are unreasonably 'conservative' assumptions, but thats the point!
  • Currently, the company generates roughly Rs.70 cr free cash. We are assuming that it will remain the same till 2028, minus Rs.5 cr maintenance capex every fifth year.
  • If we simply discount this cashflow from 2014 till 2028 at 12% discounting rate, the value per share comes to Rs.28. Discounting the same at 15% gives Rs.25/share and at 18% gives Rs.22.4/share.
  • In effect, it appears that the market doubts whether the company will be able to operate the bridge until 2018 itself, which appears too depressed.


Value, without a value-trigger is a value trap!

Well, what i have stated above is a well known fact. But what has changed now?
The trigger has come in the form of the company exiting CDR. As per the annual report, the company will pay the last installment of its CDR-subjected debt and will exit CDR before the end of FY14. After CDR exit, the company management have full flexibility and autonomy to utilise the cash generated as per what they think fit. So they can give substantial dividends, do a buyback, etc.(This is already visible if we look at the recent interim dividend, which has been doubled, compared to last year).

The risks...

In case of Noida Toll, many risks such as competing bridge, metro, etc are well known. But other risks which i think are material are;
  • With elections round the corner, the public will force the bridge to be immediately made toll-free: Although this event is a possibility, totally stripping the company of all its rights would set a very bad precedent, besides being illegal. I view this as lower probability event.
  • NTBC will alter its Memorandum of Association and take up another project, thus diverting cash: Alteration of MOA requires a special resolution, which, in our opinion will not be successful, given the current shareholding pattern. I view this as a low probability event.
  • NTBC will divert cash to other group companies through inter-corporate loans or advances: ILFS group has not been known to engage in such activities. I view this as a low probability event.
  • There will be radical changes in the original concession agreement: In its quarterly results, NTBC itself has disclosed that NOIDA authorities are in talks with the company to change the terms of the agreement. I view this as a very high probability event. However, we have factored in the same in our assumptions.
  • The toll itself is significantly cut: This is a huge risk and if it materializes, the stock should be exited immediately. I view this as a low probability event.
  • The company will not distribute any cash to its shareholders: In case there is absolutely no distribution of cash, either through dividend/buyback/bonus debentures etc over the next one and half years, one should surely think of exiting the stock.

Positioning yourself for luck...

In the meantime, there is a possibility of various corporate actions such as bonus debentures, buyback, sell-off to a PE investor, one-time settlement with NOIDA etc. Since there is currently no basis to any of these possibilities, we should totally disregard them. But if anything along these lines does happen, we would get damn lucky!!

All in all, this seems like an interesting event-based workout. For some, it would also qualify to be a decent long term investment. Fair enough! However, looking at the risks involved as well as the sensitive nature of the business in recent times (toll = evil), I would not look at it as a longer term compounding story. I am a mere opportunist here and not a "value investor" :-)

Cheers and happy investing!!!

Disclosure: Most of what i have written above is from a presentation i had made last month on the company. I am a one month old (approx) shareholder of the company. Stock price has moved a bit in the recent past and hence I would not be recommending the same (or otherwise). As usual, this is just a presentation of my thoughts and not an recommendation. (Neither am I promoting the stock, simply because I have bought it before and I now hope that your buying will take it even higher!!!). :-)




Disclaimer(s)!!
1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) As a professional investor, I may have positions in stocks discussed.
4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. I am not offering any investment advice through these articles. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours! 

Thursday, December 5, 2013

Powergrid FPO - A special situation everyone knows about

Something which is too obvious and which everyone knows about rarely works in investing. "The crowd is never right" is the gyaan we often hear and experience too.
So when the Powergrid FPO special situation presented itself, the first thing that came to my mind was that this is too obvious, which should be visible to absolutely anybody. So will it work?!

Background

  • Powergrid has come out with its FPO, priced in a band of Rs.85-90 per share. Retail applicants will get a discount of 5% on the final decided issue price. I am assuming the issue price to be Rs.90 and all calculations are based on the same.
  • So basically, retail shareholders will be allotted shares @ RS.85.5 per share. As of 5 pm on 12/5/2013, retail applications stood at 4.32 cr shares, against 27.44 cr shares reserved for the category. 
  • The issue is therefore subscribed 0.16 times in the retail category as of now, with tomorrow being the last day for applications.
  • Even though most retail applications come in on the last day, I feel there is high probability that there will not be any massive over-subscription in the retail category and chances of full allotment are high.
  • I offer absolutely no view on the company as a business etc. This is merely a play on the situation and not an 'investment' per say.

The situation
  • Apply for 2200 shares at cutoff price (for retail, it will be max Rs.85.5). Expectation here is that allotment will be full/near full.
  • Short 1 lot (2000 shares) December 2013 series Powergrid futures @ Rs.92.85. Effectively, you are creating a near 100% hedge and locking in Rs.7.35 profit (by buying at Rs.85.5 and selling at Rs.92.85)
  • With the issue closing on December 6th, allotment should happen just before December F&O expiry (26th)
  • On expiry, sell equity shares and cover futures short position (both should be at same/near-same price on expiry, hence we would realise Rs.7.35 profit per share)
  • The returns here are roughly 8.3% (thats Rs.7.35 on Rs.85.5 invested per share) pre-costs for a 20 day holding period. Not bad!!
Additional points
  • Ideally, I would have liked to short the January 2014 series futures, but I learnt that January 2014 onwards, the lot size has been changed to 4000 shares, from the present 2000. :-( Hence, one will have to short December series itself, even though it will be a touch and go situation, time-wise.
  • It seems like the whole world has gotten into this trade, of applying for the FPO/going short on December series futures. Hence, the futures are quoting at a Rs.3.3 discount to the cash market price of Rs.96.15.
  • The whole trade is of course applicable for only the retail category, making an application under Rs.2 lakhs.
Risks
  • One big risk here is if the allotment is not full/near full. In that case, the cash-futures position sizes wont match and this would not be an arbitrage trade. Also, if there is part allotment along with a significant rise in the stock price before expiry (worst case scenario), there would be a loss on this trade. (Since futures price would also rise along with cash market price and hence, loss in futures market would be greater than profit in cash market)
  • Another risk here is if the allotment is delayed beyond December 26th for some reason. In that case, the futures position would expire and we would be left holding only the shares of company, un-hedged.

All in all, its an interesting arb opportunity that makes sense. Point is, it makes sense to everyone, so will everyone earn money in it? Lets see how it plays out.

Cheers and happy investing!!



Disclaimer(s)!!
1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) As a professional investor, I may have positions in stocks discussed.
4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. I am not offering any investment advice through these articles. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours! 

Monday, September 16, 2013

NBFCs - the case of the Unknown Unknowables

For a long time, NBFCs in India have been talked about, from both the positive and negative points of view. Positive, because India is such a huge country where a large chunk of population is not served by the banking system. NBFCs therefore have a huge opportunity to serve this un-addressed market. Negative, because of the huge frauds happening, opaque lending practices, allegations of NPA 'management' etc etc. 
In this post, I am talking about 2 NBFCs; First Leasing Company of India Ltd and Tourism Finance Corporation of India Ltd. My objective is not to pass judgement about these companies, but to showcase why investing in NBFCs is full of unknown risks.

Some fantastically managed NBFCs like Sundaram Finance, Bajaj Finance have been huge wealth creators for investors. The case of First Leasing is, well, a bit different.
  • First Leasing Company of India Ltd was, well, the first leasing company of India! Started way back in 1973 by Mr.Farouk Irani, the company was the pioneer in corporate leasing industry. 
  • Over the period of 4 decades of its existence, the company reported good numbers, gave good dividends, had negligible NPAs and was considered as the benchmark in the field.
  • Last week, the CMP of the stock was Rs.32, with a book value of Rs.150 plus and a dividend declared of Rs.1.80, making it a dirt-cheap, attractive opportunity. 
  • There were also talks of a sell-out happening, making it even more attractive.
  • I had looked into this company earlier and the only thing I found amiss was that long term lending was being done with short term funds. This typically happens when an NBFC falls short of capital and needs funding. However, to be honest, I did not find any 'fraud' in the books, on the face of it.
On this background, it was quite shocking to read RBI's press release.

In the light of the findings of the inspection of the books of accounts and other records as on March 31, 2013 of First Leasing Company of India Ltd., 749, Anna Salai, Chennai 600002, the Reserve Bank of India has, in public interest and in exercise of the powers conferred on it by Sections 45JA and 45L of the Reserve Bank of India Act, 1934, directed that until further orders, First Leasing Company of India Ltd. shall not,
  1.  sell, transfer, create charge or mortgage or deal in any manner with its property and assets without prior written permission of the Reserve Bank of India;
  2.  declare or distribute any dividend;
  3.  transact any business; or
  4. incur any further liabilities.
Essentially, RBI has frozen the company's business altogether. This happens only when there is a system level fraudulent issue or there is severe non-adherence to laws and guidelines. Something of this sort happening to a company with a 40 year history, consistently negligible NPAs, great looking financials, great dividends is very shocking indeed. There are such a lot of things about the lending business we dont know and cant know. IMHO, this event will surely have an impact on overall NBFC valuations and the way the market perceives the sector and its companies.

Let me give you another example, that of Tourism Finance Corporation of India Ltd. This is again a listed company with a market cap of Rs.160 cr. Book value is Rs.50, CMP is Rs.20. They have also applied for a banking license recently! :-)

Have a look at this bid document. This is about a company they had lent to which went under and now they are auctioning off that company's assets to recover their dues. On page 11 of the document, details of their exposure are given, which i am reproducing here..


On a loan given of Rs.3.35 cr, there was interest accrued of Rs.109 cr!!! How much of this has been accounted for as income in their books is not known, but the sheer size of one of their loans with respect to the company's overall size is mind boggling. If a large write-off like this one happens, the book-value itself would be massively hit and the stock would no longer look cheap.

Learnings from all of the above:
  • The NBFC business is structurally a risky business, where a fine balance has to be maintained between growth and quality of assets. Few companies which sacrifice quality to show growth and adopt aggressive accounting do great for some time, until the bad quality loans catch up with them and then comes a huge huge write-off.
  • It is extremely critical to understand what the business is. Merely going by its financials and book-value (which a lot of investors do) will not help. Book value is an accounting concept and can be bloated very easily. If one does not understand how the business is operated, better to not get into it at all. 
  • It is also extremely critical to understand the laws governing the NBFCs. The capital and provisioning requirements of the RBI can change the overall picture of a company very fast and one needs to have a good grasp on the same.
  • All in all, one needs to acknowledge that there are a lot of 'unknown, unknowable' aspects in the NBFC business. One should therefore not rely 100% on the numbers for taking investment decisions. It is much better to go with a proven management, which is fully transparent on all the aspects of the business and is in a business which one can understand and identify with properly. Good knowledge of accounting and ability to dissect the financial statements is also essential. If investing is risky, investing in NBFCs is, ummm, more risky!
Please do greater due diligence while investing in NBFCs. There are many aspects of the business which we cannot understand by studying the financials alone.

Cheers and happy investing!!!


Disclaimer(s)!!
1) All the posts on this blog, including this one, are for educational and discussion purposes only.
2) I post articles on individual stocks as well as varied topics like behavioural finance, industry analysis etc. None of the material posted should be regarded as advice to buy/sell any stock. My articles are not recommendations to buy/sell individual stocks, and should not be construed as any form of investment advice.
3) As a professional investor, I may have positions in stocks discussed.
4) PLEASE DO NOT TAKE BUY/SELL OR ANY INVESTMENT DECISION BASED ON ARTICLES YOU READ ON THE BLOG. These are only meant to provide information and initiate discussion. Final decision is and always should be, yours and only yours!