In Security Analysis [6th Edition] Chapter 43, Benjamin Graham deals with liquidation value and discussed in detail the circumstances in which investment in such firm might be profitable. In another article by Benjamin Graham on Special Situations , he observed that “In the case of sale on a going concern basis, the LARGE PROFITS are most often to be made by those who buy before the negotiations are begun or completed” You can download key extract of this chapter from here. I think [or SPECULATE] that JRG Securities, a stock and commodity broking company, is one such stock which is currently trading at a market cap of less than INR 20Crs and with net working capital [net of debt and minority interest] of around INR 50Crs. As per my estimates even in worst case there is very LOW PROBABILITY that one will suffer losses but the TIMING and AMOUNT of upside remains HIGHLY UNCERTAIN [Absolute return of 10% to more than 100% over next 2-4 years]. Generally I do not invest in such deep value situations or cigar butts or for that matter any company which does not enjoy reasonable to strong entry barriers IRRESPECTIVE OF PRICE. But I think JRG securities case is different as the current promoter is a financial investor [PE fund] which needs to exit by middle of 2014 [assuming PE fund life of 7 years] or in worst case by end of 2016. I have a never ending desire to look for situations were LOSSES ARE CAPPED to a large extent, but which provides HIGH PROBABILITY of equity like ABSOLUTE RETURN IRRESPECTIVE OF MARKET DIRECTIONS and have reserved almost HALF OF MY PORTFOLIO for such situations.
JRG is into equity and commodity broking and also has a NBFC firm. This business is quite like a commodity business and currently at cyclical decline phase. Also for the last two years, company is incurring losses to the tune of 6-8 crs [While cash losses are less than 1.5cr for both these year]. You can download the mind map containing brief summary from here. Download calculations for NWC, Liquidation value and Worst case scenario value from here.
JRG Securities [BSE code: BSE: 532745, Market cap INR 20crs] is engaged into equity, commodity broking. It was listed in 2006 and issue was at a premium of 30 per share, face value 10 per share. One of its Subsidiary JRG Fincorp, is an non-deposit taking NBFC, majorly in margin funding against security of shares. Company got listed in 2006 and Baring PE acquired majority stake in the company in 2007.
Baring India PE acquired around 45% stake [acquired additional 4% over the 2008-12] in the company over 2007/08 at an average price of around 48/sh. The good part is that total infusion of 48 crores by Baring PE was invested in the business and there was no direct purchase of shares from promoters. Majority of current book value is because of this equity infusion by Baring PE.
On back of rapid expansion of branches, company revenues increased from 16crs in FY05 to around 70crs by FY08 [In FY08 itself it expanded its branches from 30 to around 100].
What went wrong?
In view of severe downturn in FY09 and subsequent decline in cash trading by retail investors, consolidated turnover declined by more than 50% over last five years. Prior to 2008, company has expanded its operations into Gulf countries. But by 2009 it shut down its operations in Gulf countries and also wrote down investment of around 7crs.
Company also started a NBFC in the name of JRG Fincorp in 2008 in which Baring PE invested around 25 crores [at 40% premium] for 43% stake in the company. Its loan book is run quite conservatively and company has not reported any major NPAs till FY12. [FY13 annual report not yet out].
During FY10-13, there were severe dispute between Baring PE and ex-promoters. Ex-promoters did not let company changed its name to Inditrade and also created hurdles in appointment and payment of appropriate remuneration to professional MD& CEO. Baring alleged that despite signing non-competitive agreement, ex-promoters entered into competitive business. Ex-promoter did not let Baring to raise funds through rights issue, alleging that the sole purpose of rights issue is to reduce ex-promoter stake and they filed case against company u/s 397 in companies’ law board. Last month, Baring PE and Ex-promoters have resolved their differences. Ex-promoters have withdrew the petition against the company and have re-associate with the Company in the capacity of ‘Mentors’
Baring India PE fund acquired majority stake in JRG Securities sometime in 2007. So ideally they should exit by mid-2014 or in worst case scenario by end of 2016 (if they get extension for divesting of their fund by another two years). The exit of PE fund should result in acquisition of JRG by third party at more than INR 18/sh [Liquidation value]. Even in the worst case scenario company is worth atleast 10/sh [Assuming NPA of 10% for their loan book, decline in 50% turnover and assuming employee cost and administrative expenses remain fixed]. Company has a liquidation value [I made an attempt to calculate it the way suggested by Benjamin Graham] of more than 18/sh after accounting for possibility of accumulated cash losses to the tune INR 8crs over next 2-3 years [Company has not suffered any cash loss till FY11 and cash loss is less than1.5 crs in FY12 & 13. I have not assigned any value to the business with more than 80K customers but considered only financial assets on its books like ST Loans by its NBFC subsidiary, cash, receivables and investments in equities and liquid mutual fund.
Benjamin Graham discussed about three ways in which re-rating might happen in companies trading below liquidation value: 1) Restoration of earning power commensurate with the company’s assets. 2) A sale or merger, because some other concern is able to utilize the resources to better advantage and hence can pay at least liquidating value for the assets. 3) Complete or partial liquidation. I have considered only second and third possibility and restoration of earning power in current market environment for a stock broking firm is VERY DIFFICULT.
Open offer: Who so ever buys Baring India PE stake of 49.5%, will have to come up with an open offer to buy additional 26% stake from minority shareholders. Ex-promoters still hold 11.5% stake in the company, so to get absolute control and avoid the problems from ex-promoters any potential buyer will also have to buy entire stake held by ex-promoters. Thus acceptance ratio in any potential open offer will be quite attractive at 65%.
Voluntary winding up: Assuming a worst case scenario that 1) Baring PE fails to get any potential buyer for their business 2) there is another severe downturn in market which results in decline in JRG turnover by 50% and 3) JRG incur cash losses of around INR 8cr over next 2-3 years, JRG NAV will still be around INR 10/sh. So even in the worst case of voluntary winding up, downside seems to be capped to a large extent.
Reasons for avoiding this investment idea
- Company is incurring losses (except for 2010 when it made marginal profit) for the last five years [FY08-13] in its core operations of equity broking. Over the last five years (2008-13) it’s consolidated net worth has declined by 10% in absolute terms. There is no visibility of turnaround in its operations. Things may get worse, before they get better.
- Current promoters appear to be getting very desperate to recover their sunk investment. From FY11 they have started trading in derivatives through subsidiary. Even in JRG Fincorp they bought and sold derivatives of more than 40 crores during FY12 and there is no mention of this anywhere in the MD&A. But as of now, they have appeared to run their investment book very conservative and profitably. In JRG Fincorp they started investing in FY10 and by FY12 they were completely out of equities. They made a profit of around 8 crores in the last three years. Over the last one year my GUESS IS THAT they have reduced their exposure to derivatives from around 20crs to 8crs [after going through their balance sheet of Sept-12 and Mar-13]
What can go WRONG:
- In JRG Fincorp [Subsidiary of JRG Securities, which contribute around half of its NAV, NWC and liquidation value], Baring PE fund hold around 40% through one of its group company. One possibility is that the PE may try to merge that with JRG at attractive valuation to increase its holding in JRG securities or dispose off the subsidiary at low valuation. Companies Act allow to dispose off any material assets of the company by passing merely an ORDINARY RESOLUTION. [As per the terms of contract, JRG Securities should provide exit to Baring PE from JRG Fincorp either by getting JRG Fincorp listed or buying back its 47% stake at PB of JRG securities.]. But with ex-promoter stake continuing at around 10%. Standard Chartered PE fund stake at 3% and other financial investors stake more than 5-6%, probability of any wrong doing is quite less.
- There is a possibility that in the event of severe downturn in addition to decline in turnover, company might suffer huge losses in their investments. [Not sure of their current investment pattern, but as at FY12 they were completely out of equities and even investment in commodity futures has declined from INR 20crs in FY12 to around 8crs by FY13.]
When to sell
- If no evidence of exit of Baring even by end of 2015.
- Company started pissing off cash on costly acquisition or related party transactions.
- If price reaches around 20. Then review about the decision to continue to hold vs. sell.
It’s debatable whether or not to invest in this opportunity. As long as downside is capped with fair possibility of equity like returns [double digit returns] I am comfortable with investing in any opportunity. This investment opportunity may not appeal to those investors who look for far more certainty, which CERTAINLY is ABSENT here. As mentioned in the beginning, I have a never ending desire to look for situations where LOSSES ARE CAPPED to a large extent, but which provides HIGH PROBABLITY of equity like ABSOLUTE RETURN IRRESPECTIVE OF MARKET DIRECTIONS.
- All the posts on this blog, including this one, are for educational and discussion purposes only.
- None of the material posted should be regarded as advice to buy/sell any stock. I do not have any proven stock performance record to talk about.
- As a professional investor, I may have positions in stocks discussed.
- Main objective is to seek contra views and not to recommend any particular stock as buy or sell.