An interesting observation on open offers..

This post is a result of an over-a-cup-of-tea-discussion with Mr.Niren Parekh. Niren is a very good friend and an excellent investor. Also, he is too lazy to start a blog! The post is a result of an observation made originally by him and so I cannot claim this to be my own brain-work.

Open offers are excellent special situation cases. Although the absolute return in such offers is typically not very large, if done properly, they can offer excellent short-term returns with relatively less risk. Annualised returns in most cases will be in the high teens.

The amount of open offers have increased in the recent past due to increasing M&A activity and also due to low valuations, leading to promoters wanting to increase their stakes. This has led to some interesting opportunities for astute investors..

The Basics

Open offers get triggered for a variety of reasons. It could be as a result of change in ownership control of a company (e.g. ESAB) or it may be completely voluntary (e.g. Tata Sponge).
In an open offer, an existing or a new promoter (or a third party) makes an offer to acquire the shares of the non-promoter shareholders at a certain price, as mandated by law.
After following the entire legal procedure, the promoter opens this offer and the non-promoters shareholders tender their shares in the open offer.

The Acceptance Ratio

Lets suppose that ABC Ltd has a total share capital consisting of 500 equity shares. Current promoter holds 200 shares, making his holding 40%. Non-promoter shareholders hold 300 shares, making their holding 60%. Now, to increase his stake, the promoter makes an open offer for an additional 20% (100 shares).
The non-promoter shareholders will tender their shares in the open offer. Total non-promoter shares are 300, out of which the promoter wants only 100, making the acceptance ratio 33%. Which means, out of every 3 shares tendered by non-promoter shareholders, only 1 will be accepted by the promoter and money will be paid for it. The remaining 2 shares will be returned back to the shareholders.
Now, this entire calculation is based on the assumption that all non-promoter shareholders will tender. What if some of the non-promoter shareholders are not interested in tendering? Then, with respect to those who do tender, the promoter will accept more than 33%. (Finally, he wants 100 shares. From whom and how much they come, doesnt matter!)
So, the theoretical acceptance ratio we calculate before the open offer begins and the actual acceptance ratio we see after the offer ends can be vastly different. This happens because some shareholders are not interested in tendering. Some others do not know what tendering means and completely miss the open offer! So, for those who do tender, the acceptance ratio becomes higher! This is where an astute special situations investor can make money.
Let us look at a few open offers in the recent past.

Now what we see is a HUGE difference between the theoretical and actual acceptance. This tells us that there is a high proportion of investors who have not been tendering in the open offers, investors who can also be referred to as brain-dead investors in a lighter vein! Even in the case of Akzo and Thomas Cook, the acceptance ratio has been phenomenally high. Specially in the case of Akzo, it was 100% for the small shareholder category. Any special situations investor who would have participated in these offers would have made a LOT of money. (I have not shown the annualised returns in these open offers here, since thats not the topic of this post.)

Of course the question arises..how can one profit from this observation? Can we make some educated guess as to how much will the actual acceptance ratio be, so that positions can be taken accordingly?
I have been tinkering with various factors like the extent of 'retail' and small shareholders, % of shares in physical form, etc. But so far, I have been unable to figure out a way in which the actual acceptance ratio can be predicted with fair certainty..well, the search continues!
I eagerly look forward to the open offers of Shanthi Gears and Future Capital. Lets see if this trend continues.
Till then..
Cheers and happy investing!!

P.S. This post is only to point out the extent to which the 'brain-dead investors' exist in open offers. Therefore, no discussion has been done on the returns in these offers, taxation implication, time and legal risks etc.



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) I may have positions in stocks discussed. As a professional advisor, I advise clients regarding investments. They also may or may not have positions in stocks discussed, depending on their decision. 
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! 

NBCC - Fantastic business and 'sitter' valuation, but...

National Buildings Construction Company (NBCC) is a BSE, NSE listed PSU. The company came out with its IPO in March 2012 at Rs.106 per share. The current financials of the company are as under:

Seems great! I can almost see all the Graham fans salivating!!
Well, it gets even better!


Unlike a lot of companies, where cash is more than market cap, this company is not facing any problems on the business front.

The business:
NBCC's business is pretty straight forward. It operates in 3 segments;
1. Project Management & Consultancy: In this segment, the company does residential and commercial civil work for various Govt departments. e.g. a ministry wants to build a new building or a new housing colony is to be constructed for Govt employees, NBCC is appointed to carry out the work. NBCC itself does not engage in any construction activity, but outsources it to other parties on a tender basis. NBCC thus acts as a nodal agency for the Govt, providing project management and consultancy services. It gets anywhere between 6-10% of the project cost as its fees.
2. Real Estate Development: In this segment, the company owns land and acts as a developer, constructing and selling commercial and residential real estate. The company has land bank of 125 acres spread over various cities in Northern India.
3. Power Sector: This is a smaller business segment, where the company does civil work for power sector projects. e.g. construction of cooling towers, chimneys and such other structural work.

Consider the following additional points:

1. Business is booming. The company has a current order book of more then Rs.10000 cr, while its FY12 sales stood at Rs.3500 cr. Being a Govt driven business, it is not as affected as other companies due to various negative macro factors.
2. The business does not require a lot of capital, since NBCC itself does not do any civil work. It outsources the work. The company therefore generates excellent cash and gets large advances. Fantastic business!!
3. One large commercial real estate project of the company at Okhla is nearing completion. It is expected that this project alone will generate revenues of Rs.400-450 cr and profit of Rs.180-200 cr! (Since accounting is done on completed contract basis, nothing has been booked yet).
4. NBCC has been granted CPWD (central public works dept) status. Hence, it is eligible to get numerous Govt civil construction contracts, which are otherwise not open to other companies. 
5. The company has a large land bank and numerous real estate projects in progress. More details on the same can be obtained here.

Now the obvious question..you have a company having cash on book greater than market cap. It also has a low-capital, virtually recession proof, assured business. It also has valuable assets (land). It pays full tax and gives decent dividend too. So why shouldn't one buy this left right and centre?! Well, before you do that, let me ruin your happiness by putting forth some more points!!

1. The biggest problem I have with the company is that the company's promoter is an extremeeeeeeely irrational being. The promoter is known to take decisions which make no business sense. In this case, e.g. if the promoter 'directs' the company to put money into, lets say, a large BOT project..or the promoter 'directs' the company to put money into an ailing power project, or buy a coal block! Not only will this entire cash on books disappear, but the company will be additionally saddled with debt. When will this happen? Maybe never..maybe tomorrow! Improper capital allocation is the biggest risk..There will always be this hanging sword for investors in this company and good investing cannot be done with swords around! :-D
2. The 'cash' that one sees on the books does not entirely belong to NBCC. About Rs.500 cr is the company's own money, while the rest comes from advances received. On this related topic, do read this excellent post by Prof Bakshi.
3. FY12 contingent liabilities 'claims not acknowledged as debts' stand at Rs.1055 cr! Thats quite a lot! I couldn't get much info on the nature of these contingent liabilities.
4. The business is virtually tailor-made for corruption!!! NBCC gets contracts and outsources them to others. A corrupt official can easily earn a bit 'on the side' in this process. If a large scale corruption scandal comes out, it will hit the reputation, valuation and market cap of the company! (There are corruption cases against 16 employees of the company already, as per the RHP).
5. There were newspaper reports and talks about the company getting into power generation!! Boy that would be a real bad capital allocation decision, considering the excellent current business. Although the company has denied this, the RHP talks about the company's intentions to get into BOT/BOLT/BOOM projects. 

Conclusion

The capital allocation overhang will always remain in this particular stock. Market will always be edgy, expecting the company to piss off money into some unrelated business, just because it is 'directed' to do so. With an overhang like this, its difficult that the company will get premium valuations. The cheap stock will remain cheap and may become a typical value trap. If the company really does waste cash like it is feared, then one can expect the market cap to drift a lot down too!
In my opinion, if you want to make a lot of money, investing in this company is not for you. But if you want to avoid losing a lot of money, this company is worth a look for you. Whatever you may decide, in case you invest, it would be wise to always keep tabs on what the company is doing and how it is allocating its capital. It shouldn't happen that you wake up one fine day with a big loss in the stock, then you start investigating and then you find that the company has just blown money away. Being vigilant is a must!!

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) I may have positions in stocks discussed. As a professional advisor, I advise clients regarding investments. They also may or may not have positions in stocks discussed, depending on their decision. 
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!

APW President - A Delisting Case

Until a few months ago, delisting was the flavour of the day. With recency bias of cases like Alfa Laval and Atlas Copco, an equation was formed.. MNC + above 75% holding = Profit guaranteed! In some cases, MNCs with less than 75% promoter holding ran up too! It makes no sense to participate in these opportunities when the crowd is running after them. Consensus is seldom right! I had written a post on this too..

However, over a period of time, the market has slowly forgotten the entire delisting theme. People no longer ask me (or give me unsolicitated khabars) about delisting. Its no more the 'in-thing'. So, its time to at least start looking into it. :-)

One such case which me and my friend Ninad discussed is that of APW President Systems Ltd. The company is now a Schneider Group company, with the promoters holding 75%. They have already announced their intention to delist.

I had earlier written about how to analyse delisting cases and what points one should consider for decision making, in my opinion. Let's try and look at APW from the delisting point of view..

1. Valuation Comfort: One of the most important criteria I look at while analysing delisting cases. If there is no valuation comfort, I would be more than ok giving the opportunity a pass. APW is available at a market cap of Rs.125 cr and an EV of about Rs.145 cr. FY12 sales were Rs.97 cr, while there was a loss of Rs.5.8 cr at the PAT level. On the face of it, the valuations look expensive. However, one should also take into account that any acquisition is usually followed by 'cleaning of books', where there will be quite some write-offs and hits on the profitability. Prior to the acquisition, however, the company had PAT of Rs.10 cr in FY09 and Rs.6 cr in FY10. The company definitely has potential, if its capacities are utilised properly, under the right set of promoters. In my view, at the current market cap, its neither too cheap, not too expensive..its somewhere in the mid-range, but still not at go-out-and-take-a-big-position valuation. Barely acceptable!
2. Management Quality: Management quality is of paramount importance. If the management is not good, the minority shareholders will not get a fair exit. Schneider Group is a global leader in the electrical parts, components and allied spaces. Based on my reading, I have not found anything blatantly wrong which the management has done in the past. I am ok with the management quality..Acceptable!
3. Incentive to delist: Why should promoters delist the company? What incentive do they have? Trying to study this will help us understand the seriousness of the promoters to delist the company. In the case of APW, the promoters have kept their holding at 75%. So, there is no legal compulsion/deadline for them to delist. However, Schneider has been on an acquisition spree in India in the recent past, snapping up one business after another.  Link to article. Most of the companies they acquired were either privately held, or they acquired the business in question, without acquiring the company. The group seems more comfy with having privately held companies. They may also be looking at APW as a low cost manufacturing base. Further, they have announced their intention to delist the company, even though it is not at all legally mandatory for them to do so. I cant conclude for sure whether there is a high incentive to delist, but one can say that there is serious intention to delist.
4. Floor Price: The company has announced Rs.164.30 as the floor price whereas the promoters have announced Rs.195 as the  indicative price for delisting. CMP of Rs.205 is about 40% above the floor and 5% above the indicative price. 
5. Shareholding pattern: A concentrated non-promoter shareholding pattern makes delisting easy since the promoters have to 'deal with' lesser number of shareholders. In this case, promoters hold 75% and need minimum 15% more to delist. Here, the facts become very interesting.

In March 2012, the shareholding was pretty concentrated, with just 4 shareholders holding 11.96%. 5 other individual shareholders held 2.42%. So, just 9 players held 14.38%. Delisting looked very much doable.

However, in the June 2012 shareholding, everybody has disappeared! Globe and Rajasthan, which are arb players are no longer there in the 1%+ category. M Rutty & Co, which was one of the erstwhile promoters have also disappeared, while APW Electro has reduced its holding. The overall shareholding has gotten a lot more dispersed in these 3 months, thereby making delisting more difficult comparatively.

Conclusion

At current market cap, APW is not a screaming buy. The promoters are not under any legal obligation to delist. So if they decide not to go ahead with the delisting, the price would correct a lot, since there are losses in the past year and the new management has not disclosed its plans for the company. Market would typically react to this in a very negative way. So, building a big position at this market cap seems very risky to me. I would like to attend the AGM of the company, to be held in September, to get more clarity on this (if possible!).

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) I may have positions in stocks discussed. As a professional advisor, I advise clients regarding investments. They also may or may not have positions in stocks discussed, depending on their decision. 
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!