Thursday, December 8, 2011

Today's Writing Products - Amazing result!

Although I have never tracked this company, I am writing about this because;

  1. This whole situation has a bit of entertainment value (Me and my friend Saurabh, who pointed this out to me over a cup of chai, had quite a laugh about it)
  2. I am not finding decent companies at decent valuations to write about! :-D

Today's Writing Products is a BSE-listed company. It has recently managed to perform a herculean task. In its September 2011 quarterly results, the company has managed to report a net loss of Rs.68 crores, on net sales of Rs.15.5 crores (seriously! there is no decimal error here). I agree that making a loss of more than 4 times your sales is rather difficult, but Today's has managed to do it.
The operating business itself has reported a loss in the quarter. But whats more interesting are the 'exceptional items' in the result..

  • In September 2010, the company had an inventory of Rs.52 crores. In the September 2011 result however, the company has written off Rs.25 crores worth of inventory, citing it as 'slow moving inventory'. This has been included in the 'Consumption of raw materials' in the September 2011 results. Hmm..
  • In September 2010, the company had debtors of Rs.54 crores. In the September 2011 result however, the company has written off Rs.39 crores worth of debtors 'based on continuous evaluation of overdue debtors'. Hmm hmm..
  • So thats a total write-off of Rs.64 crores. (Well, the market cap of the company is Rs.7 crores!) 

Here is what it looks like...

Ok, entertainment apart, a few questions come to mind..
  1. Were the reported inventory numbers real? Typically, products such as Today's can go 'out of flavour' or become outdated/obsolete very fast. But the company does not write it off, thereby hiding losses. However, the inevitable large write-off materialises at one time or another. We all should remember this while analysing the Koutons and the Archies of the world.
  2. The bigger question..were the reported sales real? The company could not recover money from debtors, and quite a large sum, not a small one! This obviously raises doubts.
While analysing companies, we all analyse numbers quite a lot. But its also important to look into the fact whether the numbers make sense. Whether the numbers are supported by proper tax payments, proper dividend payments and proper cash-flows.

Cheers and happy investing!

P.S. Today's is in a very sorry state. Deteriorating business, directors quitting, jazzy announcements which never saw the light of day, shares pledging, reducing promoter stake, corporate debt has it all. Better to not even look at it..

Friday, December 2, 2011

Why investing is unnatural!

Nature has bestowed all living organisms with certain instincts. Its hard-wired into the very being of organisms. We humans are no exception. And since we have turned out to be the alpha organisms on this planet, we have a bit more instincts than others, some smarter, some dumber!
Well, instincts are natural. They are like reflex actions and we are, by our very nature, slaves to them. Imagine that you have your face against a strong glass cage, housing a snake. Now, if the snake strikes, you will instinctively recoil back, inspite of knowing that the cage is pretty strong and there is no real danger to you.
Let us try to relate some of our instincts to the discipline of investing. I find that most of our natural instincts are quite useless in investing. Investing is a slow, deliberate, disciplined and a well thought out process, not an instinctive one. I am talking strictly about investing here and not 'trading'. (You know what I mean!)

Instinct to get away from danger
This is an omnipresent instinct in all organisms. Unless you yourself are the danger, you will try to run away from danger! Going against this instinct is quite something! Why do we admire our soldiers and firefighters? They fight every instinct in their body and mind while doing their work and actually run towards danger!
Now what happens in investing? History tells us that the best investment opportunities have been found when everything around is 'dangerous'. Recent memories of Mach 2009 are still fresh in our minds. That was the dangerous time when quite a lot of stocks were quoting at irrationally low prices. If investors run away from it, they lose some really good opportunities.

Instinct to avoid pain
This is a very pervasive instinct in humans. (Just ask all the pharma companies manufacturing pain-killers!) Rational humans will not deliberately do something which can cause themselves pain. The ones who do sometimes get locked up in mental institutions! Unless totally unavoidable (like, lets say, a medicine injection), we all would honestly like to avoid pain and would be willing to do anything for that.
In investing, people experience mental pain, seeing their portfolios in red. To avoid the same, they wait for the market to bottom, where they will buy truckloads and probably retire quick! Well, it just doesn't happen. You will know the bottom for sure, only after it has come and gone. Pain in investing is common. Your portfolio can give you anguish for short-medium periods of time, when things are irrational. If you have conviction and have done your homework, the short term pain is worth taking, for the long term gain.

Instinct to survive
The instinct to survive is probably the most prevalent of the base instincts. We have all heard the story of the monkey and her baby trapped in a well. We all will do whatever it takes to survive, however irrational or illogical it might be.
Does this work the same way in investing? Imagine a person who has lost a lot of money in the markets. He is close to losing everything. If you go and tell him a hot stock idea or some F&O strategy, which can 'recover his losses' fast, chances are he will jump into it without much thought or analysis. The desperation to come out, to survive is extremely prevalent. But here, he might end up hastening his death, instead of managing to survive. The instinctive brain needs to be given a rest sometimes!

Instinct of greed
Many of you will argue that this is no instinct! But I believe it is. We have an instinct to want more of what we like. Now, this 'more' may not be good/healthy for us later, but still it gives us the required pleasure at that moment and we are fine with it.
Well, we all know what greed can do to us in investing, so I will not talk much about that. Gordon Gekko famously said 'greed is good', but he also (infamously) went to jail! This is another instinct which needs to be controlled.

Instinct of instant gratification
Humans look for shortcuts! Our mentality is such that we get attracted to anything which has the potential of giving us fast results. Something which requires longer time and higher effort is something which does not appeal!
In investing, the same thing holds true. Why do people get attracted to the get-rich-quick MLMs, why are the 'hot stock tips' so popular? Instant gratification! Well, there is nothing instant about investing. Businesses take time to perform and so does your investment. Our 'instant' instinct needs to be strictly controlled!

Instinct to form groups
Since ages, humans have lived in groups for a variety of reasons. And it has worked fine. We have a natural tendency to not be alone, if we can help it. Sometimes, any company is good company. (No pun intended!)
This same instinct may not necessarily work in investing. Investing is quite a lonely exercise! If we do what the crowd is doing, the decision may not be correct. The best opportunities to buy have been when the crowd is selling and vice-versa. Always going with the consensus may not be great for your investing health! Mauboussin famously equated fund managers with zebras and is something worth reading.

Instinct of aggression - the alpha male!
The instinct to show that you are the aggressive, happening guy is ever pervasive. The dopamine kick that aggression gives is quite an experience.
Imagine an intraday trader talking about his exploits. How he had the nerves of steel and the aggression to fight the market and come out on top. This aggression may, of course, not work every time. Undue aggression at a wrong moment may be enough to wipe you out for ever! Now imagine a longer term investor talking. :-) It may of course sound boring compared with the flamboyance of  the aggressive trader! Investing is not about being aggressive just for the heck of it. The investor will let loose this instinct of aggression at rare, opportune moments. Rest of the times, this instinct needs to be carefully controlled!

Instinct to justify
I honestly think that this is one instinct prevalent only in humans. Imagine this: a cheetah is running after an antelope but he doesn't catch it. He blames it on a small pebble that tripped him while he was running! Seems very funny even to imagine right? Now imagine yourself trying to finish work before a deadline. If you can't, you will have a hundred ready excuses, which prove that 'it was not my fault'. Happens to us all! Its instinctive.
Justifying is perhaps the most dangerous thing in investing. Why did I make a loss? Coz the market itself collapsed. So my stock, which is an amazing company, also collapsed for no reason. Why did I make profit? Coz I am goddam smart! Not coz the market rose! Justifying ourselves in our brain does not help us learn from our mistakes, coz it tells us that we are not making any! Something to be avoided at all costs!

Instinct to do activity
This is another instinct hardwired into all of us. We all have the constant need to keep on doing something. Why is meditation so difficult? Its because its unnatural to sit quietly, with a blank mind!
This is prevalent in investing too. The need to 'do something' is so pervasive. Of course, its not the best of ideas to keep on doing something all the time. There are times to do nothing and there are other times to do everything! Majority of the times, the need to do activity needs to be controlled.

So what can we infer and learn from all this? 

  1. I can write really long articles!
  2. We have certain instincts hardwired into our brain.
  3. These instincts may not work in the process of investing. Relying on these instincts may prove disastrous.
  4. There is no such thing as a 'born investor'. (in my view)
  5. We need to train our brain to control our instincts while investing. Investing has to be a thought out and logical process and not an instinctive one. Controlling instincts is very hard, I agree, but no-one said investing is easy!

Hope you did not instinctively ignore this article, seeing its length! :-)

Cheers and happy investing!

Friday, November 18, 2011

Triton Valves - Numbers tell the story

Spoiler alert & warning! If numbers and number crunching puts you to sleep, please do not read this post!

Triton Valves is a BSE listed small cap company. The company's products are pretty interesting..

Triton is India's largest manufacturer of tyre valves and cores (yes, those little things that poke out of your wheel rim). It is an OEM supplier to almost all tyre manufacturers in India.

Intuitively, one might think that this would be a very good business due to following reasons:
1) The business requires massive scale. For competition to come in, such scale would prove to be a BIG entry barrier. (Imports, aka Chinese goods would surely be a threat)
2) For a tyre manufacturer (Triton's customer), the valve cost is not a large component of total cost (In FY11, Triton's per unit selling price of a valve was just Rs.14.35). So a small increase in price would not be a huge deal for the tyre manufacturer.
3) Due to all these, Triton should be having pricing power, assured and sticky business and growing customers.
Sounds like a very interesting business and opportunity right? I thought so too and glanced through the company.

Well, the numbers show a totally opposite picture. So this post is not only about Triton but also about the importance of numbers in analysis and investment decision making. I personally feel that a good look at the numbers is very essential to get comfort level while investing in a company.

FY04 onward, Triton's sales have grown at a 17.5% CAGR (all numbers in Rs.Cr)

The profitability, however, shows a totally different picture. Operating profits grew at a CAGR of 9.3% and PAT grew at a CAGR of 5.4% only

Cash flows have also shown a deteriorating picture

As a result, the balance sheet has gone for a toss, with debt piling up..

Inventory CAGR (25%) and debtors CAGR (20%) has been much higher than sales CAGR (12%). So every time the company's sales increased, the working capital requirement increased more than the increase in sales, resulting in perennial need of cash for funding working capital.

So what was the cause of all this deterioration? Lets see..

The selling price per unit of Triton's products has grown at a CAGR of 5.2% and 1.7% respectively.

But the raw materials price per unit has grown at a much higher CAGR of 15.6% and 11.5% respectively.

So as raw materials prices rose, Triton was not able to raise its products ka selling prices proportionately, leading to falling margins. In FY04, raw materials consumption was 38% of sales. By FY11, it had become 64% of sales!

Now what will happen if you put more money into the business and expand capacity, but the margins keep going lower? On the expanded capacity, you will earn lesser percentage returns. The return ratios suffer. ROCE, RONW have dropped over the past 6 years.

So what conclusions can we draw from the data?

  • Triton does not have pricing power. The growth in selling price per unit has not even been in line with the growth in the raw materials price per unit. This has caused a hit on margins.
  • Hit on margins, coupled with need for expansion every 2-3 years means that even the new assets deployed will generate lower returns. Further, these assets need to be financed by debt, since working capital also blocks cash. This has led to balance sheet deterioration too.
  • Customers have basically squeezed Triton on two major fronts; product pricing, working capital. And as I have often observed, margins once sacrificed become virtually impossible to regain.

So, the numbers say that (till now, at least..lets not talk about future right now) Triton is not an exceptional business, has no moat or pricing power of its own and will earn super profits only due to luck (e.g. sudden fall in commodity prices). Well, thats just what the numbers say.. What do you say? :-)

Cheers and happy investing!!

P.S. My apologies if I let loose the 'analyst' in me on all you unsuspecting folks! :-D 
P.S. Part 2: This is just a number crunching analysis. This does not reflect upon the quality of management (the Gokarns are decent folks, I think) or what they have managed to achieve in really trying times, over the last 7-8 years.

Tuesday, November 15, 2011

The biases of value investors..

Value investors are considered to be a class apart. They do things differently, they have their emotions under control and they make fantastic returns over longer periods of time. We have n number of examples to substantiate the same. Listen to Buffett's interview vis-a-vis a broker or an analyst or a hedge fund manager's interview and you will agree!
On the blog, I have discussed quite a few examples of biases and mental screw-ups that investors face. (The articles can be found under the 'behavioural finance' label on the right hand side of the blog). Well, value investors are supposed to be well aware of these biases and generally avoid them. But they are humans after all and it got me thinking as to what other biases specifically affect the value guys?
My thoughts on this topic are based on observations of my own behaviour/thought process and that of others whom I consider to be value-oriented investors and with whom I interact. I agree that a specific value investor may not be prone to all the biases listed and also that there may be other biases out there affecting value investors. I would like to add that I am (and probably will be) very much a victim of some of the biases listed below. So lets try and take the mask off the value investors eh? :-D

The 'absolute cheapness' bias
Followers of Graham will especially understand what I am saying. Typically, value investors run screeners to find stocks that are quoting at absolute cheap valuations; e.g. PE ratio of less than 8 times etc. Of course, it is just a starting point, but I have rarely seen investors of this breed being comfortable with valuations of 30-40 times. Even value investors who take investing decisions exclusively based on a company's business model and not just numbers like PE ratio will flinch at the thought of a stock quoting 40 times trailing earnings. The flip side of this bias? Focus on absolute cheapness might lead to missing the bigger picture or ignoring hidden assets of a company which are currently not earning anything.

The 'under-researched stock' bias
A large number of hard core value investors I know enjoy the process (of finding an opportunity) more than the result (profit/loss). Everybody loves profit, of course! :-) But because of this inclination towards the process, lot of value oriented people are obsessed with trying to discover something new, trying to catch something that the market has not understood. There lies their 'kick'. How many value investors will try to discover value in an Infosys or a Tata Steel? As a result, value investors enjoy digging into unknown companies' ARs and trying to find value. The flip side of this bias? Such value investors will miss a 'well covered' stock, like a large-cap, which sometimes becomes a 'sitter' due to Mr.Market going bonkers!

The 'conservatism' bias
Value investors have a licence to be conservative! :-) Lots of them can be also classified as pessimists too! Of course, when a pessimistic guy finds an attractive idea and loads up on it, results can be fabulous. Of course, this wont happen very often, but thats ok! I feel 1 or 2 ideas in an year, in which you can load up is quite ok! The flip side of this bias? Lotsa opportunity losses because the 'conservative' value investor let it go; and selling the stock too early, because the 'conservative' value investor thought the stock has become 'overvalued' too early.

The 'sometimes the best thing to do is to do nothing at all' bias
I feel this is one bias behind which value investors hide when they are actually scared and afraid! It becomes nothing but a mental justification. E.g. a value investor might be actually scared that the market will fall because of debt in Europe, unemployment in US, interest rates in India, real estate in Middle East, fudged data in China and coz there are too many craters on the moon. So, he might not buy a stock he thinks is really cheap, so that he can buy it lower when the market falls! What he is actually doing is trying to time the market but the mental justification to this is 'sometimes inaction is the best action'! This is a very very dangerous bias and will surely lead to confusion, incorrect decisions and overall misery!

The 'bad management' bias
Without taking any names (for my protection), there are certain families or groups which are considered to be 'bad managements' due to their past activities and history. Now I have to mention something, which happens lotsa times: someone says that ignore this company, its a bad management. I ask why is it bad? And the answer usually is 'someone told them' or 'its generally said that they are bad'. Very few times, people give sensible reasons as to why is a particular management bad. Usually, they just 'think' that its bad, thats all! Value investors are usually ethical people and they wont want to earn money in a 'wrong' way. Well I also agree with this and while there are certain groups whose companies I wont touch, having this in-toto mindblock may sometimes lead to some really good opportunities being lost. Managements might change, new generation might take over which is radically different. Keeping an open mind (but an alert brain) helps!

The 'ignore macro stuff' bias

A lot of value investors I know take investing decisions based purely on valuations and not based on macro scenario. This has its pitfalls too. e.g. interest rates affect own discounting rates, industry scenario will change our growth assumptions. I personally am not very great at analysing macro stuff, but totally ignoring macro happenings will lead to incorrect decisions. I think that a fine line is to be maintained here as per one's inclination as well as ability to understand and analyse macro economic data.

The 'circle of competence' bias
We all have heard Buffett and Munger talk about the circle of competence n number of times. It essentially means; identify what you are good at and what you know, identify what you are not good at and what you dont know and then just stick to the former! But some lazy value investors escape taking efforts by saying that something is 'out of my circle of competence'. e.g. I give the very same answer when someone asks me about any pharma company, saying that I do not understand pharma. Now what stops me to get off my behind, read read read and understand pharma? Nothing! But I still havnt done it! So this is a good justification for my laziness right?! Btw, this also raises the debatable topic of should one be comfortable with a COC or should one go about expanding it?! This topic probably deserves an independent post! :-)

The 'we have to do things differently' bias
I have experienced some value investors having this kida and compulsion of doing things differently. They have this OCD to be different all the time. I agree that being different is a good trait of a value investor, but bring different, thinking differently and acting differently just for the heck of it doesn't make sense! The flip side of this bias? You will frustrate people you talk with and they might probably hit you on the head with something. On a serious note, such investors will make a simple straight forward decision complicated and make a mess of things!

Well there you have it! Some biases that I think value investors face. I do not claim that all of these biases are undesirable and should be avoided. Some of them are very much desirable, depending on the kind of investor you are. But what is important is to recognise these biases, identify whether a bias exists in yourself and to watch and monitor it carefully. See to it that it doesn't cloud your decision making process.

Cheers and happy (value) investing!!

Thursday, November 10, 2011

Bharat Bijlee - Going cheap..but yet to electrify!

Bharat Bijlee (BBL) is one of the oldest transformers companies in India with a very conservative and respectable, but very secretive (!) and closed management. (I know..I have been attending the AGM for the past 3 years) The present financial position of the company is as follows:

The profits one sees in the results include exceptional items, which need to be disregarded to know the real position of the business.

About the company

BBL manufactures sub-station transformers upto 220 KVA, with an installed capacity of 13380 MVA. BBL is also into manufacturing of electric motors, gearless machines used in various industries. The company also has a business segment for executing substation projects on turnkey basis. Please check out the AR here and the September quarter numbers here to get a feel of the two businesses of the company.
The past two years have been really bad for the transformers sector. Overcapacity, rise in costs and reduction in Government orders have hit the sector extremely hard. The performance of all transformer players like BBL, Voltamp and TRIL has deteriorated and so have their stock prices!
BBL's transformers business is no exception and in fact, in the June 2011 quarter, the transformers division reported losses, with the September 2011 quarter being just a shade better. In a normalised environment, BBL's transformers business does Rs.500 cr of business on existing capacity, with 10-12% operating margins (upto 20% in really favourable scenario) and 7-8% PAT margins. But, I do not expect a favourable environment for the transformers sector for the next 3-4 quarters at least.
 The electric motors division, however, is reporting healthy numbers both in terms of topline and bottomline. Margins are in healthy two-digits, with the management taking active steps to improve the business, as evident in their actions mentioned in the AR as well as the last 3-4 quarters' numbers. Here , sales growth of 15%, 12% operating and a 8% PAT margin is very much achievable.
The very positive factor about BBL over the last 3 years has been its cashflow. In a challenging environment, where competitors' cashflow has been hit worse than their margins, BBL has shown consistently high cash generation. (Numbers in Rs. Cr)

Anyway, coming back to the earnings perspective, I expect transformers business cycle to turn-around in FY13, with players making normalised margins again. BBL's electric motors business is showing decent traction and continues to grow (segmental margins (17%!!!) have shot through the roof in the September 2011 results)
So lets paint a scenario here, for FY13 numbers. (Please note that I am totally allergic to formal analyst-type 'projections'. Whenever I try to get a feel (i will desist from calling it projections) of future earnings, simplicity and conservatism are the things I give utmost importance. So what you see here is merely a reference point and is in no way, fairly accurate, imho!)

So, can the business do Rs.56 cr of PAT in FY13? (which is Rs.42 cr of earnings in today's terms) I think the probability of that happening is quite high. Also, please note that I have not at all considered the 'other income' on investments, which is fairly high for the company. (Rs.14 cr for FY11)
Valuing this at a low multiple of 8x yields a valuation of Rs.336 cr.

Now come the investments! BBL has the following investments at present (FY11 end)..Number of shares are also in crores..dont mind the decimals :-)

I have taken a 20% haircut to the market value of equity shares (One may take a higher cut for more depressing valuation!!) So, that works out to another Rs.308 cr.
BBL holds these shares since ages and usually, I wont value them at market value, since the company did not intend to sell them. However, in FY11 as well as Q1FY12, the company has sold some shares of Siemens, which is why it makes good sense to me to now consider the market value of the investments.

So, simply adding the business value (Rs.336 cr) to the investments value (Rs.308 cr) and reducing existing debt (Rs.95 cr) gives a total valuation of Rs.549 cr, which is Rs.970 per share. The stock currently quotes at Rs.700, a discount of about 25%.

What I intend to do

1) The company is going cheap for sure. If one compares this with Voltamp, which has about the same transformers capacity (but not same types of transformers), one will realise the 'relative cheapness' of BBL. However, since there are very few relatives whom I like, I never walk down this road! :-) (I have not included this 'peer comparison' to keep the length of the post respectably short!)
2) However, for a cyclical, which is not exactly going through a rosy period right now, the valuations are not dirt cheap and the discount is not high enough.(although you may argue that in the first place, the calculations supporting this 'discount' do not appear accurate, like 'projections' do..well, i do not mind the inaccuracy, as long as i am inaccurate by being on the lower side) Anyway, so I do not intend to make any haste in buying this one. If it drops nicely, nice! If it doesn't, better to move on to some other company.
3) I do intend to keep close watch on the company. Last year, the management passed an enabling resolution to raise upto Rs.400 cr debt. Do they intend to expand lots? Do they intend to start a new business line? I would like to see what they do and how they progress.

All in all, nothing electrifying about it, which would make one ogle and drool.. Hope that time comes too! Till then,

Cheers and happy investing!

Monday, October 3, 2011

Network18 Preference Shares - Amazing return, amazing risk!

Hello all..
Network18 Media and Investments Ltd is in the business of forming and selling subsidiaries, getting into joint ventures and raising finance. (Ok, that was sarcastic..its broadly a media company)
In March 2008, the company came out with a rights issue consisting of equity and preference shares. The preference shares of the company are listed on BSE (scrip code 700132) and NSE.

The opportunity
  • The preference shares have a face value of Rs.150 and are to be redeemed at par in May 2013.
  • The preference shares have a 5% dividend payout, which is cumulative.
  • Till today, the company has not paid any dividend on the preference shares and it is fair to assume that the entire chunk will be paid along with the principal at the time of redemption.
  • So, at the time of redemption, a person holding the preference shares should get Rs.150 (principal) and Rs.37.5 (accumulated dividend @ 5% p.a. for 5 years). Thats a total of Rs.187.5/-.
  • The preference shares are presently trading at Rs.105/-.
  • So if one buys it at present at Rs.105, then one would get Rs. 187.5 in May 2013.
  • Thats a return of 79% in 20 months! Super cool!

The problems

Nothing is for free and same is the case here. Lets just take a look at the risks and the problems...
  • Network18 is not exactly a conservative investor's dream. The business is damn difficult to understand, given the fact that it changes all the time due to frequent M&A activities. The profitability has been erratic, with the company making profits just once in the last 5 years. More importantly, cash-flows have been really pathetic, with the company reporting a negative cash flow from operations of Rs.306 cr in FY11.
  • The company has Rs.1775 cr of debt but it has about Rs.350 cr of liquid investments too.
  • The company keeps on getting money by selling subsidiaries and businesses here n there!
  • The company will require about Rs.195 cr to redeem the preference shares (along with dividend), which may not seem out of reach, but considering the large debt and negative cash-flows, seems unnerving, to say the least..
  • The biggest risk here is the management. They are no saints, lemme tell you! Just look at this postal ballot they got passed..
  • Basically what they did was something like this...the Companies Act confers voting rights on preference shareholders, if their dividend is not paid for a period of 2 years. Since Network18 had not paid dividend, the preference shareholders would have gained voting rights.
  • So the company declared that it had received letters from preference shareholders that they would like to waive their extra rights (now why would anybody do that) and hence, through postal ballot, they got these preference shareholders' rights waived. (Promoters must be holding at least 50% of the preference shares, as per my reading)
  • So would they pay up at the time of redemption? Or would they find some loophole or the other and do some hanky-panky? Thats a tough one to answer..

To conclude
  • Although the possible return here is mouthwatering, there are 2 big risks; the financial position and the management. 
  • Both of them scare me to a great extent, to take a meaningful position.
  • If one is ok with these risks and one thinks that they are not very material, Network18 offers a great opportunity to make respectable returns in this uncertain market. The preference shares are fairly liquid too. 
  • Given my risk appetite, I personally intend to give this one a miss for now, but I would like to keep a watch on future events (like insider buying) to revisit my decision. For the bold and the dangerous people out there, do take a look at this opportunity.
Cheers and happy investing!!

Edited note (added on 03/10/2011): After talking with a coupla legal dudes and taking some serious professional legal opinions, it turns out that in case of unavailability of profits, there is no onus on the management to declare and pay cumulative preference share dividend. In such case, they could very well get away with redeeming the preference shares at Rs.150, and not paying the cumulative dividend at all. Which essentially means, that they would have used the preference shares ka paisa free of cost for 5 years! :-)
In such case, (assuming they honestly redeem it without changing the terms of the issue and all) the return would be about 42% in 20 months..anyway, the risk remains very high and I am not really inclined to get into it..

Saturday, September 3, 2011

Regret Aversion Bias and investing...

People exhibiting regret aversion bias avoid taking decisive actions because they fear that, in hindsight, whatever course they select will prove less than optimal. Basically, this bias seeks to forestall the pain of regret associated with poor decision making.

Regret aversion bias and the decision to sell...

Investor A: Wasup buddy? Howz the market treating you?
Investor B: I am completely out of it. Sensex fell from 18000 to 16000. Same thing happened in 2008 also. I thought it will bounce back again, so I didn’t get out at that time. And I regretted it heavily.
Investor A: But weren’t you bullish when the market was 18000? So at 16000, you should be more bullish right?
Investor B: Noooo man..I don’t want 2008 repeating. Better to get out now. I will see what to do when things stabilise.

Sounds familiar? Investor B sold his holdings, not because they were overvalued, but because he had experienced huge regret when he didn’t sell in 2008 and he did not want to have the same experience again. In order to avoid regret, Investor B has taken a blanket sell decision, which is not a ‘studied’ decision and may prove to be very wrong. Then why did he take this decision?

His thought process..

Please click to enlarge

So basically, what Investor B says is that an opportunity loss is preferable to an actual loss! Hence, the decision to sell will cause him minimum regret. That’s why the decision to sell is the best decision to take. But was that the best decision? He may have sold some really undervalued stocks too, just to avoid regret!
How does it affect investors: Regret aversion bias thus makes investors take irrational and panic selling decisions, which are not well thought out.
What should one do about it: I sincerely believe that, especially, decisions to sell should be taken solely on the merits (or demerits) of that particular stock. Trying to time the market is the worst possible way to take sell decisions.

The other side of the coin.. Regret aversion bias and the decision to buy

Scenario 1: You are looking to buy a stock. You bought it, but after buying it, suppose the price goes down. Will you regret your decision to buy?
Scenario 2: You are looking to buy a stock. But you decide not to buy it, and after that, the price goes up. Will you regret your decision not to buy?

Of course, you will experience regret in both scenarios. The question is, in which scenario will you experience more regret? Sooo, given a choice, which scenario will you prefer? Majority of us will prefer scenario 2 (come-on, be honest!), where there is no actual loss, hence lesser regret!

How does this affect investors: on this side of the coin, regret aversion bias makes investors numb. When the market falls and stock prices are going down, this bias stops investors from buying and lapping up the undervalued stocks, for fear that they may fall further! When the time comes to be aggressive, regret aversion sets in and causes indecisiveness in investors.
So what to do?
I too get affected by this bias and coupled with my ‘conservative’ (a.k.a. fattu) attitude, I incur lotssss of opportunity losses. But typically, here is what I do..
  • Do not think about results of past actions while taking present decisions.
  •  Study each company you are looking at very well. If possible, write down your reasons for buying/selling or not buying/not selling on a piece of paper. When you write things down, your mind will not cook up excuses later!
  • Concentrate on the particular stock/company and ignore overall sentiment. If you think its undervalued, then buy. Period. If you think its crazily undervalued, then buy like crazy! Sureeee, the stock may (rather, will) go down after you buy. Accept it and make peace with it. Your portfolio will not show positive returns every day. So don’t be afraid to see paper losses, if your study has been in depth and you have the conviction.
The market gives us opportunities all the time. In bullish times, opportunities to sell are more than those to buy.. and vice versa during bearish times. Take advantage of these opportunities and be at peace!!

Cheers and happy investing...

P.S. For those of you writing in to know my views on 'where the market will go', please refer to this post.

Tuesday, August 2, 2011

Mahindra Composites Ltd - AGM (Follow-up)

Thanks a lot for the response to my earlier post. The large number of emails I got tells me that investor awareness is not dead yet! My friend Ayush tweeted the post and brought it to the attention of Mr.Anand Mahindra. (Thanks dude, I didnt need to write to the Mahindra Group management because of you.)

Now, I sincerely believe in being objective and disclosing both sides of the coin, hence this post...

Today morning, I got a call from Mr.Satoor, the CEO of Mahindra Composites, expressing regret for any misunderstanding that may have occurred at the AGM. He reaffirmed the Company's and the Group's commitment towards shareholders, regardless of the number of shares held. He also invited me to discuss any unanswered questions I had over a cup of tea and said that the management is always willing to answer all shareholder queries promptly. Free tea is always good, so, thank you for the invitation Sir! :-)

I personally thought that it won't be right to write just about my part of the story or to mention only negative aspects. Its fair to go on record and also mention about what the management did about the AGM fiasco and the prompt and professional way in which the CEO handled the matter..

Cheers and happy investing!!

Monday, August 1, 2011

Mahindra Composites Ltd - AGM

Hello again! In the last post, I had wished you all a happy AGM season! Me and my colleague attend lotsa AGMs.. Lets just discuss a bit about what happened recently at an AGM I attended. A fair warning; this post does not contain any buy/sell advise or does not offer any opportunity for the reader to earn money. For what its worth, it will be useless for a majority of readers! :-D

Ok..just a bit of basics first..

  • A company is owned by its equity shareholders, who appoint a group of people to manage the company on their behalf (Board of Directors)
  • Once a year, these managers meet the owners to discuss what all they did and what all they intend to do going forward (AGM)
  • Usually, the Board of Directors and the management of the company treat the shareholders with professional courtesy and at least a bit of respect.
Now lemme just tell you people what happened at the recently held AGM of a company called Mahindra Composites Ltd, which is part of the Mahindra Group.

A couple of days before the AGM, a Mumbai based analyst friend of mine called up the CS of the company. The problem was that he had bought the shares a bit late, so he was not a shareholder of the company as on the applicable record date. My friend enquired whether he would still be allowed to attend the AGM. Now usually, companies do allow such analyst-shareholders to attend the AGM (although, legally, they can surely disallow). In some cases, the company people politely refuse, saying that as per law, such request cannot be entertained. However, the reply of the CS of Mahindra Composites to my friend was "kya re, mere baap ka company hai kya? I said no..Dont ask again!!" Thats one hell of a rowdy CS, we thought!  :-D

So my friend (very wisely) decided not to come all the way to Pune, from Mumbai to attend the AGM. I, on the other hand (not very wisely), went ahead for the AGM. And it turned out to be one of the most pathetic AGMs I ever attended. Here is what happened...

  • Myself and one more person who came late, were the only non-employee shareholders at the AGM. All other shareholders present were employees, wearing the company's uniform.
  • Mr.K (lets call him so), the CFO, came across as an extremely rude and arrogant person, who does not display a ounce of professionalism, taking shareholders fully for granted. Upon seeing my questions which i provided in printout form, his response was "these questions have nothing to do with the AGM of the company, hence they will not be answered". (Although the questions were related to the company's performance and its plans in the near future.. Discussing all this is actually what the AGMs are held for!!) During the AGM too, i asked one question, but was asked to sit down by the CFO and was not allowed to ask questions to the CEO. After being polite for a while, i had to raise my voice (something which I never ever do anywhere!). After about 5 mins of heated arguments, he said that most of the questions are forward looking, and will not be answered by them since 'SEBI does not permit them'. :-) Creating a bigger scene and disrupting the AGM would have been easy, but I thought there is no sense in letting ego come in between..And that wouldnt have been very professional on my part too..
  • Mr.K then asked me how many shares i own? (My shareholding in Mahindra Composites is only 1 share, bought for Annual Report purposes). Upon learning that, Mr.K suggested that i should not bother asking questions, since i hold only one share. So, i asked him if the management of the company treats small and large shareholders differently. To which, he replied yes!!! The entire staff left immediately after the resolutions (which got over in 15 mins), leaving no chance for asking questions.
  • Even post the AGM, the CFO was extremely rude and essentially was asking me to get lost (though not directly, of course!)
So what do we gather from this?
  1. A good Group pedigree does not automatically mean good management. 
  2. As minority shareholders, we have to humbly learn and admit that we are nothing! And sometimes, people like Mr.K will remind us that!! Well, a dose of humility never goes waste! ;-) 
  3. Things like these affect investing decision making (I would not buy the shares of such a company where the management thinks that ye to apne ghar ka company hai. Shareholders and all are just a formality!) I just cannot think of partnering with such people, by buying shares of Mahindra Composites. 
  4. However, such factors cannot be brought in an excel sheet. So we should all remember that there is life beyond the excel sheet and a huge number of investment decision making factors lie outside the purview of the excel sheet.
So cheers and happy investing!!

Saturday, July 30, 2011

Sugar Sector and Mind-maps!!!

Hello and happy AGM season to all!
Sometimes, it so happens that while taking an investment decision, one's thought process becomes more important than fundamental analysis, ratio analysis, etc etc.. (Most of the times, its because one is unable/incapable to do fundamental analysis, etc!!!)

For example, consider me and the sugar sector!! We just don't get along! I hate the sugar sector from the bottom of my bottom! I just cannot make any estimation or take a view on the future of the sector. Here's why..
- The price of raw material (sugarcane) is controlled by the Government.
- The price of the finished product (some of it) is controlled by the Government.
- Imports/exports can also be controlled by the Government.
- Government people aren't very rational lotsa times. One cannot even guess what they can do!!
- Soooo, what can happen to the sugar sector in between all this mess is anybody's guess.

However, it so happens that if one plays a commodity cycle (like sugar) right, the returns can be HUGE. Soooo now, we have a situation, where there could be an attractive opportunity, but we have absolutely no idea how to analyse it fundamentally, etc.

So here is where something called as mind-maps come in. When you want to arrive at a decision using a very structured thought process, mind-maps come in very handy. They are a flowchart kinda thing, where a logical flow of thoughts helps you arrive at a decision.

So I scribbled up a mind-map relating to something in the sugar sector, coz I had nothing better to do at the time! :-D Here it is...

Please click to enlarge

Some more points regarding the same:

  • One can totally ignore the sector as such.. No harm in doing that at all. There is no compulsion. Huge number of other (but not comparable) opportunities are available out there.
  • If one opts to go this way, one would be holding on to the stock for 2-3 years without having the faintest idea why!!! So it can get very very uncomfortable. 
  • If one wants to take an exposure to the sector, one may also want to do a basket approach. Buy Balrampur, buy Renuka and also buy the worst company in the sector! 
Now for some idea killers (a.k.a. why all of the above sucks!)
  • Extended sugar cycle depression: You could have a situation where you are stuck in the position for a long looooong time without any decent returns. 
  • Capital allocation: How much of your portfolio can one allocate to such a kind of position? Basically, you are taking a position without much 'actual' thought, right?
  • Probable opportunity losses: Once capital gets allocated there, one may have to suffer the heartburn of suffering opportunity losses, at least for some time.
  • Irrational decision making down the line: If one cannot control emotions here, there can be some irrational decision making one can get into. It wont be comfortable holding positions like this...
  • When to sell? While taking the position, one has no idea about the 'value' of the company. So one will have no idea at what price it becomes overvalued, at what price to sell, etc. So it could cause real confusion later..
Anyways, it could very well be the case that you do not agree with me at all. And that's absolutely ok. We are different people, we will have different opinions! Investing is extremely relative. But even if you don't agree with this way of getting into the sugar sector, at least do give a thought to the concept of 'mind-maps'. Its a great way of taking decisions.

Cheers and happy investing!!

Friday, July 15, 2011

Kesar Terminals - whats in store-age?!!

I had written about this about Kesar Terminals (KTIL) here and here. Lets have a small follow-up on the same.

The business:

The business of KTIL is a very simple one. You erect liquid storage tanks at a port, which can store a variety of liquids like chemicals and oils. You rent them out. Simple! Anyone importing or sometimes exporting liquids will need a place to store them at/very near to the port of import/export. KTIL provides this service to such importers/exporters.

  • Currently, KTIL has 64 such tanks with a capacity of 1.27 lakh kiloliters right in front of the jetties at Kandla port.
  • As part of its expansion plan, KTIL has taken possession of 10 acres of land in Kakinada Port in AP, where it plans to put up dry and liquid cargo handling facilities. Also, KTIL has purchased 16 acres of land at Pipavav port in Gujarat where it plans to put up liquid storage facilities and a container freight station.
  • Capex for the same will be Rs.31 cr @ Pipavav for a 36000 TEU CFS capacity and Rs.27 cr @ Kandla for 40000 kiloliters liquid storage capacity.

Currently, the market is valuing this company at an EV of about Rs.48 cr. Now, the business of the company itself is an annuity business. Do a one-time upfront capex and receive rent on it every year. Rentals of course fluctuate as per macro scenario, but KTIL has long term contracts for about 70% of its capacity, meaning that 70% of its tanks will probably never lie 'un-rented'.
Because of the annuity nature of the business, one can attempt a DCF based valuation of the company. Please note that I am not a big fan of DCF. Imho, DCF can be (rather, should be) done only for a limited types of businesses. So, the valuation is merely for reference purpose and I do not claim in my wildest dreams that it is precise and correct! Certain assumptions to the DCF like growth rate of free cash, discounting rate, etc are relative and everybody's assumptions will surely be different, resulting in different results. (That's what makes DCF an analyst's best friend!)

So, after assuming certain things, we arrive at an intrinsic value of Rs.119 per share, against current market price of Rs.83 per share.
So, should one rush to buy the shares, based on this? HELL NO..and heres why..

  • Our calculation is entirely based on past and present situation. However, we have to take into account that the company is going for a massive capex over the next 2 year period. Capex of Rs.58 cr (much more than even the current market cap of the company!)..
  • For this, the company will have to raise a large amount of debt and possibly, dilute equity too. (In my opinion, raising equity at decent valuations must have been the primary reason for the demerger).
  • Due to this, the current free cash, dividend and the more-or-less pretty picture may not last for a period of time in the near future.

So what would I do?

Wait!! To buy more, I would wait for the entire picture on financing to get clearer. How much dilution, how much debt and from whom? (Public deposits/term loans/FCCBs or what?) 

On a different (yet very very important) note, do check THIS out. And consider this...
  • CRL Terminals (the company which was sold) is a similar business to KTIL, having capacity of 2.6 lakh kiloliters. Other financial details of the company are unknown.
  • KTIL has capcity of 1.27 lakh kiloliters plus land at 2 places.
  • CRL was sold for Rs.278 cr. KTIL's market cap is Rs.42 cr, EV is Rs.48 cr.
  • Sooo, a business, just like KTIL, which was just 2 times of KTIL's size, was sold at about 6 times KTIL's EV. This was just FYI. ;-)
Cheers and happy investing!!

P.S.: Me and my good friend Ninad have exactly opposite views on investing in KTIL.. So, with his due permission, this post is dedicated to him! :-D

Wednesday, June 29, 2011

The 'Value' Mindblock

Each of us have got different views, different opinions and different mindsets when it comes to investing. Some of us like to 'play' in stocks, some like to get into under-researched stocks with good businesses and some are content investing in 'bluechips'.
However, as investors, each and every one of us should properly understand one thing; what do we properly understand?! We should know our circle of competence/our comfort zone and invest accordingly. This will ensure not only decent returns, but also a good night's sleep.
This brings us to the topic of the post - a mindblock that 'value' investors face. The value gang typically goes for stocks that are cheap vis-a-vis their future potential and which also offer a decent margin of safety in case things go a bit wrong. Personally, I also look for a 'trigger' which will help the discovery of value in such stocks. Otherwise, such stocks will remain perennially cheap. (Look at Ultramarine Pigments for example).
In this entire exercise of investing, I often face a certain mindblock. Let me tell you about it with an example. Look at the following companies.

The companies I have illustrated are all established, proven and robust businesses. They are not concept stocks like, lets say, Zee Learning or Delta Corp, which have interesting business, but have yet to 'prove' themselves.
Now the question is, will I buy any of the above companies at present market caps? The point is, I just cant!!! Why not? The valuations!! Look at just the PE Ratio to begin with. Such high PE Ratios tell us that Mr.Market expects a lot of growth from these companies in future (As the companies have delivered in the recent past). Mr.Market also likes the business models which could actually deliver the growth expected of them. And yes, these companies really could deliver.
My problem with such stocks is that there is no margin of safety for black-swan/unforseen events. The valuations already discount a high future growth. And as long as the growth comes in, the valuations continue to be high. But what if for some damn reason, the growth does not come in. What would happen to the valuations (and effectively the stock price) then?
Lets take Jubilant Food for example. Personally, I thought that it was expensive at 400 bucks. I thought the same when it became 500, then 600, 700 and now 800!!! Jubilant Food has been nicely growing for the past coupla years. They have recently expanded their products portfolio, which could help sustain and increase future growth. The valuations therefore continue to be high and the stock will give returns as long as the growth sustains.
The question is, what will happen to the valuations of such stocks, if the expected growth does not sustain or some unforeseen event screws up the basic business model? Crash in the stock price is an understatement.

There comes the mindblock:

  • Should one buy into such 'high growth' stories, paying through the nose for the growth? Or
  • Let them be and suffer opportunity losses (like I suffer all the time). Invest in the 'cheap' cheap stories and stick to what you understand and are comfortable with.
Views invited...

Cheers and happy investing!

Wednesday, June 15, 2011

Goodyear India Ltd - Seeking Answers

I have been tracking Goodyear since quite some time. The reasons I really like this company are:

  1. Excellent brand and brand recall: Goodyear is associated with quality and blah blah (You get the point)
  2. Good positioning in the industry: Goodyear manufactures farm and medium commercial truck tyres and trades in radial passenger tyres and off-road tyres (manufactured by an associate company). Their positioning in replacement market is also very good and the company is making active efforts to improve it further.
  3. Extremely strong balance sheet: Cash of Rs.217 cr against a market cap of Rs.700 cr. The company is selling some land in Ballabgarh, which is expected to bring in another Rs.150 cr as per broker reports.
  4. Decent valuations: At about 10x trailing and 2.2% dividend yield, it isn't over the top expensive.
  5. I will not talk about the delisting angle, because thats been done-to-death in today's market.
However, there are some points in my mind where I am horribly stuck! They are as follows:
  • The company's main raw material is rubber. Does Goodyear use higher proportion of synthetic rubber? What is this proportion? What are the cost advantages here? (For CY2010, their per kg rubber cost was Rs.153)
  • What is the break-up of manufactured goods sales and trading sales? (essentially, I am trying to understand the margins they make in the tyres they procure from an associate company)
  • The AR states that this arrangement with the associate company (Goodyear South Asia Tyres Pvt Ltd) is on a non-exclusive basis and can be terminated by either party after giving four months' notice. If this happens, what is the back-up plan that Goodyear India has? (These sales constitute approximately 20% of the company's total sales)
  • Almost all tyre companies are aggressively putting up capacities. Goodyear India seems to be chilling out. Their installed capacity has increased just from 12.7 lakh tyres in 2005 to 14.2 lakh tyres in 2010. The AR also does not talk of any aggressive growth plans. Why this contrarian approach? What is the management's thought process?
  • What is the break-up of OEM sales and replacement market sales?
  • Goodyear India pays money to the parent under heads such as 'expenditure of trademark fee' and 'expenditure of regional service charges'. The amount paid is about Rs.35 cr. Is this a formula based payment (such as percentage of sales, etc) or is it arbitrary? 
If anyone has answers to these questions, I would be highly indebted if you mention them in the comments to this post or email me on

Cheers and happy investing!!

Sunday, June 5, 2011

Jagatjit Industries - As weird as it gets!!

A few clarifications from my side, which will help you choose whether to read further or not!!

  • The basic idea for this weird case was pointed out to me by a friend of mine. I worked on it fully, but its really not my original discovery.
  • There is no money making opportunity here.
  • IT GETS REALLY REALLY CONFUSING! (and funny too!) Its a fine example of how funny situations can emerge by following the law to the letter!!
Ok, so now you know that there is no money to be made here. Still, if you wana read, here goes!

Jagatjit Industries' history is the stuff that Star TV serials are made of! We have the grand old founder, his three sons from two marriages who, of course, don't get along, we have a fight for control of the company, cases filed by two brothers against one with the CLB seeking justice, creative issues of financial instruments (equity) and of course, to top it all, we have a very very very veryyyyyyy weird open offer!! 
Spoiler: the open offer would result in a 380% acceptance ratio!!!

Sounds interesting? Lets check it out! 

The background

The shareholding of Jagatjit Industries goes like this:
Please click to enlarge

Ok, some points for you:
  1. Jagatjit Industries had allotted 25 lakhs Differential Voting Rights shares to one of its promoters, in which, one share carried 20 voting rights. So, these 25 lakhs shares are equal to 5 crore shares (25 lakhs shares multiplied by 20), as far as voting rights are concerned.
  2. Now, due to this, the promoters had to make an open offer to shareholders, aggregating to 20% of the VOTING CAPITAL of the company.
  3. Now, because of the DVRs, the voting capital will be different than the actual capital, right? 
Here is how the open offer calculation goes..
The original open offer was made in April 2006, when the GDRs were not issued yet. Hence, the total capital for our calculation purpose is only 2.09 crores equity shares. (without considering GDR wala shares)
Let us calculate the open offer, based on 'voting rights' criteria:

Please click to enlarge

So basically, the open offer has to be 20% of the voting capital of the company (which in this case, is different than the equity capital, since some shares carry more votes!!)

Therefore, the open offer will be for 20% of 6.85 crores equity shares, which is 1.37 crores equity shares. BUTTTTTTTT the public holding is only 35.8 lakhs equity shares!! So whom will the promoters make an open offer to??? Hilarious!!
Here is what the Jagatjit Industries' Company Secretary (CS) and SEBI ka conversation might have been like... :-)

CS: Sir, we have to make an open offer for 20% of the voting rights. So in our case, we have to make an open offer for 1.37 crores equity shares, right?
SEBI: Yessir, thats what the law says and thats what you will have to do!!!
CS: But Sirrrr, our public holding is only 35.8 lakhs shares. So, to whom will we make an open offer for 1.37 crores shares???
SEBI: Hey thats none of my concern. You have to do what the law says...
CS: But Sirrrrrrrrrr, if the open offer succeeds fully, ALL the public shareholders will tender and we will have to accept it fully.
SEBI: Yaaa, so??
CS: Sirrr, promoters will then hold 100% shares!!! Isn't that kinda like automatic delisting??
SEBI: Yaaa, so??
CS: But Sirrrr, delisting without reverse book-building??
SEBI: O teri!!! Is this whats happening???
CS: Yessss Sirrrr...thats what i have been trying to explain!!!
SEBI: Ok, give us some time to think about it and we will get back to you soon!!
CS: Ummm...well ok..

Well, SEBI did think about it for five years, which has resulted into this new open offer!! Now, the promoters will have to pay the shareholders interest for five years too!! Hence the open offer has been fixed at Rs.38 PLUS Rs.31 interest, thats Rs.69!!! Shares are quoting now at Rs.68.80. Remember, you can buy any quantity you want from the open market and tender it at Rs.69. IT WILL BE FULLY ACCEPTED!! The offer is open upto June 13, 2011.  In fact, an offer for 1.37 crores shares, when public holding is just 35.8 lakhs shares, means 380% acceptance ratio!! 

All in all, this is one hell of a weird, yet interesting situation which has arisen by following the law to the letter, which will also result in promoters holding 100% of the shares, enabling them to delist the company without going in for reverse book-building!! Can other companies get any ideas from this? ;-) Hope not!!

Hope you enjoyed this as much as I did!!

Cheers and happy investing!!!

P.S. There are some points relating to Jagatjit Industries that i have deliberately not mentioned since they were not relevant to the crux of the article..

Wednesday, May 25, 2011

SBI Triplets - Update

This is just an update and a FYI kinda post...
Yesterday, I had posted some stuff on SBI and possible merger of its subsidiaries. SBI Chairman Pratip Chaudhuri has given an interview in ET today. Link for the same.. (Wish I had waited one more day before posting!) :-)

Some relevant stuff from the interview...

Is there a rethinking on the merger of your associate banks? 

We have already absorbed two of them. Now, the dilemma is that subsidiary absorption requires lot of capital (which is) a cost. At the same time, we are more worried about the future of subsidiaries. Most of the subsidiaries are relatively small and have a small geographical presence. Banks like State Bank of Travancoreare not known in the eastern, western and northern parts of India. Therefore, they are limited by their name, culture and history to a particular geography . They can't grow beyond a certain size, and banking is a business which requires capital. Now, how long can you pump in capital? And there is lot of duplication. So, theoretically, merger is a desirable thing. 

But then you have to recognise operational issues because you have to harmonise and make uniform service conditions and there will be a lot of branch overlap. So, another subsidiary absorption or merger does not happen two or three years before the first one has happened . So, let us first digest State Bank of Indore. With Indore merger, our Bhopal circle alone has 1,100 branches. Now there is an issue of size in the Bhopal circle itself. Now if we merge the other subsidiary, what happens to the related circle of the bank? So we are in the process of rationalising and making the national banking structure more robust. Now, from 10,000 branches, we have grown to 13,000 branches, but the number of circles has remained constant at 14. So we need to increase the span of management. 

Does that mean you will not pursue the merger now? 

Associate bank merger is not happening in a hurry. It is not because we are not convinced that merger is the right thing but it is because it requires capital and operational efficiencies. 

So you are pressing the pause button on the merger of associate banks? 

At least for the next one year. We need to give good performance at the end of March 2012 and be on a strong wicket ourselves. It (further merger) will be only in June-July 2012. 

Its now abundantly clear that there ain't gona be no merger in a hurry! Merger of unlisted subsidiaries will happen in second half of CY 2012. Merger of listed subsidiaries will happen much after that!! One should take a buy/sell decision and view the triplets accordingly!!

Cheers and happy investing!!!

Tuesday, May 24, 2011

The SBI Triplets - will their value be discovered?

A big hello to all!
State Bank of India (SBI) has 3 listed subsidiaries; State Bank of Mysore (SBM, 92% holding), State Bank of Bikaner and Jaipur (SBBJ, 75% holding) and State Bank of Travancore (SBT, 75% holding).
In this post, I am not analysing them as 'banks' per say. I am analysing them more from a special situation point of view. In case you would like to know more about analysing banks, do refer to two very good posts by Rohit here and here.

The basic funda
SBI has 5 subsidiaries at present, 3 listed, 2 unlisted and wholly-owned (another 2 have already been merged). These subsidiaries are growing very well, with consistent high increase in book value over the years.
In the recent past, SBI management as well as the Government have been making announcements indicating their seriousness in merging all its subsidiaries with itself. linklinklink and link. For people who are not 'linky', what these articles and announcements broadly state is that over the next 18-24 months, SBI intends to merge all the 5 subsidiaries with itself, starting with the wholly owned ones and then the listed ones.

The opportunity (?)
There is a mismatch between the valuations of SBI and its listed subsidiaries. The possible opportunity lies during the merger of SBI's listed subsidiaries with itself. Let us see if this opportunity exists.

A basic snapshot of SBI and its 3 listed subsidiaries reveals the relatively low valuation of the subsidiaries when compared with SBI itself. Of course, the triplets should be valued lower than SBI, considering their smaller size and reach. Also, I have not taken SBI's book value, adjusted for its various investments. The subsidiaries are being made a bit bigger through rights issues, before they are merged with SBI. SBM and SBBJ rights issues are over and SBT rights issue is in the pipeline.

The big question - is there money to be earned during this merger? At what valuations will the merger happen?
Well, let us see what happened in the merger of State Bank of Indore (SBIndore), just for reference.

The merger of SBIndore happened in the second half of 2010. The swap ratio was fixed at 34 shares of SBI for every 100 shares of SBIndore.
I managed to get my hands on SBIndore 2010 AR. At the time of the merger, the book value of SBIndore was approximately Rs.1100, while that of SBI was Rs.1191 per share. The stock price of SBI at that time was Rs.2100.
So, on a book value basis, SBIndore shares were valued at Rs.405, a discount of 63% to book value!!!
On a stock price basis (not really useful, since only SBI is listed), SBIndore was valued at Rs.714, a discount of 35% to book value!!
Now, SBIndore was wholly owned, so this is not really representative of what the listed subsidiaries will be valued at. But to me, it gives a clue that one should not assume an extremely attractive valuation when the merger happens. The current cheap valuation of the listed subsidiaries correctly reflects this perception, imho. So, at present price, I do not see a very attractive opportunity arising from the merger, which is still some time away.

What would I do?

  • Though these banks are valued cheap, I expect them to remain cheap till clarity emerges from SBI as to the time and valuation of the mergers.
  • I would prefer to commence buying into these subsidiaries at 25-30% discount to their book values at least. I expect them to valued at least at book value during the merger process.
  • I would view SBT differently, purely from the rights issue perspective. My experience in SBBJ rights issue has been good and possibility of higher-than-eligible allotment exists.

The risks
  • Delay in merger proceedings: Till now, there is no 'commitment' from SBI as to the timing of the merger. All announcements are purely indicative.
  • Erosion of the subsidiaries' book value themselves: Primarily due to pension and gratuity liabilities. The notes to the recent results do give indication of the same.
  • Erosion in SBI's performance and book value: As we have seen in the recent results, this is quite a risk. If SBI's own book value is impacted, leading to a derating in the stock and slide in the stock price, the merger would not give high returns for subsidiaries' shareholders.
  • Opposition from employees: This is quite a black-swan type event! However, there was no opposition during the SBIndore merger, where 90% employees consented to the same.

To conclude, I do not find the SBI triplets to be really attractive investment opportunities at present. However, I would keep them in my watch-list and wait for proper opportunities, if they come by..

Cheers and happy investing!!