Note: This is going to be a four part series. In part I, we will try to analyse past delisting failures and some common pattern. In part II, we will try to study past successful delisting and to identify patterns, if any. In part III, we will try to develop checklist based on past delisting failures and in part IV, will try to analyse some current delisting opportunities based on checklist developed in part III.
Acknowledgement: In doing this series, I was immensely benefited by various blog posts by Ashish Kila , Neeraj Marathe, Ninad Kunder and Prof. Sanjay Bakshi. This does not mean that they will support this framework or will agree with some investment opportunities which I may identify. Needless, to mention that all errors or misinterpretation are solely mine.
I presume that readers are aware of the legal framework for delisting of companies in India. If not you can refer to first 22 slides of this presentation by Ashish Kila. In all the price charts, I have taken share price starting one week after announcement of delisting by the company.
I was introduced to mental models around two years back when I read Prof. Sanjay Bakshi presentations here. But I was not using those models very actively. For last couple of months though, when I started using them actively I could see drastic improvement in my thinking and decision making process. This entire work on delisting is based on thoughts gathered from few such models, most notably 1) Invert always invert – which suggest us to think of ways in which we can fail and then avoid such situations 2) Base rate of probability – odds in terms of prior probabilities. 3) Checklist model – which tells us how to make better decisions 4) Prisoner’s dilemma – why two individuals might not cooperate, even if it appears that it is in their best interests to do so 5) Picking up pennies in front of road roller – there is a high probability of a small gain, and a small probability of a very large loss
I think the best way to develop a framework to analyse delisting [for that matter any investment ideas] is to determine the base rate probability [read page 8 & 9 for more details from Sanjay Bakshi interview. As Prof. Sanjay Bakshi said
“one of the great lessons from studying history is to see what has really worked well and what has turned out to be a disaster – and to learn from both.”
According to this paper, primary characteristics of failure patterns can be summarised as
- It shows how a fault is manifested in a given system until it produces a failure.
- It helps to identify countermeasures to avoid or mitigate failures.
- It allows the reconstruction of a failure scenario by seeing its effect in specific units.
- It provides a guide of application for software development to follow that helps to reduce failures.
So let’s try to identify the faults which were manifested in some of these delisting cases which resulted in disastrous losses to their investors. At the same time we should be aware of the Opacity of History as explained by Nassim Taleb
“the retrospective distortion, or how we can assess matters only after the fact, as if they were in a rearview mirror”
This was one of first company I analysed and I had posted my review here. I was more focused on upside and completely ignored downside. I also failed to understand the impact of prisoner’s dilemma which could kick in during reverse book building process [RBB]. Read Prof Sanjay Bakshi post on Essar Shipping here to understand how SEBI regulations are partly responsible for this.
You can download the mindmap summary from here
Investors [though correct word should be speculators] who invested in this company incurred losses upto 40-50% post delisting failure. Below are some of the reasons I could identify for steep losses [after paying steep tuition fees]:
- Pathetic fundamentals: Company was already incurring losses for last two and half years.
- Dispersed shareholding: Company required 15% shares for delisting to be successful. Top 2 shareholders held only about 5% and balance 10% was distributed among more than 60 shareholders.
- Steep valuation: Despite the fact that company was incurring losses, it was trading at more than 3x BV.
- Failing to calculated expected returns as suggested by Benjamin Graham here [see page 2] and my entire focus was only on upside.
- Failed to understand implication of prisoner’s dilemma which kicks in during RBB and not exiting during RBB stage itself.
I think failing to consider expected returns and prisoner’s dilemma is common mistake on the part of investors, because of which they incurred steep losses and hence not repeating again in other cases.
You can download mindmap summary from here. Post delisting failure, losses were in the range of 30-40%. Below are some of the reasons I could identify for steep losses
- Pathetic Fundamentals: Sales growth was flat during 2005-10 and average EBITA margins was less than 1%
- Dispersed shareholding: Company required around 7% for delisting to be successful. There was no meaningful stake even by top 20-40 shareholders.
- Steep valuation: It was trading at steep valuation of more than 4x PB and more than 24x EBITA multiple
- No incentive to delist: Most important, there was no incentive to company to delist. Company has another unlisted entity in India, which was exactly in the same business as listed entity. Sales of unlisted entity were 12x more than listed entity. This entity had registered sales growth CAGR of 28% and average EBITA margin of 11% during the same period, compared to flat sales growth by listed entity during same period.
Post delisting failure stock price declined by 35-45%. Again the reason seems to be same
- Pathetic fundamentals: Company was incurring losses during FY10-12. There was excess capacity in the transformer industry and company capacity utilisation for Fy09-11 was between 30-40%
- Dispersed Shareholding: Company required around 13% for delisting to be successful. There was not even a single shareholder with more than 1% stake. HNIs held around 5% stake [around 20 individuals]. Bodies corporate around 3.1% and another 6-8% by top 100 entities.
- No comfort on valuation: Even at floor price it was trading at more than 1.7x BV. Though going by future potential this may not strictly be steep. But one can reasonably conclude that with no immediate turnaround prospects, price will decline steeply if delisting fails.
Post delisting failure investors suffered 30-40% losses. This is one of those few cases which I think which is easy to say in hindsight that one should not have invested.
- Fundamentals of the company were neither very great nor pathetic. Sales and EBITA grew at a CAGR of 12% over 2005-11. Average ROE [pre-tax was around 26%]. FY12 performance was bad, where despite the fact that sales increased by 45%, EBITA declined by more than 90%. But it was easy to dismiss FY12 performance as ‘managed’ one.
- Valuations on little higher side: It was possible to buy the stock around INR 70, at which price company was valued at 18x EV/EBITA [based on average EBITA during 2005-11]. This valuation is definitely at little higher side, but not overly exorbitant considering the fact that company was projecting more than 40% growth in sales for FY13 and EBITA was impacted in FY12 due to FX volatility. [Company imports more than 70-80% of its goods and INR depreciated by 12% during FY12]
- Dispersed Shareholding: Yes, Shareholding pattern was scattered and it was possible to say that building book would be difficult.
This is again a very interesting case and highlights the importance of shareholding pattern, which was the sole reason for failure of delisting. Because of good fundamentals, share price decline was only 15%, unlike previous cases.
- Fundamentals of the company were good. Company registered more than 15% CAGR in sales and operating profits during 2003-08. ROCE averaged more than 30% and company was debt free.
- Trading at fair value: During delisting period company was trading around 14-15x EV/EBITA multiple. It could be considered as trading near fair value.
- No other entity in India: Parent company did not have any other unlisted/listed entity in India.
- Major problem, was the shareholding pattern: Company required around 6% stake for delisting to be successful. But HNI and Financial institutions holding was less than 1%. Around 3% stake was held by more than 160 corporates and another 7-8% by more than 4K retail shareholders. So it was highly unlikely that book could be built.
WELL Managed delisting cases
Here I would like to discuss those cases, where delisting was successful and investors who failed to appreciate that there WON’T BE ANY DISCOVERY OF FAIR PRICES must have incurred losses. But investment at right price [at or below floor price] would have resulted in profits.
It’s a very interesting case. Atleast the price chart, suggests that no one was suspecting there will be any collusion between top shareholders and promoters. Company managed to get delisted at INR 720, when the average price from announcement of delisting to opening date of RBB was more than 830. Company managed to get delisted at US80/MT valuation which is atleast 30% discount to replacement value. Well indeed nicely managed.
Now this is a company where
- Fundamentals were good
- Valuation cheap to fair
- Concentrated holding
Despite of presence of most of the factors which one should look at while investing in delisting cases investors suffered losses of atleast 10-20%. The above case shows investors also need to question whether discovery of fair price is possible, whether investors are professional or related parties. A casual look at the will indicate that just top 4 shareholders need to come together for delisting to be successful. Out of these three were private limited companies and top shareholder was Tamil Nadu Industrial Investment Corporation ltd which is a company owned by government of Tamil Nadu. I guess government owned companies are very easy to CONVINCE. [This is one of the situations which I found easy to analyse in hindsight but, I must confess that if I had studied delisting at that point of time, I would have invested]
It was possible to avoid the above situation, if one had studied Binani Cements delisting case, where promoters managed to get the delisting done at enterprise value of USD80/ton, which I think was below replacement value. As Neeraj Marathe noted here “J P Morgan had acquired 25% stake in Binani Cement @ Rs.24 in 2005. Out of this, they disposed 10% @ Rs.75 through an offer for sale in 2006-07 IPO. They further sold 3.4% more in the 2010 buyback @ Rs.90. They hold remaining 11.6%. Ganesha had also acquired its 10% stake pre-IPO. They haven’t sold anything yet. [Tendering by these two shareholders was enough for delisting]. He correctly estimated the delisting price to be around INR 90. This case shows how it is difficult to expect fair price when there is concentration of holding with few entities.
From the above chart it’s clear that delisting happened at nominal profit to floor price and even market was anticipating that. Delisting was deferred by SEBI and those who tendered their shares got stuck for 6-7 months.
The average price [after delisting announcement and till public announcement of RBB] was mostly below the floor price. There were some 40 individuals who held the required quantity for delisting to be successful. Read detailed post on this investment idea here. There were also allegations of persons acting in concert with promoters, buying from open market and tendering at lower price. Read here.
I could note the following points from brief analysis of Nirma:
- Nirma was on path to Diworsification starting somewhere between 2006/07 wherein it started investing heavily in unrelated business. By end of FY10, company had deployed more than 45% of its capital in non-core businesses.
- Growth in core-business of FMCG was pathetic. Sales grew at a CAGR of merely 6% whereas EBITA declined by 4%.
- Low returns of ROE: On an overall basis, ROE [pre-tax] which averaged around 16-17% during 2003-06, declined significantly to around 6-7%.
- Delisting happened at around 1.4x TTM BV and company was trading at average PB multiple of 1.3x during 2005-10. On an overall basis, delisting has not happened at ultra cheap valuation, though one can argue that sum of the parts valuation is much higher.
I analysed this situation here , in which I WRONGLY suggested buying Amrit Banaspati at or above floor price. Entire delisting process was over within 4 months and the final delisting price was 5% above floor price. But the average price during delisting was around INR 146. In this case entire delisting process was over within four months. But taking cues from Alternative History concept as explained by Nasim Taleb, what if delisting process got delayed for any reason. In case of Nirma delisting got delayed by 6-7 months. Was there any margin of safety built in, when I suggested buying at floor price? Answer is BIG NO. So with the benefit of hindsight, it can be said that one should invest in managed delisting cases only at a reasonable discount to floor price.
From the above we can reasonably say that the most lethal combination is to invest in a company with a combination of pathetic fundamentals, dispersed shareholding and steep valuation. If someone is interested in doing financial suicide, then he should also look for cases where there is no incentive to delist and should not bother to calculate expected returns and should focus only on upside. Finally he should tender his shares in RBB in all the above cases.