December 6, 2006

Postmortem of an arbitrage opportunity

I was analysing a potential arbitrage for Infomedia Limited in april. I posted my analysis here and here.

At the time of analysis the stock was selling at 210. Based on a quick analysis, I felt the intrinsic value for the stock was around 180-190. As the terms of the buyback stated that for any holding greater than 50 shares, the acceptance ratio would be around 14%, I passed the opportunity as I felt that post the buyback, I may not be able to sell the stock at a price higher than the purchase price and I was not comfortable buying and holding the stock at 210.

So how did my thesis play out?

Well my thesis proved to be correct, but I still missed an opportunity as I did not track the stock subsequently. Let me explain,

If I had bought the stock at 210 and attempted to arbitrage, I would have suffered a loss of 16% on my investment (assuming a sale price of the stock at 170 after the close of the buyback on 8th August).

However had I continued to track the stock, there was a buying opportunity in june (see graph above, around 8 – 15th) when the stock traded briefly between 115- 140. A purchase at that price (and sale at 170 after buyback) would have given me an annualised return of 135 %.

So lesson for me is that I need to keep tracking an arbitrage stock till the end of the event to take advantage of any sudden opportunities which may come up.

Additional note: I read a few analysis from some brokerage houses of the above arbitrage and found that the analysis covered only the upside and had no mention of the risk or downside.


arun said...

Hello Rohit,

I could not understand what you are trying to convey in your previous blog.

I had only 50 shares and i opted for the buyback by the company.I bought those shares at 180 and sold it for 245 to the company.During that phase the share value fell to around 115 and now it trades in the range of 135-150.

What do you think about the valuation o this stock.I feel that this stock may give a very good return over a period of time say two years.Also i feel that there is a limited downside.

Please share your views.


Rohit said...

Hi arun
the terms of the offer stated for holding of 50 shares or lower, the acceptance ratio would be 100%. so the arbitrage would work (profits were small though)
my post is valid for holding higher than 50 shares.
my personal view point is that the stock may be fairly valued. ofcourse i go by conservative expectations in terms of performance. if you expect the company to do well then the stock should do well

ValueArchitects said...

Haha, I think you are suffering from deprival superreaction, due to loss of an oppurtunity…. ;)kidding. And sorry for a long reply..

Few facts first. One, cash in hand was (47cash + 37 MFs as on March -06. The entire cash cannot be taken as free cash. So your figure of 126c is incorrect.

Secondly, Macmillan is into soft-bpo kind of servicing operation. They are publishers. On the other hand, Infomedia is a information-bridge. Printing is just incidental to their business - a channel, which is getting eroded due to internet. The 2 businesses profile are different.

Thirdly, a large no of stocks have given fundoo return from may-june.. Isnt it ?

I did some analysis on PE deals, after an article appeared in ET glamorising blueblooded PE guys (and few girls like Renuka Ramnath of ICICI) doing "deals" in india. The deals like Infomedia, PTL, Swaraj Mazda, Pheonix were studied in details.

Now somethings interesting. After arrival of ICICI as owner - the business hasn’t improved. Infact it has gone down operationally. (Fck the mkt, and the ways of PE guys to use it for their benefit).

ICICI-V bot Infomedia in sept 03( then mkt cap was 175c), After bonus in Aug04, mkt cap went to 320c (not bad!). ....... Now was the turn of money lyin in the company's coffers (nearly 80c). ICICI V did buyback - shelling out nearly 80c [=245 x (2.2-1.96c)] ........... In the process, ICICI-V got rid of their 0.19c shares (and earned 46c!!). (some backward calculation shows that they would have tendereed almost their entire stake, so as to make the acceptance 15%). Not bad, Ms Ramanath.

Now chk the performance of the business since past 10 quarters. Fy04 OP was 28c, FY05 was 25c, FY06 14c, H1fy07 8c. The performance has been getting screwed over past 2 years. On the other hand, ICICIV has increased the div/management fees. The hard-headed PE managers are acting not smartly to increase wealth in long-run, but as plunderers in short term. They dont seem to understand taht they might be struck with a dead golden-goose in hand.

Effecting use of capital, Rohit? Well, smarter manager would have done a LBO here, and utilised its unleveraged balance sheet - At the same time, it would have brought the disciple-of-debt on the incumbent management - the way KKR did it.

Next, change in the business economics. The paper biz is getting hit by more and more internet penetration. We dont open up yellow pages for anything now - we just love google!!

Overall, not happy with the performance of the biz or the mgmt. Lots of value accreative/creative things could have done. Do u still think, its is/was/will be good co ever??

Comments invited..

ValueArchitects said...

Heres the article..


Rohit said...

Hi value architect (strange to call someone by that name)

appreciate your comments above. frankly i never looked at infomedia in that detail and liked your insights into their business

i started looking at infomedia mainly as an arbitrage opportunity. On looking at their AR , i could not see the company being undervalued. my typical approach is to look at a company and check if it seems to be undervalued. if yes, then i dig deeper for more facts. if however it seems fairly valued or overvalued i give it a pass. its like looking at something which weighs say 200 kgs (or more) and deciding that i cant lift it. not a very good approach because i may find that my analysis is faulty or i may be missing an opportunity. but i kind of prefer error of ommision than error of commision.

so on looking at the company, i felt that it may not be undervalued at 210 (the price in april) and after the buyback i was not interested in continuing to hold it. so decided to give it a pass.

at 110-130 it may have been a different issue and could be a decent arbitrage opportunity. the 126 cr no. is from the 2005 AR. so you are right , 2006 AR shows much lesser cash.

in case of macmillan, i have been dissapointed with the business results as they have yet to scale their BPO operations and achieve growth (if they are doing it, then its still not visible in the results)

i am not sure that the extent of hit to the publishing business in india would be as high as in the US. eventually yes, but still interest penetration is low in india. so i think the poor perfromance may be more of the managements doing than anything else.