Friday, December 31, 2010

Alembic Ltd - Demerger

New year 'celebrations' are nothing but another excuse to drink. So wish you all a very very happy new year. :-)
Now that we have the 'happy new year' and all out of the way, lemme come to the point. Alembic Ltd is executing a demerger scheme. Let us see if there is any money to be made here.


Alembic Ltd is basically a pharma company, into API and formulations. The company can be divided into two parts; one which contains the entire pharma business, except the PenG business. This is a profitable business with 12-13% operating margins and 6-7% PBT margins. The other part contains PenG business, land and power assets. The PenG business is a loss making business, as detailed later.


The scheme:

  • Under the scheme of demerger, the first part of the business (the good part) will be transferred to Alembic Pharma Ltd. (Alembic Pharma (APL) is currently a wholly owned subsidiary of Alembic Ltd.) 
  • Alembic will retain the second part (PenG business, land, power assets).
  • The total debt of Alembic will be split into 85%(APL) and 15%(Alembic)
  • Shareholders of Alembic holding 1 share will get 1 share in Alembic Pharma.

The shareholding:


Public holding in APL would be lesser, since Alembic already holds some shares in APL.


The facts:
  • Currently, the market is valuing Alembic at Rs.900 cr mkt cap and EV of about Rs.1280 cr. On a PE basis, the stock is currently quoting at about 20x.
  • The pre-demerger numbers of Alembic also include those of PenG division. This is a loss making division of the company, with Rs.115 cr revenues and Rs.24 cr loss before tax for FY10.
  • If the FY10 numbers are split to reflect the demerger effect, it would be as follows: 


The opportunity:

Let us try and value the two businesses separately:

Alembic Pharma Ltd:
  • This company would contain the API and formulations business (domestic as well as export). FY10 revenue attributable for this company was Rs.1030 cr, with operating profit margins of around 12.7% and PBT margin of 6.8%. EBITDA of Rs.130 cr and EBT of Rs.74 cr.
  • The business is profitable and growing at 10-12%. APL also has recognized brands such as Althrocin, Roxid and Azithral in its portfolio.
  • Post demerger, APL would have no further need of expansion. Consequently, the free cash generated by the business would be utilized for repayment of debt. (APL debt Rs.350 cr. Alembic total cash from operations for FY10 Rs.127 cr). Consequently, in the EV, the debt should be replaced by market-cap going forward next couple of years.
  • Alembic’s peers and companies in the sector quote at premium valuations, as much as 12x EV/EBITDA and 24x TTM EPS.
  • Valuing Alembic at lower multiples of 10x EV/EBITDA(FY10) and 15x FY10 PAT, market cap comes to around Rs.950 cr. Value per share = 950/18.84 = Rs.50/- (to be used as a reference only).

Alembic Ltd:
  • Post demerger, Alembic will be left with the loss making PenG business, land and power assets. Also, it will have 29.5% stake in APL. Residual assets of Alembic would be Rs.250 crores, which is 35% of gross block.
  • On a conservative basis, I would value the PenG business at ZERO (although it certainly should be accorded some value).
  • Alembic will hold 29.5% of APL, which is worth Rs.280 cr. I am giving a 90% haircut to this and taking only 10% of the value, Rs.30 cr. (Pessimistic calculations help provide some MOS)
  • The power assets consist of 3 cogen plants, total 11 MW and 4 windmills of total 5 MW. Since they are used for captive consumption, I would accord them ZERO value.
  • Alembic would also have land of 115 acres at Vadodara. Out of this, the manufacturing facilities occupy about 45 acres. So what should be valued is only 70 acres. As per information obtained, the land rate in the area is Rs.600-700 per sq.ft. I would value the land at Rs.500/sq.ft. Valuation works out to Rs.140 cr.So, the residual business of Alembic may be valued at Rs.30 cr + Rs.140 cr = Rs.170 cr, or Rs.13 per share.

Total valuation comes to Rs.63 per share. (Rs.50 for APL and Rs.13 for Alembic)

To sum up:
  • Dilution in APL is killing off possible arbitrage in the deal.
  • To get some margin of safety, stock can be bought below Rs.55 per share.
  • There is a probability that BOTH the companies may get delisted for some period of time. (Got to get clarification from the CS on this).
  • regarding the time involved in this deal happening, the management had this to say in a recent TV interview: "The demerger is in process right now. We are awaiting some final approvals which we should hopefully get by the end of December and if all the timelines go well then hopefully by about March we will look at listing a separate company."

At CMP of 67 bucks, I do not think there is much money to be made. Lets hope that the stock drifts down. Position should be taken only if the stock comes at a price where there is comfort.

Cheers and happy investing!

9 comments:

excel_monkey said...

Neeraj,

great job penning down the demerger process

thanks for the detailed research

two things I would like to highlight here are:

1. there was a news a week back that the Alembic Pharma could be sold off at some latter date - divestment could be the logic behind the whole dermerger process

http://www.moneycontrol.com/news/buzzing-stocks/alembic-may-divest-pharma-biz-post-demerger-sources_508307.html

hence the Alembic ltd's stake in Alembic pharma could be worth more than one has computed.

2. The land price that you have taken is for the raw land or for the developed land?
Usually only some 60-70% of land is sale able the rest 30-40% is marked for roads and public amenities


Regards,
Excel

Neeraj Marathe said...

Hi Excel,
1) Yes, i agree with u that selling off APL could be the reason for the demerger. However, there is no confirmation of the same. In case it happens, the sale will be at very high price than the current one. But i cant base my decision on speculation, which is why i am not considering it in my analysis.
2) I have valued land as a parcel, since that is how they could sell it. I have done it taking lower rates. U can, of cors, do it any other way. What u say also makes total sense..
Cheers!
Neeraj

Rohit Chauhan said...

Hi neeraj
as you point out, alembic ltd valuations are tricky.

again the key to the arbitrage would be more on how the market will value the company in the short term if one wants to exit immeditately. PenG can be taken as zero, on APL holding i think the haircut is too much.

i agree market will discount it by a large no. as the management is unlikely to sell APL holdings.

on power assets, i think ZERO valuation is too conservative even if used for captive consumption. you see the company is getting an economic benefit by having these assets. also with open access, they could always sell these assets. i think its easy to value these assets based on per MW cost of putting these assets.

also in such the current market it is unlikely to find very compelling deals ..so makes sense to wait. but i would still create a token position and see how it plays out. the loss or tution fees would be worth it

rgds
rohit

Neeraj Marathe said...

Hi Rohit,
Yes, i agree with u that the valuation i have taken is ridiculously low for the points u mentioned..but doesnt it make sense to depress valuation as much as possible? specially in such special situations, its been my experience that higher the MOS, better the result, coz there can be a lot of unforeseen events happening..
valuation is more of an art, rather than a defined science and all of us will always disagree on the same..
wish u a happy new year man..lukin fwd to interesting articles on ur blog..
cheers!
Neeraj

Viyan Sanjeev said...

Hi Neeraj,

Have been following Alembic demerger story for quite sometime. The court approval for demerger is expected by 3rd week of January. The final hearing by the Gujarat HC was over on 29-Dec-10. (one can check this in the GUJ HC website - Case no. 152 & 153 under company petitions segment). I would like to add the following things -

The pharma business whose results will be independently publised from FY11 onwards will have a net profit of Rs.80 crs and with 18.85 cr shares, its EPS for FY11 will be Rs4.25 per share. Six months (apr10-sep-10) results indicate that the total company has made a net profit of Rs.33 crs taking into account PENG losses of Rs.8 crs. Pharma business is likely to grow at 20% p.a for the next 2 - 3 yrs. Operating margins of pharma entity is set to improve by 100 bps per year for the next 2-3 yrs. Taking into account, market could give a multiple of at least 15 times FY11 EPS of Rs.4.25. The real estate business could be worth anywhere between Rs.15 to Rs.25 depending what the markets chooses to consider / discount.The company is also considering replacing PENG with alternate products atleast to recover overheads and arrest losses. So, in my view, there is an arbitrage opportunity in Alembic demerger.

Neeraj Marathe said...

Hi Sanjeev,
Thnx a lot of the update and your view..
Cheers!
Neeraj

excel_monkey said...

Hi Sanjeev,

Why to wait for APL to list
there are far better options available in the market you can get a Unichem or Torrent or FDC for similar or better valuations.

The de-merger would have been accretive to the shareholders if this holding structure was not there

so ultimately the holding company with 29.5% stake in APL would quote at a fraction of its real worth

same as happened with Bajaj Holding created out of demerger of Bajaj Auto

the upside I see here is that this structure has been adopted as promoters intend to sell this company

so they will have a listed operational company with with lot of cash (after selling 29.5%) as well as they would have some money in their private capacity (selling 44.96% stake)

one should take a position in this stock only if one is sure that the company would be sold at a latter date

Regards,
Excel

Abhinav said...

Hi Neeraj, Could you please explain the haircut to Alembic's holding in APL. Why have you taken only 10% and not full 100% value of the sharholding of 280 Cr.

Neeraj Marathe said...

Hi Abhinav,
Lemme ask u a counter question.. WHY should one take 100% value?
Do refer to my post on holding company valuations to understand my views on the same. http://neerajmarathe.blogspot.com/2010/07/investing-in-holding-companies.html
Cheers!
Neeraj