Special Situation: Indo-Rama Textiles
Note Prepared by Ankur Jain:
Note Prepared by Ankur Jain:
This triggered the Take Over Code under SEBI Regulations and the acquiree company had to come out with a mandatory open offer to purchase minimum of 20% of the outstanding paid up equity capital from the minority shareholders. The shares left with the minority shareholders were 35.98% (100-14.99-49.03) out of which a minimum of 20% were to be accepted. Spentex came out with an open offer on
Experience of other similar opportunities in the securities market show that the spread between the market price and offer price narrows as the date of closure of offer approaches. In that case, if one gets the expected return due to the narrowing of the spread, there is no need to tender the shares and hold them for a longer period and also take the uncertainty regarding the selling price of the returned shares.
Calculating the economics of the deal, thinking backwards. Taking the opportunity cost of capital @ 15% per annum (twice AAA bond yield),for 82 days, the absolute return should have been at least Rs. 2.40/share in order to justify the investment in this opportunity i.e. sales realisation should have been minimum Rs 74.40/ share.
The possible scenarios in this special situation were: (1) Buying Indo Rama Textiles shares @ Rs. 72 and selling at anyprice above Rs 74.40 in the open market without tendering the shares (2) Buying the shares of Indo Rama Textiles @ Rs.72 and going through the tender process.
In case the shares were to be tendered, we based our calculations assuming the percentage of “brain dead investors” to be 5% of the total outstanding shares. Brain dead investors are the investors who don’t participate in the corporate action due to a number of reasons primarily being death, stock market illiteracy, too-much-paperwork syndrome, postal (in) efficiencies, signature mis-match on the tender forms etc.
Assuming the brain dead investors to be 5%, the shares left for tendering would have been 35.98-5 = 30.98%, which gives an acceptance ratio of 0.64 (20/30.98). In effect, for every 100 shares tendered, 64 shares will be accepted and 36 will be returned back to the shareholders. Cash outflow for the 100 shares would have been Rs. 7200 (100*72). Cash inflow for the shares accepted would have been Rs. 5385.60 (84.15*64). Thus the cost of the returned shares would effectively have been reduced to (7200- 5385.60)/ 36 = Rs. 50.40/share.
A big assumption is the price at which the share would settle post the open offer which would be the realized price for the returned shares.
At the cost of Rs. 50.40, the P/E of the company would be 7.25 X whereas pre-open offer, the company is selling at 11.5 x.
Why would the multiple contract? Operationally, there will been no change in the economics of the business due to the open offer; there will be no dilution of equity. Only thing that will happen was that the equity will changed hands. The risks that were inherent were the market risk and the risk of the new management running the company. Thus, the chances of P/E multiple contracting were low. Also, expected dividend payout of the company would act as a floor price for the stock. (Last year, it paid out 23% dividend, Face value Rs.10)
In his 1998 Letter to the Shareholders, Mr. Buffett wrote:
To evaluate arbitrage situations you must answer four questions: (1) How likely is it that the promised event will indeed occur? (2) How long will your money be tied up? (3) What chance is there that something still better will transpire – a competing takeover bid, for example? and (4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?
We asked ourselves the same questions and the answers were:
- Spentex Industries has a history of doing successful acquisitions of CLC Global Limited and Amit Spinning. Thus, the chances of the promised take over and open offer were very high.
- The money will be tied up for a maximum of 82 days. This period can reduce considerably if the spread between price and offer narrows and we decide to sell in the open market.
- We didn’t have an answer to that question. But if some better offer comes, what do we have to loose?
- If the proposed open offer doesn’t go through, we will be left holding shares of a company which is not grossly over-valued and moreover, the stock price is protected by the dividend yield. The shares will have to be sold in the open market. But chances of that happening are minimal.
Based on the above calculations, shares in this company were acquired at Rs. 72 around
The returns might look miniscule in comparison to the market boom during the same period. However, given the current level of the market and our resultant aversion to market risk, we thought it to be an excellent opportunity which offered satisfactory returns with very little risk of permanent loss of capital. And that’s what investing is all about…Ankur Jain,