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.
Let me clarify at the outset. I am in no way trying to criticize the original investment ideas or its analysis. I am fully aware that in hindsight, things are much clearer that they appear to be at that point of time. What I am trying to do is to present ALTERNATIVE HISTORY of same situation. Moreover, in delisting one is trying to pick up pennies in front of road rollers, so avoidance becomes more important than participation.
You can read the Part I here
Finally I was able to complete Nassim Taleb excellent book “Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets”. I must admit that it was a very difficult read for me and I was not able to fully understand many of its sections. But I found this book to be one of the excellent resource to understand special situation investments like delisting better and will quote extensively from this book, in explaining my thoughts about delisting.
Nassim Taleb mentions in the book that “I start with the platitude that one cannot judge a performance in any given field (war, politics, medicine, investments) by the results, but by the costs of the alternative (i.e., if history played out in a different way). Such substitute courses of events are called alternative histories. Clearly, the quality of a decision cannot be solely judged based on its outcome.” He also adds that “We tend to think that traders were successful because they are good. Perhaps we have turned the causality on its head; we consider them good just because they make money. One can make money in the financial markets totally out of randomness.
I think same applies to Delisting situations. One can make huge profits in situation in which expected returns were negative. But one should not forget that, if one repeatedly invests in such situation over a period of time, returns will be negative. Lets analyse some situations in which I think expected returns were negative.
Shareholders have made 40% return in this case despite the fact that shareholding was very scattered and it was already trading at fair to steep valuation. A cursory glance at shareholding pattern will make it clear that delisting was very difficult.
In addition to above @ INR 1,800 it was trading at 27x PE. The price at which delisting happened implies PBT growth of 20% for next 10 years with zero investment in capex and working capital
What could have gone wrong?
- Many companies with similar shareholding structure or better shareholding structure failed to get enough quantity in RBB eg . Ricoh India, APW President etc.
- Share price was in the range of INR 2,000 even during the first four days of RBB. So anyone who sold during RBB process to avoid event risk of delisting failure would have made only 10%. Now if like Saint Gobain and APW President cases, Atlas Copco RBB was delayed, annualised returns would have been much lesser [assuming shareholder exit during RBB stage]
- Like Blue Dart, promoters could have rejected discovered price. Going by the fact that valuations were already quite steep, possible upside was around 10-15% in the event of successful delisting but downside was more than 25-30%, if delisting failed because of steep valuation.
What caused this?
and what caused this?
In both the above cases there was arm twisting by existing shareholders apparently lead by DWS Mutual fund, forcing promoters to pay higher price than he was willing to. Eg. Deutsche DWS mutual fund acquired 4% stake post delisting news in case of HSBC investdirect at an average cost of 260-270 and it also acquired 4% stake in Suashish Diamonds @ 330-350
Even at average acquisition cost of INR 260-270 to the largest shareholder DWS , HSBC Investmart was trading at steep valuation of 3x FY 09 BV. In addition to this it was incurring huge losses starting from FY09 till RBB period and there were no immediate prospects of turnaround. So going by valuation, there was very low probability of reasonable return. Recently HSBC has shut down retail broking and retail depository services it acquired through acquisition of HSBC investmart read here .
On the contrary, Suashish Diamonds was trading at 1.1x of BV and the networth mostly consist of liquid assets like cash and receivables. Company has lot of immovable property which is still being carried in books at original cost.
Now outcome is completely beyond expectations. In case of HSBC Investmart, shareholders were successful in making 50% + return in less than a year despite the fact that it was already trading at steep valuation. Considering the fact that company was already incurring losses, downside was quite steep, in the event of failure of delisting.
This is an excellent example which shows what happens when investors WRONGLY ATTRIBUTE their success to their skills when it was more a result of LUCK. Overwhelmed by their success in case of HSBC Investmart case, DWS mutual fund tried the same tactic in same of Suashish Diamonds, but failed to give enough attention to the incentive of promoter to get the company delisted.
What if HSBC Investdirect management was as conservative on valuation as Blue Dart’s management?
Blue Dart valuation
DHL acquired Blue Dart during 2004 at average price of INR 350, at which it was trading around 23x FY05 EPS. Maximum price indicated by DHL was INR 550 [26x FY06 EPS]. During FY06-13, sales have increased by 3x and net profit by 4x. Share price during the same period has increased by more than 3x the discovered price of INR 950. With the benefit of hindsight, we can say that even at discovered price of INR 950, Blue Dart was trading at fair value or might be at discount to fair value.
In Blue Dart’s case, surprisingly investors incurred 5-7% losses, as DHL rejected the discovered price of INR 950. Though going through market price we can say that, market was never expecting such a high discovered price, as share price was below INR 600 most of the time during delisting period. Losses were capped because of good fundamentals. This case is also another classic example of prisoner’s dilemma, as DHL rejected the discovered price of INR 950. Assuming that DHL was expecting only half of realised growth during FY06-13, that price was still not steep when compared to price agreed by HSBC for HSBC Investmart.
I think before investing in delisting cases, one should factor in a) The best that can happen, if you take risk [most of the people factor best case] and b) The worst that can happen if you take risk [most people fail to factor worst case]. The worst case scenario, which did not play out was HSBC refusing to accept the delisting price, HSBC withdrawing the delisting. In either of the case, the downside was going to be very huge [> 50-60% decline in prices]. I agree that probability of such events playing out were less, but it’s not zero. My estimation is that, best case scenario profits were 10-15%.
After going through HSBC Investmart case, I am reminded of Nassim Taleb quote “Markets (and life) are not simple win/ lose types of situations, as the cost of the losses can be markedly different from that of the wins. Maximizing the probability of winning does not lead to maximizing the expectation from the game when one’s strategy may include skewness, i.e., a small chance of large loss and a large chance of a small win. If you engaged in a Russian roulette– type strategy with a low probability of large loss, one that bankrupts you every several years, you are likely to show up as the winner in almost all samples— except in the year when you are dead. [Emphasis mine]
Patni Vs TTK Prestige
What caused this?
And what caused this
iGate was debt free prior to acquisition of Patni. There were concerns that acquisition of a much larger and older Patni (expected annual revenue USD700 million) by a younger and smaller iGate (expected annual revenue USD300 million) may lead to major integration issues for the combined entity [Source: Newspaper reports]. In addition to this, iGate had funded the entire acquisition costing USD1 bn through debt and optionally convertible shares.
TTK prestige delisting was withdrawn by management citing capital constraints….
At an average acquisition cost of around 440 by largest shareholder, Patni was trading at around 2x BV. Considering the fact that average post tax ROE of the company during FY02-10 was around 18%, we can consider that it was trading at most at fair value. On the other hand TTK prestige was trading at less than 10x TTM EPS.
Here largest shareholder could make only 18-20%, despite the fact that Patni fundamentals were much better than HSBC Investmart and Elliot Management cooperation was essential for successful delisting of Patni, just like DWS mutual fund in case of HSBC investmart. Average investors return would have been much lower at 6-7%, assuming they acquired shares in Jan/Feb 12 and sold it during RBB process. Even for those, who surrendered shares in RBB, return was merely 10%.
Investors in TTK prestige incurred losses of 30-40% despite the fact that TTK prestige fundamentals were equally good and valuations were not steep either. Now what happened to TTK Prestige could have happened to Patni, infact there were more chances of iGate withdrawing the delisting compared to TTK Prestige. iGate balance sheet was already much stretched because of Patni Acquisition. I don’t know any way in which Investors could have anticipated delisting withdrawl in TTK prestige.
I would like to end this part with some excellent quotes by Charlie Munger and Nassim Taleb
Charlie Munger once said “We care more about thinking about things that have never happened. Think of a 60-foot tidal wave hitting California. Can you imagine?” I think in situations like delisting where returns are quite asymmetric, it’s very important to think about worst case scenario, even if history shows, probability of such events is low.
Nassim Taleb mentions in the book that “Accordingly, I will use statistics and inductive methods to make aggressive bets, but I will not use them to manage my risks and exposure. Surprisingly, all the surviving traders I know seem to have done the same. They trade on ideas based on some observation (that includes past history) but, like the Popperian scientists, they make sure that the costs of being wrong are limited (and their probability is not derived from past data)
At the risk of repeating myself on the importance of considering both the quantum of upside and quantum of downside let me add one more quote from Nassim Taleb ” it is not how likely an event is to happen that matters, it is how much is made when it happens that should be the consideration. How frequent the profit is irrelevant; it is the magnitude of the outcome that counts. It is a pure accounting fact that, aside from the commentators, very few people take home a check linked to how often they are right or wrong.”